Trusts and Estates

21 April

• Finishing up Problem 2, the ivory tusk. So it's in the gross estate, but what is the fair market value? What a willing buyer would pay a willing seller in an arms-length transaction. Not really helpful in this case... If it's illegal to sell the tusk, maybe its value is zero. But it does have some value. Should we argue for high or low?

  If the estate tax base is under $3.5M, we want high. Otherwise we want low. Note that we're not saying just "the estate," or "the gross estate." It's the estate tax base-- including gifts and stuff.

  So anyway, you have to get this appraised, but you might not want to spend a lot of the estate's money on that (if you're sure the tax base is under 3.5M; note also that this is an administration expense).

• What about fungible items, like shares of stock? You could look at the share price at the time of death. What if someone dies on a weekend? Or what if someone died on 9/13/2001? There are regulations that say what to do with stocks and bonds, and we don't have to worry about them. Just know that they exist.
• As long as we keep things within the range of defensible values, we'll probably be OK. And almost everything has a range of values. And a lot of the time, any valuation is somewhat absurd.
• Blockage = bulk sale = volume discount.
• You can argue that your estate should get a blockage discount or a minority control discount, etc. There's no dispute that those discounts are available, but there's always dispute about how much they should be.
• Problem 3.
  The person has $3.501M. Debts of $3.481M.

  Yes, an estate tax return must be filed: Gross estate + adjusted taxable gift is > $3.5M. You have to file a return, whether or not you'll actually owe taxes.

  So subtract the debts from the gross estate, and then the $10K marital property deduction, and you get an estate tax base of $10K (50% of the deferred marital property).

• Problem 4.
  Assuming this is a legal loan, it looks like this is part of the estate: the principal and the interest. She owns the right to receive that money. Now in families, sometimes there's nothing in writing, so you get disputes. So write stuff down.

  But we can make a valuation argument here. Maybe it's worth less than $3,500: if you put it on the market, a collection agency wouldn't give you that full amount. So in that sense, it's worth less than that. There are brokers (called "factors") who do this, incidentally. If the estate is subject to tax, you would like this lower valuation. Or, maybe we could argue the other way: this is only 8% interest-- you can't get that on the open market right now. You'd pay maybe a little more, if you had confidence that you'd get paid back eventually: this is why bonds don't trade at face value.

  And forgiving the loan in the will makes no difference: it would still be in the estate.

• Problem 5.
  So the suit is an asset. It's going to be hard to value, but for sure it is an asset. Note that some causes of action are extinguished when someone dies, but this isn't one of those. You look at the strength of the case and what the likely recovery is, and you base it on that.

  You can call a law firm, and they'll try to figure out the value. Talk to people that handle discrimination cases. You might be able to argue that it's worth $0, of course.

• Property passing by right of survivorship: § 2040. Problem section C.
• Problem 1
  § 2040(b) says $40K. (between husband and wife has special rules: that's why it's (b)-- the "fractional share rule"). Note that there was a gift in 1985, but it was a gift to a spouse, so there's no consequence.
• Problem 2
  Same as 1. Note, by the way, that whatever value appears in the gross estate here will be offset by the marital deduction. So let it be valued as high as anyone wants.
• Problem 3
  Same as 1, except it's under § 2033: this is not a survivorship arrangement.
• Problem 4
  There was a $20K taxable gift in 1985. And $80K in the gross estate. And this is because we've got the "consideraton furnished" rule (§ 2040(a); (b) is much more common). Here, the decedent furnished all the consideration, so the whole value is in the gross estate (and, had the son died, 0% would be in his gross estate). This is a tax rule only-- it does not change the underlying ownership.

  Why do this? It's a policy decision by congress. Putting your spouse on as a joint tenant accomplishes two things: sharing the property right now, and creating a survivorship interest. But with a non-spouse, the motivation might be different: if you want a non-probate transfer, don't do it this way. So congress decides this is fine to do, but we're going to tax this as a transfer at death, because that's what we think you're trying to do.

  Now we don't add the taxable gift in as well-- that would be double-taxation. Adjusted taxable gifts do not include things already in the gross estate. So here's a place where the estate tax law doesn't line up nicely with the ownership. But that's OK-- you just need to recognize it. So even though it was a taxable gift, it's not an ADJUSTED taxable gift.

  And note that consideration is furnished during life, not valued at death.

• § 2042: Life insurance. The key thing to know is that life insurance is subject to tax (not INCOME tax, but ESTATE tax). So if you have incidents of ownership in a life insurance policy (being able to name the beneficiary, and being able to borrow against it are the main ones), it goes in your gross estate.

  So one clever estate planning technique is to try and create a large life insurance policy and get rid of all the incidents of ownership, so you can avoid the estate tax.

23 April

• For the exam: 1" margin, 10pt type, 2 sides of paper.
• The TWEN site has all the statutory headings, and you can put that in your statute book. You can tab your statutes book.
• Problems 1 and 2 are about gifts: the donors are still alive.
• Problem 1. Gifts have carryover basis.
  • A: $25K
  • B: $25K
  • C: No.
• Problem 2. The only exception to the rule of carryover basis is that you can't gift a loss. If the value of a gift is more than the basis, the basis carries over. If the value is less, you reset the basis down. So the basis is $5/share.

  You can gift a gain. This is a potential way to transfer capital gains to someone in a lower tax bracket.

• Now, basis at death. This is contentious, and people change it sometimes to carryover basis (there was uproar the last time this happened, and so it was repealed).

  So folks say it would be an accounting nightmare to expect the recipient of property at someone's death to know what the basis is. But perhaps that's baloney, and they're only so uptight about it because they think basis is always going to be stepped up. But if the economy continues to suck, people won't like this as much, because they'll inherit assets that rebound after they're inherited.

• Problem 3. Basis is mechanical-- it's just done according to the estate tax treatment. Once you know that, you're in business. So here's the plan: who owns it? is it in the gross estate?
  • A: It's all in D's gross estate. It's 100% D's, and we value it at the time of death. So $200,000.
  • B: D's half gets a new basis, because it was in his gross estate (§ 2033). So that's $100K. S's half remains at $25K.
  • C: We don't actually know that the whole thing is community property, but if there's no information to the contrary, we just assume that everything after 1986 was community property. But if there's no information, then we can say it's community property. But it would be reasonable to maintain that there's some unclassified property in there. So anyway, our best guess is that it's owned by the two of them. So D's half gets new basis (§ 1014 - "usual rule" : that's an acceptable cite for this principle). But now we have § 1014(b)(6): if the decedent's half of community property gets new basis, so does the spouse's. So the new basis is $200,000.
  • D: So this is just like C, but the other spouse dies. So this is just like C.
• As long as an asset is entirely community property, the surviving spouse's basis will always be the same as the decedent's.
• Why is there a special rule for community property? Because historically it was deemed to be more fair (the 1940s). Traditionally, the husband did the earning, and assets were titled in his name. In a common law state, if the husband died, all the property was in his gross estate, and it all got new basis. But in a community property state, he only owned half of it, so only half was in his gross estate, so only half got new basis. So wives in community property got less stepped-up basis. So the solution was to say that both halves would get new basis.

  Of course, this is without regard of whether it's left to the spouse. And today, we have much more sophisticated estate planning, and the "double adjustment" problem is less of an issue.

• Problem 4. Now we're talking about survivorship and when it makes a difference.
  • A: There was a $25K gift in 1985. D died, owned 50%, that half gets new basis (§ 1014 - usual rule). So $75K. Spouse didn't die, and it's not community property, so spouse keeps old basis. So, the basis in the entire property is $100K. Note that this is not marital property because the marital property act doesn't reclassify it.
  • B: D's half gets new basis, just like above. § 1014 - usual rule. Spouse gets new basis because it's community property: § 1014(b)(6). So the basis in the entire property is $150K.
  • C: $75 in each half (the community property rule doesn't care about survivorship). So the total is $150, but we don't know if D's will gives his half to S.
  • D: They each own half, but since D provided the entire consideration, 100% of it is in the gross estate. So that's $150 under § 1014- usual rule.
• In the gross estate = new basis. Community property = new basis for spouse. This is simple.
• Problem 5. This is § 1014(c). No new basis on interest, dividends, rent, or retirement funds. And the fact that this was non-probate makes no different: new basis doesn't care about probate/non-probate.
• Problem 6. This is a true story. These kids inherit a nice asset, but they're going to have to pay a lot of income tax.
  • Keep your house-- you might need it. There are other ways to avoid probate; a revocable trust, for example. The best way to save in taxes is to hold onto the house (there will be no estate taxes due), and give the children the advantage of new basis.
  • § 2036: property is in the gross estate if you give it away and retain substantial control. That's a slam-dunk in this case: tax law doesn't follow property law directly-- even though the property is owned by the kids, the fact that she retains control means she'll be taxed. So it's in the gross estate, and they should try and get an appraiser that will appraise high, because they've got room.
• Problem 7. Another true story.
  • Make my role clear-- as long as there are no secrets, it is probably OK. And put those terms in writing: it's good customer service.
  • Hold onto the apartment building.
• Problem 1. The review problem.
  All the assets listed are in the gross estate.
  • The 100% of the car is in the gross estate ($25K). § 2040(a). Joint tenancy between non-spouses, and D gave 100% of the consideration.
  • The house is also in the gross estate-- nothing about it is a non-probate transfer. So $300K. (note that the probate property is probate property, even though it's going into a trust, because THE WILL says it goes there-- to be non-probate, it would have to already be in the trust).
  • The furnishings also: $10K. This, like the house is under § 2033.
  • Varoom stock: $375K § 2033 again.
  • Life insurance is in: $3.4M under § 2042.
  The $5K trust isn't in the gross estate because it was a gift over which D retained no control.

  So the gross estate totals up to $4,110K.

  Now the deductions.

  • Mortgage: $110K
  • Funeral expenses: $5K
  So we deduct $115K from the gross estate, and we get $3,995K, and that's the taxable estate.