Trusts and Estates

14 April

• So this is sort of a basic introduction to estate taxes; it doesn't assume we know anything much about tax.
• The debate about the estate tax is a big political issue, especially after the 2001 election.
• There's just no way that we're really going to revert to the 2001 law; the most likely thing is to settle at or near the 2009 limits.
• Arguments in favor: it's a tax on the wealthy, and only a very small percentage actually pay estate taxes, and it's not really that much money ($18B or so), and we don't want to establish wealthy dynasties.
• If we raise the exemption to $5M, only about 700 estates would have to pay taxes, and we'd still collect $12B.
• It's rare for anyone to actually pay the whole tax.
• Arguments against: unfair tax on the dead, it's on money that's already been taxed, it might sap initiative (because people won't be able to keep their money in the family), it might affect farms and small businesses (organizations with little liquidity, whose assets are tied up in a way that can't easily be divided).
• Horn v. Peckham: if you can't handle a matter with reasonable skill and care, and if you don't refer to a specialist, you could well be liable (held to the standard of a specialist). This is why you need an intro to tax: it's unavoidable, and your clients will come after you if they need to write a check to the government.
• Basis (income tax) and estate tax are interrelated, and we are going to see that a few times. Basis is an income tax term for the starting point from which gains and losses are measured. It's often called "cost basis," but that's not a legal term-- and it's problematic-- so don't say that.
• If you die, you get new basis in most assets according to the treatment under the estate tax. Regardless of whether you pay estate tax, or how much assets you've got, etc. But this is a big deal if you get something in a will, and then you go to sell it: the basis is (generally) whatever it would be valued at under the estate tax.
• With a gift during life, generally you have "carryover" basis: the same basis that the donor had.
• So there's one interesting implication for estate planning, regardless of whether your client will be paying estate tax or not. The estate tax affects everyone, in that sense.
• Sometimes the "new basis" is called "step-up basis." Do not call it that: that's just a nickname... it could just as easily step down.
• WI has no gift or estate tax. At this time.
• A gift must be a gift of a present interest (i.e., it is given at the same time it is received). A gift must be outright. The alternative is some kind of deferred gift (e.g., a trust). So the $13K annual exclusion only applies to gifts.
• Not all gifts count: tuition/medical paid directly to provider
• So. Suppose you are given $60K this year. You take the $13K annual exclusion out of there. There's a taxable gift of $47K, then. And what if your sister gets an $83K gift? That's $70K taxable. If the donor was the same, then that person has made $117K in taxable gifts. You don't actually have to pay a gift tax until you get up to $1M. It's pretty rare to go over that mark, but if you do, the tax is due when your income tax is due. And whatever amount you use of that $1M becomes part of your $3.5M exemption at death.

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• So the $13K exemption replenishes every year-- it's a huge freebie. The $1M sticks with you, though.
• Problem 1A:
  1. § 2503(e): just pay tuition directly to the institution.
  2. Use marital property (two gifts of $8K each) § 2503(b)
  3. Spread it over 2 years
  4. Use individual property, but use gift-splitting for tax purposes: § 2513 (i.e., spouse agrees to file a gift tax return showing consent to split the gift). This is different from #2, where the gift is made together out of property jointly owned.
  5. Just dump it in a joint account and write a check (i.e., give half to the spouse); same as #2, but the property can be individual in origin, and you don't have to do the paperwork of #4
• For the exam, no need to cite tax statutes so precisely (unless they've been a big deal in class). § 2503 is the one where the gift exemptions are outlined.
• Problem 1b: give all $16K and report $3K as a taxable gift.
• Problem 2: So the donor has really given this away, but the child might not get it until as late as 2019. So this is a gift of a future interest, which means that the annual exemption doesn't apply. § 2503(b) is only for gifts of a present interest. But § 2503(c) might help: there's an exception to the present interest rule if you pay out the trust when the beneficiary is 21, you get the $13K exclusion. So we'd need to change the date here: as the problem states it, the trust will run to age 21 + 1 week. And we also can't make restrictions on it (like "has to be used for education"). So you'd have to change the letter of the trust, but you could make your wishes known to the trustee, so even though there's no legal restriction, your will might still be obeyed.
• Lots of times clever tax lawyers want to be able to give money to kids in trust, and not have it accessible at 21. There are two strategies for creating a phantom present interests. They're kind of stupid, but courts have blessed them.
  1. A Crummey trust. Put money into a trust for a 5-year-old, and the terms say that the money can be withdrawn within 30 days by the trustee. That's a present interest, but it vanises. This is under § 2503(b). Of course, the down side is that you have to give notice every time the trust is funded (often this is annually). So it's cumbersome.
  2. § 2503(c). Say that at 21, the kid has the right to demand payment for 30 days. Again, that's a present interest. But you then educate the kid about why they shouldn't do that. This is a Minority Trust, and you're basically betting you can convince a future 21-year-old to do something you want.

16 April

• The gift tax credit is cumulative and integrated with the estate tax.
• There are two ways to have a present interest for gifts:
  1. § 2503(b). When the owner gives up dominion and control (not when it arrives at the recipient).
  2. § 2503(c). Transfer to someone under 21, in trust, no substantial restrictions.
  There are ways around this: the Crummey power, and just a plain old Minority Trust.
• All the gift statutes are in § 2500 (so disclaimer, e.g., is in 2518). § 2000 is the estate tax. Income tax is §§ 1-1999 (so basis is in 1014).
• The only difference between a gift of a present interest and a gift of a future interest (for gift tax purposes) is that the first $13K of a present interest doesn't count against their $1M lifetime gift exemption.
• Note that the law doesn't give you a $1M exemption; it's an exemption for the TAX on $1M. For people who aren't actually paying, it makes no difference. (so, estate tax: $1,455,800; for gift tax: $345,800). It's not a big deal, but the point is that it's measured not in terms of the value of the gift, but in terms of the tax on the value of the gift.

  It's the exact same thing, as long as you're not paying tax. If you ARE, however (p. 7), the estate and gift taxes are progressive: the first $10K is at 18%, the next $10K is at 20%, and so on up to 45%. So the exemption covers taxes that would be paid a the lower rate. In other words, if you're paying this tax, you're going to be paying it at the higher rate.

  So if you go over the $1M limit by $1, you pay tax on that $1 at 41%.

• Don't speak of basis for estate tax purposes. When the decedent dies, there are estate tax consequences, but basis is irrelevant. Later, when the recipient of property from the state wants to sell an asset, it might be subject to income tax. We need a starting point from which to measure gain or loss-- that's the basis. Basis in many assets received by reasons of someone's death is based on the way the estate was taxed.
• Now, being smart people, when we are helping people with estate tax issues, we'll look one move ahead, and try to minimize basis problems in the future. So they are separate issues, but they are interrelated.
• As a result, if someone is actually going to pay estate tax, they want it to be as low as possible. Because the tax is based on what the items in the estate are worth, they want them to be valued as lowly as possible (and valuation is often not obvious for non-monetary assets).
• Now, 99% of people are not paying tax. So why do we care about this? Because we're not just determining what estate tax we pay: we're also determining the basis of the assets, and the recipient wants the basis to be as high as possible. If you're in the 1% that have to pay, you make the value as low as possible: this is an imposition on the recipients, but their income tax will be at a lower rate than 45%. And the rule is: we would always prefer to pay less tax in the future than more tax now. On the other hand, if you're in the 99%, you make the value as high as you can, thereby conferring a benefit on the recipients (for tax purposes, losses will seem larger and gains will seem smaller).
• Post-it note for p. 24. This page is an extremely important summary. This is the first page in section 3 of the statutes.
• Plusses are things that are added up to form the gross estate. The first column is the statutory number. And some things you've tried to get out of your estate might come back into it for tax purposes. This can be excellent news, if no estate tax is due: you get new basis, and no tax.
  • 2033: property owned at death. This has a special meaning: probate property.
  • 2035: transfers of "exploding assets" like life insurance (not just changing the beneficiary) within three years of death. We shouldn't see this in this course.
  • 2036: transfers with retained life estate/use/control.
  • 2037: we're not worrying about this one.
  • 2038: revocable transfers (POD bank accounts, transfer on death deeds, etc). Non-probate transfers that are revocable (revocable living trusts).
  • 2039: annuities and employee benefits-- these could just as easily have been under 2038. Beneficiary on your retirement plan doesn't keep the retirement plan from being taxed.
  • 2040: property passing by right of survivorship JTWROS, etc.
  • 2041: we skip this one
  • 2042: life insurance. It's not subject to income tax, but it is subject to estate tax.
  • 2043: beyond the scope of this course.
  • 2044: beyond the scope of this course.
• Know the following: 2033, 2026, 2038, 2039, 2040, 2042
• Pretty much anything that people own or control will fall into one of those categories for the gross estate.
• Now we go on to deductions.
  • 2053: three things (this is kind of a "fairness deduction"). administration expenses, debts, and funeral expenses.
  • 2054: casualty losses
  • 2055: charitable deduction
  • 2056: marital deduction (transfers to surviving spouse)
  • 2057: deduction for state estate or inheritance taxes paid
• 2055 and 2056 are either very simple or very complex. It's simple if it's an outright transfer (I leave $100K to the American Red Cross Dane County Chapter). Simple. Spouse gets house as survivorship marital property: outright. I leave this to my spouse as long as she doesn't get remarried: trouble. Any strings attached or conditions make it complex.
• So there are two marital deductions: one for lifetime gifts (2523?) and then the estate tax one (2056).
• Adjusted taxable gifts: this all the taxable gifts minus any that are already counted in the gross estate.
• So! Whether or not you pay an estate tax depends on your estate tax base: the gross estate minus the deductions plus the adjusted taxable gifts. You can have a huge gross estate, and still not pay any estate tax.
• Now we apply the tax rate schedule, and we get the tentative estate tax. Even this is not the tax, because we get to apply our credits.
• Credits now! Really there's one big one we need to know about
  • 2010: Unified estate tax credit: 1,455,800. For 99% of the people, this gets them to $0.
  • We won't see the other credits in this class.
• Phew. Now we've got our tax.
• So. Property owned at death. The basic rule here is that we use fair market value at the date of death when evaluting property (what a willing buyer would pay a willing seller in an arms-length transaction). Every once in a while, we'll have "alternate valuation:" exactly 6 months after someone dies, you can re-value all the assets, if you're actually paying a tax and all the values have gone down. It's a big deal right now, because we're in a period where large assets may be way down. This is another fairness notion: we don't want people to be burdened with disposing of estates the moment the decedent dies (which they'd have to do, if the market were plummeting), so that there's not more tax than there are assets, basically.

  The 6-month deal is very serious. An extra day and you're shafted, and a fiduciary who has failed to protect the family assets should be prepared for a lawsuit.

• Problem 1
  • A. The house is probate property, but it's marital. It's worth $90K, and he owns 50%. And there's an $80K mortgage, but THAT DOES NOT MATTER: the assets in the gross estate are valued at fair market value. The mortgage is a debt-- a deduction. It works out to $5K in the end, but 50% of the house's VALUE is includable in the gross estate.
  • B. This is the same as part A.
  • C. $90K: the whole value of the house.
  • D. Same as A and B.
  • Now, the house was stipulated to be $90K, but nobody stipulated to what half the house was worth. We value this based on a fair market transaction: what's the value of half a house on the fair market? There might be a discount for lack of control or lack of marketability: it's virtually impossible to sell half a house for what it's worth. What should we do about this? Depends on what else is in the estate: if we're paying tax, we might want that discount. If there's no tax or the whole asset is going to the spouse, we don't want to beat down the value.
• Problem 2. So the tusk would have a value of $5K if it were to be sold, but it's not going to be sold. Clearly this is a piece of probate property, so it is in the probate estate. But what's the fair market value of a souvenir that might even be illegal to sell? It's irrelevant that it was acquired for $5: we are concerned about fair market value today. So how do we value it? Well we argue for high, if we're not going to be paying tax, and we argue for low if we're paying tax.