fundamentals of gift tax

Electronic copy available at: http://ssrn.com/abstract=2212313

FUNDAMENTALS OF GIFT TAX

Mark E. Powell

Albrecht & Barney

1 Park Plaza, Suite 900

Irvine, California 92614

(949) 263-1040

[email protected]

Andrea Kushner Ross

Karlin & Peebles, LLP

8383 Wilshire Boulevard, Suite 708

Beverly Hills, California 90211

(323) 852-0039

[email protected]

Electronic copy available at: http://ssrn.com/abstract=2212313

TABLE OF CONTENTS Page

i GIFT TAX JOINT 11-5-12.docx

ARTICLE I HISTORY OF THE GIFT TAX ...................................................................... 1

ARTICLE II 2011 TAX ACT ............................................................................................ 4

2.1 OVERVIEW ...................................................................................................... 4

2.2 GIFT TAX PROVISIONS OF THE 2011 TAX ACT ........................................... 4

2.3 THE GIFT TAX RATE ....................................................................................... 5

2.4 PORTABILITY................................................................................................... 5

ARTICLE III WHAT IS A GIFT? ...................................................................................... 7

3.1 “GIFT” DEFINED ............................................................................................... 7

3.2 ELEMENTS OF A GIFT .................................................................................... 7

3.3 GIFT TAX PAYABLE BY DONOR .................................................................. 15

ARTICLE IV THE DONOR ............................................................................................ 17

4.1 NATIONALITY OF THE DONOR .................................................................... 17

4.2 COMMUNITY PROPERTY, JOINT TENANCY AND TENANCIES IN COMMON ....................................................................................................... 18

4.3 GIFT SPLITTING ............................................................................................ 18

4.4 INDIRECT TRANSFERS ................................................................................ 19

4.5 CORPORATE GIFTS ...................................................................................... 19

4.6 SETTLEMENT OF DISPUTE .......................................................................... 20

ARTICLE V INCOMPLETE GIFTS AND GIFTS WITH RETAINED INTERESTS ......... 21

5.1 INCOMPLETE GIFTS ..................................................................................... 21

5.2 POWERS THAT DON’T MAKE A TRANSFER INCOMPLETE ....................... 22

5.3 COMPLETION OF INCOMPLETE GIFT ......................................................... 23

5.4 TRANSFERS WITH RETAINED INTERESTS ................................................ 23

ARTICLE VI VALUATION OF GIFTS ........................................................................... 28

6.1 GENERAL CONCEPTS .................................................................................. 28

6.2 PUBLICLY TRADED STOCKS AND BONDS ................................................. 29

6.3 CLOSELY HELD BUSINESS INTERESTS ..................................................... 30

6.4 PARTIAL INTERESTS .................................................................................... 37

6.5 LIFE INSURANCE AND ANNUITIES .............................................................. 38

6.6 BELOW-MARKET INTEREST RATE LOANS ................................................ 39

6.7 ENCUMBERED GIFTS ................................................................................... 41

6.8 VALUATION PENALTIES ............................................................................... 41

ARTICLE VII EXCLUSIONS FROM GIFT TAX ............................................................ 43

TABLE OF CONTENTS (continued)

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7.1 EXCLUSIONS GENERALLY .......................................................................... 43

7.2 ANNUAL EXCLUSION GIFTS ........................................................................ 43

7.3 TUITION AND MEDICAL CARE ..................................................................... 45

7.4 GIFTS TO MINORS ........................................................................................ 46

ARTICLE VIII MARITAL DEDUCTION ......................................................................... 47

8.1 UNLIMITED MARITAL DEDUCTION .............................................................. 47

8.2 TERMINABLE INTEREST RULE .................................................................... 47

8.3 EXCEPTIONS TO TERMINABLE INTEREST RULE ...................................... 47

8.4 DONEE SPOUSE NOT U.S. CITIZEN ............................................................ 49

8.5 IRC SECTION 2519 – TRANSFER OF INCOME INTEREST ......................... 49

ARTICLE IX CHARITABLE DEDUCTION .................................................................... 50

9.1 AMOUNT OF DEDUCTION ............................................................................ 50

9.2 GIFTS OF PARTIAL INTERESTS .................................................................. 50

9.3 GIFT TAX RETURNS FOR CHARITABLE GIFTS .......................................... 51

ARTICLE X GENERATION SKIPPING TRANSFER TAX ............................................ 52

10.1 OVERVIEW .................................................................................................... 52

10.2 RELATIONSHIP TO GIFT TAX ....................................................................... 52

10.3 TYPES OF GENERATION SKIPPING TRANSFERS ..................................... 52

10.4 GENERATION-SKIPPING TRANSFER TAX RATE ....................................... 54

10.5 DEFINITION OF “TRANSFEROR” .................................................................. 55

10.6 SKIP PERSONS VS. NON-SKIP PERSONS .................................................. 56

10.7 GENERATION ASSIGNMENTS ..................................................................... 57

10.8 EXCLUSIONS FROM GENERATION-SKIPPING TRANSFER TAX .............. 58

10.9 EFFECT OF DISCLAIMERS ON GENERATION-SKIPPING TRANSFER TAX ............................................................................................. 59

10.10 ALLOCATION OF GST EXEMPTION ............................................................. 59

10.11 SAMPLE NOTICE OF GST ALLOCATION ..................................................... 60

ARTICLE XI COMPUTATION OF GIFT TAX ............................................................... 61

11.1 STEP 1 – COMPUTATION OF TAX IN CURRENT YEAR AND PRIOR YEARS ............................................................................................................ 61

11.2 STEP 2 – SUBTRACTION OF PRIOR TAX PAID .......................................... 61

11.3 STEP 3 – APPLICATION OF UNUSED GIFT TAX CREDIT .......................... 61

TABLE OF CONTENTS (continued)

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11.4 EXAMPLE ....................................................................................................... 61

ARTICLE XII GIFT TAX PROCEDURE ........................................................................ 63

12.1 GIFT TAX RETURNS ..................................................................................... 63

12.2 TIME TO FILE ................................................................................................. 64

12.3 PAYMENT OF TAX ......................................................................................... 66

12.4 STATUTE OF LIMITATIONS .......................................................................... 67

ARTICLE XIII COMMON GIFT STRATEGIES .............................................................. 69

13.1 IRREVOCABLE LIFE INSURANCE TRUST ................................................... 69

13.2 QUALIFIED PERSONAL RESIDENCE TRUST .............................................. 69

13.3 GRANTOR RETAINED ANNUITY TRUST/GRANTOR RETAINED UNITRUST ...................................................................................................... 70

13.4 SALE TO INTENTIONALLY DEFECTIVE GRANTOR TRUST (“IDIT”) .......... 71

ARTICLE XIV PRESIDENT OBAMA’S FEBRUARY 2012 BUDGET PROPOSAL ...... 72

14.1 INTRODUCTION ............................................................................................ 72

14.2 RESTORE 2009 ESTATE, GIFT AND GSTT TAX REGIME .......................... 72

14.3 REQUIRE CONSISTENCY IN VALUATION ................................................... 72

14.4 MODIFY RULES ON VALUATION DISCOUNTS ........................................... 73

14.5 REQUIRE MINIMUM TERM FOR GRANTOR RETAINED ANNUITY TRUSTS ......................................................................................................... 73

14.6 LIMIT DURATION OF GSTT EXEMPTION .................................................... 74

14.7 COORDINATE INCOME AND TRANSFER TAX RULES APPLICABLE TO GRANTOR TRUSTS ................................................................................. 74

1 GIFT TAX JOINT 11-5-12.docx

ARTICLE I

HISTORY OF THE GIFT TAX

The first federal gift tax was enacted in 1924.1 Although its opponents labeled it

a direct tax and argued that it amounted to a deprivation of property without due

process, the U.S. Supreme Court sided with the government and upheld the tax.

However, in 1926, Congress repealed the tax because, according to the Senate

Finance Committee, the tax generated relatively small revenue, taxpayers could easily

evade it, and there would be administrative difficulties in administering it.2

In 1932, the U.S. Supreme Court decided that gifts made within 2 years of death

were not necessarily includible in the donor's gross estate for estate tax purposes.3

Fearing that taxpayers would avoid the estate tax by making close-to-death gifts,

Congress enacted a new gift tax,4 which was meant to supplement both the estate tax

(by avoiding close-to-death gifts) and the income tax (by limiting a taxpayer's right to gift

income-producing property to family members who would pay income tax at lower

rates). This gift tax included a $30,000 lifetime exemption (compared to a $60,000

estate tax exemption), and its rates were three-fourths the corresponding estate tax

rates.

A savvy taxpayer took advantage of the lower gift tax rates and reduced his

overall transfer tax liability by making lifetime gifts, which in turn reduced his estate for

estate tax purposes. In 1976, Congress addressed this by combining the estate and gift

tax rates onto a single rate schedule, and taxpayers received a “unified credit” against

1 Revenue Act of 1924, P.L. 68-179.

2 S. Rep. No. 52, 69th Cong., 1st Sess. 9 (1926).

3 Heiner v. Donnan, 285 U.S. 312 (1932).

4 Revenue Act of 1932, P.L. 72-154.


the estate and gift taxes.5 This credit was phased in over five years, and after 1980,

taxpayers had a $47,000 unified credit against the taxes.

The Economic Recovery Act of 19816 brought several major changes to the gift

tax. Among other things, the unified credit was increased over six years to $192,800,

and the maximum tax rates (applicable to estates over $2,500,000) were reduced from

70% to 50%. In addition, the unlimited marital deduction (for both taxes) was

introduced.

The Tax Reform Act of 19847 introduced § 7872 and the concept that certain

below-market loans included a gift equal to the amount of foregone interest.

The Technical and Miscellaneous Revenue Act of 19888 imposed greater tax

implications for transfers to non-citizen spouses and introduced § 7520, which still says

that value of any annuity, life interest, term-of-years interest, remainder interest or

reversionary interest must be determined using tables based on an interest rate equal to

120% of the federal midterm rate.

The Improved Penalty Administration and Compliance Tax Act, part of the

Omnibus Budget Reconciliation Act of 1989,9 introduced penalties for tax underpayment

due to incorrect valuation.

The Omnibus Budget Reconciliation Act of 199010 introduced Chapter 14 and the

value rules under § 2701 for intrafamily transfers.

5 Tax Reform Act of 1976, P.L. 94-455.

6 P.L. 97-34.

7 P.L. 98-369.

8 P.L. 100-647.

9 P.L. 101-239.


The maximum estate and gift tax rates were raised to 55% on estates over

$3,000,000 in the Revenue Reconciliation Act of 1993,11 which also imposed a 5%

surtax was imposed on large estates.

The Taxpayer Relief Act of 199712 imposed some significant changes to the gift

tax. The amount a taxpayer could protect using the unified credit was increased over

nine years to $1,000,000. The adequate disclosure rules (discussed in detail below)

were introduced. Section 7477 created a Tax Court declaratory judgment mechanism

for challenging the Service’s determination of the value of a gift.

Fundamental estate and gift tax changes were introduced in the Economic

Growth and Tax Relief Reconciliation Act of 2001 (“EGTRRA”).13 These are discussed

in detail below along with the Tax Relief, Unemployment Compensation

Reauthorization, and Job Creation Act of 2010.

(Footnote Continued from Previous Page.) 10 P.L. 101-508.

11 P.L. 103-66.

12 P.L. 105-34.

13 P.L. 107-16.


ARTICLE II

2011 TAX ACT

2.1 OVERVIEW

(a) EGTRRA

(1) EGTRRA increased the estate tax exemption from $675,000

in 2001 to $3,500,000 in 2009. In addition, the maximum estate, gift tax and

generation-skipping transfer tax rate, which was 55% in 2001, was gradually reduced to

45% by 2009.

(2) Under EGTRRA, the estate tax and generation-skipping

transfer tax was repealed in 2010, but a decedent’s assets were subject to carry-over

basis with limited step-up. The estate tax was scheduled to be restored in 2011 with a

$1 million exemption (IRC Section 2010 “applicable exclusion amount”) per person and

a 55% tax rate.

(b) The Tax Relief, Unemployment Insurance Reauthorization, and Job

Creation Act of 2010 (the “Tax Relief Act”) was signed into law by President Obama on

December 17, 2010.

(c) Tax Relief Act sets the gift tax, estate tax and generation-skipping

transfer tax exemption at $5 million per person (indexed for inflation) and a 35% tax

rate.

(d) Under the Tax Act, estates of descendants dying in 2010 have two

choices:

(1) Remain in the estate tax regime and pay estate tax at a 35%

tax rate for estates greater than $5 million, OR

(2) Elect into the carry-over basis regime, which means the

estate will not be subject to estate tax. However, the estate will not receive an unlimited

basis step up in estate assets. Basis will be allocated in a new form, Form 8939.

2.2 GIFT TAX PROVISIONS OF THE 2011 TAX ACT

(a) The gift tax exemption remains $1 million in 2010.


(b) Starting January 1, 2011, the gift tax exemption is “reunified” with

the estate tax exemption and increased to $5 million.

2.3 THE GIFT TAX RATE

The gift tax rate for 2010, 2011 and 2012 is 35%.

2.4 PORTABILITY

(a) The Tax Act provides for gift and estate tax exclusion “portability”

between spouses, by allowing the surviving spouse to inherit a “Deceased Spousal

Unused Exclusion Amount” (“DSUEA”) that can be applied to shelter both the survivor’s

gifts and taxable estate. The survivor could therefore have a $10,000,000 gift and

estate tax exclusion because the full exclusions of both spouses can be used by the

survivor.

(b) The Tax Act14 amends IRC § 2010(c)(2) to provide that the

“Applicable Exclusion Amount” which a person can exclude from transfer taxes in 2011

and 2012 is now the sum of his Basic Exclusion Amount (the portion of the $5 million

exemption not used against lifetime gifts), plus the DSUEA.

(1) The Basic Exclusion Amount is a new term under the Tax

Act, which represents the inflation adjusted amount which was previously simply

referred to as the “Applicable Exclusion Amount” (or AEA). The DSUEA is also a new

term, which is defined at new IRC § 2010 (c)(4)(B) as being the unused Basic Exclusion

Amount of the “last deceased spouse.”

(2) The DSUEA is available only from the “last deceased

spouse”, thus preventing a particular individual who has survived multiple husbands

from “accumulating” DSUE amounts from each husband. In the context of remarriage,

the calculation of the DSUEA is based only upon the Basic Exclusion Amount of the last

14 See § 303(a) of the Tax Act.


deceased spouse, rather than the full “Applicable Exclusion Amounts” of the last

deceased spouse.

(3) Since the Applicable Exclusion Amount under the new law is

comprised of two components (the Basic Exclusion Amount, plus the new DSUEA) and

the definition of DSUEA itself references only the Basic Exclusion Amount, the portion

that is effectively excluded from the definition is the DSUEA of that person’s previously

deceased spouse if she survives more than one spouse. This has the result of

preventing any DSUEA that a wife had available from her first husband carrying over

(upon her death) to her second husband.

(4) New IRC § 2010(c)(4)(B)(i) instead references only the Basic

Exclusion Amount, so any amount carried over to the second husband does NOT

include any DSUEA received by the wife from a previous first husband.

(c) There are significant limitations and technical issues with the new

portability provisions:

(1) The law creating portability will expire in 2013.

(2) An estate tax return must be filed at the first death in order

for the surviving spouse to claim the unused exclusion even if there is little or no taxable

estate.

(3) There is no inflation adjustment for the unused exclusion.

(4) The DSUEA allowance is helpful only if both spouses die

between January 1, 2011 and December 31, 2012.


ARTICLE III

WHAT IS A GIFT?

3.1 “GIFT” DEFINED

(a) The gift tax is imposed on the “transfer of property by gift.”15 “Gift” is

defined very broadly to include “any transaction in which an interest in property is

gratuitously passed or conferred on another, regardless of the means or device

employed.”16

(b) The gift tax was intended to be comprehensive. When the gift tax

was reinstated in 1932, Congressional committee reports document this intention.

According to these reports, the term “property” was used in the “broadest and most

comprehensive sense” to “reach every species of right or interest protected by law and

having an exchangeable value,” and the term “transfer by gift” was meant to include

every transaction in which “property or a property right is donatively transferred or

conferred upon another, regardless of the means of the device employed in its

accomplishment.”17

3.2 ELEMENTS OF A GIFT

(a) Transfer for Less than Adequate and Full Consideration

The gift tax is meant to complement the estate tax by preventing depletion

of a taxpayer’s estate through tax-free transfers.18 If property is transferred for less than

15 IRC § 2501(a)(1).

16 Treas. Reg. § 25.2511-1(c).

17 H.R. Rep. No. 708, 72nd Cong., 1st Sess. 27 (1932); S. Rep. No. 665, 72nd Cong., 1st Sess. 39 (1932).

18 Harris v. Comr, 340 U.S. 106, 107 (1950).


adequate and full consideration in money or money’s worth, the excess of the value of

the transferred property over the value of the consideration received is a gift.19

The consideration received by a transferor may be either tangible or

intangible, but the consideration must be measurable in money or money’s worth.20

Consequently, the following are not consideration for purposes of the gift tax:

(1) A promise of love or affection or a promise to marry;21

(2) A promise to graduate from college;22

(3) A parent’s support obligation;23

(4) A divorce settlement, including child support payments;24

and

(5) Settlement of a lawsuit.25

(b) Donative Intent is Not Required

Early on, the U.S. Supreme Court ruled that donative intent is an “elusive”

state of mind and that the gift tax turns on the more workable external test of transfers

for less than adequate and full consideration.26 The tax is based on the objective facts

19 IRC § 2512(b).

20 Treas. Reg. § 25.2512-8.

21 Treas. Reg. § 25-2512-8; Comr v. Wemyss, 324 U.S. 303, 308 (1945).

22 Rev. Rul. 79-384, 1979-2 C.B. 344.

23 Hooker v. Comr, 10 T.C. 388 (1948), aff’d, 174 F.2d 863 (5th Cir. 1949). Cf. Wiedemann v. Comr, 26 T.C. 565 (1956) (payments for support of adult child were taxable gifts).

24 IRC § 2516; Treas. Reg. § 25-2516-1.

25 Noland v. Comr, T.C. Memo 1984-209.

26 Comr. v. Wemyss, 324 U.S. 303, 306 (1945).


of the transfer and the circumstances under which it is made, not on the subjective

motives of the donor.27

Although donative intent is not required to create a gift, lack of donative

intent can prevent a transfer from being deemed a gift. Transfers made in the ordinary

course of business are a common example. Sometimes, a transfer is made in a

business setting for less than adequate and full consideration, but these bad bargains

do not result in gifts if the transfer is (1) bona fide, (2) at arm's length, and (3) free from

donative intent.28

(c) Part Gift, Part Sale Transactions

As noted above, where unrelated parties engage in an arm's-length

transaction in which one party receives more value than the other, there should be no

gift. But where related parties (or any others not dealing at arms' length) engage in

such a transaction, the transaction is treated as part gift and part sale.29 In such a

transaction, a gift occurs in an amount equal to the excess of the value of the property

transferred and the value of the consideration received. A common example is the

transfer of encumbered property. To the extent the donor is relieved of liability on the

debt (i.e., the donee assumes the liability), a gift results.30 Since relief of indebtedness

causes income tax ramifications, it should not be a surprise that the same transaction

can have gift tax implications.

27 Treas. Reg. § 25.2511-1(g)(1).

28 Treas. Reg. § 25-2512-8.

29 IRC § 2513(b).

30 Treas. Reg. § 25.2512-8.


(d) Exercise or Release of Power of Appointment

If a taxpayer has a power of appointment over property, his exercise – or

in some cases release – of that power may result in a gift of the property.31 The term

"power of appointment" is not defined in the IRC, but the gift tax regulations and IRS

rulings assimilate common law definitions and show that the term includes any

"authority . . . to designate recipients of beneficial interests in property" and all powers

that enable the taxpayer to determine to whom or to what extent a beneficial interest will

pass.32 Under Regulation § 25.2514-1(b), the following are examples of powers of

appointment:

(1) A beneficiary's unlimited right to consume principal;

(2) A beneficiary's power to affect the beneficial enjoyment of a

trust by altering, amending, revoking or terminating the trust; and

(3) A person's power to remove a trustee and appoint himself as

the trustee if the trustee has the right to benefit under the trust (and the Service has

asserted33 that such a trustee makes a gift to the remainder beneficiaries upon

resignation because he has given up his own interest in the trust).

Certain administrative powers are not powers of appointment under

§ 2514, including: a power to amend only the administrative provisions of a trust;

management powers exercisable in a fiduciary capacity; and a beneficiary's right to

approve accountings by a trustee (thereby relieving the trustee of continuing obligation

with respected to reported transactions).

The following terms are important:

31 Always check whether a power of appointment was created before or after October 21, 1942, because very different rules apply to powers created after that date. This text focuses on powers created after that date.

32 Restatement (Second) of Property § 11.1 cmt. a (1986).

33 Rev. Rul. 79-421, 1979-2 C.B. 347.


(1) General Powers of Appointment – a power that may be

exercised for the powerholder's direct or indirect benefit in that it may be exercised in

favor of the powerholder, his creditors, his estate, or the creditors of his estate;34

(2) Powers Limited by Ascertainable Standards – even if a

powerholder can exercise a power for his or her benefit, the power is not a general

power of appointment if its exercise is "limited by an ascertainable standard relating to

the health, education, support or maintenance of the possessor;"35

(3) Joint Powers – a power is not a general one if it must be

exercised either in conjunction with the creator of the power36 or in conjunction with a

person having a substantial interest in the property37 that will be adversely affected by

an exercise of the power in favor of the powerholder; and

(4) Special Powers – a power is not a general one if it is

exercisable only in favor of one or more designated persons or classes of persons other

than the powerholder, his estate, his creditors, or the creditors of his estate.38

34 IRC § 2514(c).

35 IRC § 2514(c)(1). Although Regulation § 25.2514-1(c)(2) allows for some variation in language concerning the ascertainable standards ("support in reasonable comfort," "maintenance in health and reasonable comfort," and even "medical, dental, hospital and nursing expenses and expenses of invalidism" are acceptable), use of the words "welfare," "enjoyment," and "happiness" will make a power of appointment a general one. See, e.g., Miller v. U.S., 387 F.2d 866 (3rd Cir. 1968). And even though "comfort" is used in the example in the Regulation, it should be avoided. Id. In all likelihood, use of "emergency" will cause a power to be a general one. Sowell Est. v. Comr., 74 T.C. 1001 (1980).

36 IRC § 2514(c)(2).

37 Treas. Reg. § 25.2514-3(b)(2) requires the joint powerholder have an interest in the property that is "not insignificant," and the Tax Court has written that there must a possibility that the joint powerholder may, presently or in the future, personally benefit from the property. Towle's Est. v. Comr., 54 T.C. 368 (1970).

38 Treas. Reg. § 25.2514-1(c)(1).


State law may impose formalities on the "exercise" of a power of

appointment,39 but generally a taxpayer is deemed to have exercised a power when he

takes any action meant to designate recipients of beneficial interest in property. A

power is deemed exercised even though the disposition cannot occur until a future

event (for example, the powerholder's death) if the exercise is irrevocable and the

disposition is not impossible at the time of the exercise. For example, a beneficiary's

execution of instructions directing the distribution of assets after his death is an

"exercise" if the instructions are irrevocable.

A "release" of a power of appointment may occur indirectly.40 In fact, they

usually occur indirectly, and they are often based on particular circumstances. If, for

example, a taxpayer holds a general power of appointment over a trust holding shares

of a closely held corporation and consents to a recapitalization that reduces the value of

the shares, then he has released his power of appointment based on the reduction in

value.41

The "lapse" of a general power of appointment may be treated as a

taxable release of the power. The operation of an irrevocable life insurance trust

provides a common example of a lapse. These trusts often include withdrawal powers

by which a gift in trust qualifies for the annual gift tax exclusion. For a limited period of

time each year, each beneficiary has a noncumulative right to withdraw a proportion of

the assets contributed to the trust. When the withdrawal period ends, all withdrawal

rights lapse. Typically, this would amount to a release of the withdrawal rights and a gift

(from the current beneficiaries to the remainder beneficiaries or even among the current

beneficiaries). However, IRC § 2514(e) specifically provides that the lapse of such a

right is not considered a release if the value of the assets actually affected does not

39 Treas. Reg. § 25.2514-1(d).

40 Treas. Reg. § 25.2514-1(b)(2).

41 Rev. Rul. 86-39, 1986-1 C.B. 301.


exceed the greater of $5,000 or 5% of the aggregate value of the assets subject to the

withdrawal right.

Generally, only general powers of appointment give rise to taxable gifts,

but in certain circumstances special powers can result in taxable gifts. If a special

power is exercised to create another power of appointment and if local law provides that

the rule against perpetuities begins on the creation of the new power of appointment,

then the exercise is treated as if it were an exercise of a general power of

appointment.42 This specific statutory provision was meant to prevent property from

passing through generations of beneficiaries without ever being subject to the estate

tax.43 It only applies in states that have extended their rule against perpetuities period

or extinguished the rule altogether. Consequently, it is sometimes called the "Delaware

Tax Trap."

(e) Disclaimers

A taxpayer can renounce unwanted gifts, bequests, and powers without

adverse gift tax implications through the disclaimer mechanism set forth in IRC § 2518.

If the disclaimer is a "qualified disclaimer," then the disclaimer causes the transfer to be

treated as a transfer from the original donor (not the person making the disclaimer) to

the taker of the interest. A nonqualified disclaimer, on the other hand, may be treated

as a release, causing the transfer to be treated as a gift from the original donor to the

disclaiming person followed by a transfer from the disclaiming person to the taker of the

interest.

42 IRC § 2514(d).

43 S. Rep. No. 382, 82d Cong., 1st Sess. 3 (1951).


Under the current rules,44 there are four requirements for a qualified

disclaimer:

(1) It must be in writing;

(2) It must be received by the holder of legal title of the property

to which it relates within nine months of the later of the day on which the transfer

creating the interest is made or the day on which the disclaiming person attains the age

of 21;

(3) The disclaiming person must not have accepted the interest

or any of its benefits before the disclaimer; and

(4) As a result of the disclaimer, the interest passes without any

direction on the part of the disclaiming person to either the spouse of the transferor or a

person other than the disclaiming person.45

(f) Indirect Gift Through Other "Failures" to Act

Gifts can be made indirectly, and any transaction that shifts

economic value, right or benefit to another person may cause a gift tax. The following

transactions have been found to cause gifts:

(1) Mom makes a loan to son and never attempts to collect it,

and the statute of limitations renders the loan unenforceable;46

44 To determine which rules apply, you must know when an interest was created. Treas. Reg. § 25.2511-1(c)(2) provides rules from disclaiming interests created before Jan. 1, 1977. Section 2518 originally applied to disclaiming interests created after Dec. 31, 1976. The current version of § 2518 applies to disclaimers of interests created after Dec. 31, 1981. Most significantly, a disclaimer of a post-1981 interest can be effective under federal tax laws even if it is not effective under local law.

45 IRC § 2518(b).

46 Lang Est. v. Comr., 613 F.2d 770 (9th Cir. 1980).


(2) Grandmother transfers some class A shares in a closely-

held corporation to an irrevocable gift trust for the benefit of her grandchildren and never

converts her shares to class B shares, and as a result, she forfeits the right, attached

only to class B shares, to put her interest in the corporation if it fails to pay the

prescribed dividend, sending economic benefit to her grandchildren;47 and

(3) A trust beneficiary fails to exercise a power to convert

unproductive property into productive property, resulting in loss of income to the current

beneficiary while preserving the value of the principal passing to the remainder

beneficiaries.48

3.3 GIFT TAX PAYABLE BY DONOR

The gift tax is an excise tax on the donor’s transfer of property, not a tax on the

donee’s receipt of the property.49 As a result, the donor is primarily responsible for the

tax.50

If a donor dies before payment of the gift tax, the executor or administrator of his

estate is responsible for paying the tax,51 and the executor or administrator will be

personally liable for any unpaid gift tax to the extent assets are distributed to anyone

else.52

47 Snyder v. Comr., 93 T.C. 529 (1989).

48 Dickman v. Comr., 465 U.S. 330 (1984); see also PLRs 9045047, 9035029 & 9035022.

49 Treas. Regs. §§ 25.2511-2(a).

50 IRC § 2502(c); Treas. Reg. § 25.2502-2, 25.2511-2(a).

51 Treas. Reg. § 25.2502-2.

52 31 USC § 3713(b); Treas. Reg. § 25.2502-2.


A donee becomes personally liable for the tax if it is not paid when due to the

extent of the value of the gift to the donee.53

53 IRC § 6324(b).


ARTICLE IV

THE DONOR

4.1 NATIONALITY OF THE DONOR

(a) The gift tax applies to any individual who is a citizen of the United

States, or who is a resident of the United States as defined in IRC § 7701(b).54

(b) Nonresident aliens (“NRAs”) are subject to U.S. federal gift tax as

follows:

(1) NRAs are taxed on gifts of real property located within the

United States.55

(2) Intangible property “located” in the United States is not

subject to gift tax unless the NRA was an expatriate (as defined in IRC § 2501(a)(3)).56

Generally speaking, an expatriate is a donor who, within the ten year period ending with

the date of the gift, lost his or her U.S. citizenship.57

(c) The U.S. gift and estate taxation of NRAs, as well as the foreign gift

and estate taxation abroad of U.S. citizens and residents, can be affected by applicable

treaties between the United States and foreign countries.

(d) PRACTICE TIP: If you are working with a donor with family

overseas, be mindful of the Form 3520, which is an informational return that must be

filed to report, among other things, (i) the formation of a foreign trust, (ii) the transfer of

assets or cash to a foreign trust, (iii) distributions from a foreign trust made to a U.S.

54 IRC § 2501(a)(1).

55 IRC § 2511(a); Treas. Reg. § 25.2511-3(a)(1)(i).

56 IRC § 2501(a)(2); Treas. Reg. § 25.2511-3(a)(2)(i).

57 See IRS Notice 97-19. The income tax, gift tax and estate tax rules governing NRAs are very complex and are beyond the scope of this presentation. Special care should be taken when advising NRAs and U.S. residents living abroad.


person and/or (iv) the receipt of $100,000 or more from a NRA or a foreign estate.

There is no additional tax assessed with this form, but the penalties for failure to timely

file a Form 3520 are substantial. The initial penalty is the greater of $10,000 or (i) 35%

of the gross value of the property transferred to a foreign trust for a U.S. person who

failed to report the establishment of a foreign trust or (ii) 35% of the distributions

received from a foreign trust for a U.S. person who failed to report distributions received

or (iii) 5% of the gross value of the trust’s assets treated as being owned by a U.S.

person for failure of that U.S. person to report the U.S. owner information.

4.2 COMMUNITY PROPERTY, JOINT TENANCY AND TENANCIES IN

COMMON

(a) General Rule: If the property transferred is co-owned with another

individual or individuals, then each owner is the transferor of his or her pro-rata share.58

(b) HOWEVER, beware of IRC § 2040, which provides that the entirety

of joint tenancy property is includible in a joint tenant’s estate for estate tax purposes

unless (i) the joint tenants were married, in which case one-half (1/2) of the property is

includible, or (ii) it can be shown that the surviving joint tenant provided consideration

toward the acquisition of the property, in which case the surviving tenant’s interest is

subtracted from the valuation. Thus, it is critical that records are kept to document the

respective interests in property.

4.3 GIFT SPLITTING

(a) A husband and wife may elect to treat a gift of noncommunity

property as made one-half by each spouse for gift tax purposes. The election is made

on a gift tax return.59

58 Treas. Reg. § 25.2511-1(e).

59 IRC § 2513.


(b) Gift splitting maximizes the use of annual exclusion gifts by using

the annual exclusions available to both spouses.

(c) Example: Husband wants to make a gift of $25,000 to each of his

two children (total of $50,000) from a prior marriage with his separate property funds.

Will husband have to use gift tax exemption to cover these gifts? No, provided husband

and wife elect gift splitting. Husband can make annual exclusion gifts to his children of

$26,000 ($13,000 per child), and wife can make annual exclusion gifts of $26,000 to

husband’s children ($13,000 per child). If husband and wife elect gift splitting, then the

full $50,000 will be covered by husband and wife’s annual exclusions.

4.4 INDIRECT TRANSFERS

If X makes a transfer to Y on the condition that Y make a subsequent

transfer to Z, then Y is merely an intermediary, and the transfer is treated as a gift made

by X to Z.60 Examples of indirect transfers:

(a) Trusts: If X establishes a trust that directs Y, the Trustee, to make

income distributions to Z, then X has made a gift to Z.

(b) Life Insurance: If X purchases life insurance and then directs the

life insurance company to change the named owner to Z, then X has made a gift.

4.5 CORPORATE GIFTS

If a corporation makes a gift (i.e., a charitable contribution), how is the gift

treated?

(a) General Rule: A gift by a corporation is attributable to the

shareholders on a pro rata basis.61

60 Treas. Reg. § 25.2511-1(h)(2).

61 Treas. Reg. § 25.2511-1(h)(1).


(b) Exception: If a renegade shareholder makes a gift of corporate

assets by raiding the coffers without consulting the other shareholders, then the gift is

not attributed to the shareholders who did not participate in the gift.62

4.6 SETTLEMENT OF DISPUTE

A makes a payment to B to settle a contract dispute. B accepts less than what

was originally stated as the sales price in order to settle the dispute. Is A’s transfer to B

a taxable gift as to B?

NO. A bona fide settlement of a dispute is not a taxable gift.63

62 See Neeley v. United States, 613 F. 2d 802 (Ct. Cl. 1980).

63 Commissioner v. Estate of Vease, 314 F. 2d 79 (9th Cir. 1963); Estate of Reed v. Commissioner, 171 F. 2d 685 (8th Cir. 1948).


ARTICLE V

INCOMPLETE GIFTS AND GIFTS WITH RETAINED INTERESTS

5.1 INCOMPLETE GIFTS

A transfer must be complete to be a taxable transfer. The following types of

transfers will be considered incomplete for gift tax purposes:

(a) Power retained by transferor. If the transferor retains a power

over the property (i.e., a general power of appointment pursuant to IRC § 2041), then

the transfer will be incomplete.

(b) Power to revoke a transfer. If the transferor can revoke the gift,

then it is not a completed gift for gift tax purposes.64

(c) Power to amend or alter a transfer. If the transferor has the

power to amend or alter the transfer, then the transfer will not be considered a

completed gift.

(1) Power to amend. If the transferor has the power to amend

the trust to which the transferor transferred property, then the gift will not be a

completed gift.

(2) Power to alter. If the transferor retains the power to alter

the beneficial interests of the gift (i.e., change the beneficiaries), then the gift is not a

completed gift.65 However, Chief Counsel Advice Memorandum 20120802666, which

was released on February 24, 2012, involved an irrevocable trust over which the donors

retained a limited power of appointment to appoint the Trust as constituted at their

deaths. The ruling found that the donors relinquished dominion and control of the Trust

during their lifetimes, and as such, the IRS found that the donors made a completed gift

64 Treas. Reg. § 25.2511-2(b).

65 Treas. Reg. § 25.2511-2(c).

66 Chief Counsel Advice Memorandum 201208026 (September 28, 2011).


for gift tax purposes. Thus, the state of the law on using limited powers of

appointment to create incomplete gifts is unsettled for now. One suggested

strategy is to give the donors a power over lifetime distributions (i.e., the power

to veto income distributions).

(d) Power to revoke, alter or amend with consent of another party.

(1) A gift will be deemed incomplete even if the transferor holds

the power with another party if the other party is not adverse to the transferor.

(2) A power to revoke, alter or amend is will not be deemed to

be held by the transferor if the transferor holds the power with an adverse party.67

(3) Adverse Party Defined. An adverse party is a person

whose interest would be adversely affected by the exercise of the power.

Example: A makes a gift to a trust for the benefit of B, C and D. A retains the

power to revoke the trust (in which case all property returns to A), but A can only

exercise this power with B. B is considered an adverse party because the exercise of

the power of revocation will adversely affect B’s interest.

5.2 POWERS THAT DON’T MAKE A TRANSFER INCOMPLETE

(a) Power to affect time or manner of enjoyment. A power to affect

the manner or timing of enjoyment of a gift without affecting the underlying beneficial

interests will not render a gift incomplete.68

(b) Administrative powers. A transferor may retain administrative

powers over transferred property without causing the gift to be deemed incomplete.

67 Treas. Reg. § 25.2511-2(e).

68 Treas. Reg. § 25.2511-2(d).


Administrative powers include investment powers and powers relating to the purchase,

management and sale of property.69

(c) Ascertainable standard. A transferor can retain control over the

disposition of property and have the transfer be considered a completed gift as long as

the transferor’s power is limited by the ascertainable standard, commonly known by the

acronym “HEMS,” which stands for health, support, maintenance and education.70

5.3 COMPLETION OF INCOMPLETE GIFT

An incomplete gift becomes complete when the transferor releases the

power that caused the gift to be incomplete, or when the property is no longer subject to

the power.71

5.4 TRANSFERS WITH RETAINED INTERESTS

(a) If a donor makes a gift and retains an interest, the retained interest

is generally not subject to gift tax.

Example: A makes a transfer to a trust. A receives all of the income for life, with

remainder to B. If A does not have the power to revoke the trust, then A has made a

completed gift, but only as to the actuarial present value of the remainder interest.

(b) The burden is on the donor to demonstrate the value of the retained

interest. A transfer with a retained interest is treated as a gift of the entire property less

the retained interest, but only if the donor can demonstrate the value of the retained

interest.72

69 Treas. Reg. § 25.2511-2(b).

70 Treas. Reg. § 25.2511-1(g)(2).

71 Treas. Reg. § 25.2511-2(f).

72 Treas. Reg. § 25.2511-1(e).


(c) IRC § 2702 Exception. IRC § 2702 applies to transfers in trust.

IRC § 2702 provides that the value of the retained interest is not subtracted for gift tax

purposes if the following conditions are present:

(1) The donor retains an interest in the property transferred.

(2) The donor has transferred the property for no consideration.

If the donor receives consideration for the transfer, then IRC § 2702 will not apply.

(3) The transfer is made to one or more members of the donor’s

family. For purposes of these rules, the donor’s family includes the donor’s spouse, any

ancestor or descendant of the donor or the donor’s spouse, and any spouse of an

ancestor of the donor or the donor’s spouse.73

(4) Exceptions to IRC § 2702 Treatment.

(A) Incomplete Gifts. If a gift is incomplete due to the

donor’s retained right to revoke or amend, then the transfer will not be subject to IRC

§ 2702.

(B) Qualified Interest. If the retained interest is a

qualified interest, then it will be deducted from the value of the property for purposes of

determining the gift. A qualified interest is defined as (i) the right to receive a fixed

annuity, at least annually; (ii) the right to a unitrust interest (right to fixed percentage of

principal), valued at least annually; or (iii) a remainder interest following an annuity or

unitrust interest described in (i) or (ii) above.74

(C) Qualified Personal Residence Trust. IRC § 2702

does not apply to Qualified Personal Residence Trusts (“QPRTs”), which are trusts in

73 IRC § 2702(a)(1) and IRC § 2704(c)(2).

74 IRC § 2702(a)(2)(B) and IRC § 2702(b).


which the donor transfers his or her personal residence (or an undivided interest

therein) and retains the right to live in the residence.75

(d) IRC Section 2701 Exception. IRC § 2701 is similar to IRC § 2702,

except that IRC § 2701 applies to transfers with retained interests in entities.

(1) General Rule: If the donor makes a transfer of junior equity

(common stock) and retains senior equity (preferred stock), the donor is treated as

making a gift by the donor of the donor’s entire interest in the entity without a reduction

for the donor’s retained interest in the nontransferred senior equity.

(2) IRC § 2701 applies to transfers between family members.

(3) Applies to “applicable retained interests,” which are generally

rights to dividends and liquidation rights.

(4) After the transfer, the applicable retained interest must be

held by the donor or a member of the donor’s family.

(5) IRC § 2701 does not apply if one of the following conditions

is present76:

(A) Market quotations are readily available (as of the date

of the transfer) for such interest on an established securities market,

(B) Such interest is of the same class as the transferred

interest, or

(C) Such interest is proportionally the same as the

transferred interest, without regard to nonlapsing differences in voting power (or, for a

partnership, nonlapsing differences with respect to management and limitations on

liability).

75 Treas. Reg. § 25.2702-5.

76 IRC § 2701(a)(2).


(6) Determination of value of gift

(A) The entity as a whole is appraised.

(B) Subtract the value of all interests senior to the

transferred interest.

(i) “Applicable Retained Interests” held by the

donor and the donor’s family members are generally deemed to be worth zero.77

However, a right to receive a qualified payment (i.e., a right to receive a fixed dividend)

is valued by determining the present value and disregarding liquidation rights.

(ii) Other senior interests are valued at fair market

value.

(C) The remaining value is allocated among the junior

interests. There is a “minimum value rule” which provides that the value of the junior

equity must be deemed to be worth at least 10% of the entity’s value.78

(7) Example: A owns 1000 shares of common stock and 1000

shares of preferred stock of corporation. A decides to give 500 shares of common stock

to B, her daughter. Each share of the preferred stock has a dividend right of $200. The

corporation is valued at $1 million. What is the value of the gift?79

(A) Step 1: Start with the value of the corporation, which

is $1,000,000.

(B) Step 2: Value the senior equity, which is A’s

preferred stock. A has a right to receive a qualified payment (dividend); the value of the

preferred stock is $200,000.

77 IRC § 2701(a)(1) & (3)(A).

78 IRC § 2701(a)(4).

79 Treas. Reg. § 25.2701-3(b)


(C) Step 3: Determine the value of the junior equity

being transferred - $1,000,000 - $200,000 = $800,000. The minimum value rule doesn’t

apply because the gift is deemed to be worth more than 10% of the corporation.

(8) Planning consideration: Gifts of corporate interests in

which the donor retains an interest can still work, but care must be taken in devising

these gifts. The retained interests must be qualified payment rights in order for the

planning to be useful.


ARTICLE VI

VALUATION OF GIFTS

6.1 GENERAL CONCEPTS

(a) The amount of a gift generally is the fair market value of the

property transferred.80 "Fair market value" generally means the price at which the

property would change hands between a willing buyer and a willing seller, both of whom

have reasonable knowledge of all relevant facts and neither of whom is under any

compulsion to buy or sell.81 In determining fair market value, both the buyer and the

seller are hypothetical persons,82 not the specific transferor or transferee,83 which

means the actual buyer and seller's relationship must be ignored.

(b) Gifts of partial interests are valued based on actuarial tables,84 not

the willing buyer/willing seller regime mentioned above, including life estates, term-of-

year interests, remainders or reversions, and interests in private annuities. Using these

tables avoids an examination of the facts and circumstances of every case and provides

administrative convenience.85 Of course, there are situations in which it is appropriate

to look at the facts and circumstances surrounding a transaction because using the

tables would lead to a "substantially unrealistic and unreasonable" valuation.86 There

80 IRC § 2512(a).

81 Treas. Reg. § 25.2512-1.

82 Bright Est. v. U.S., 658 F.2d 999 (5th Cir. 1981).

83 Rev. Rul. 92-12.

84 IRC § 7520.

85 Shapiro Est. v. Comr., T.C. Memo 1993-483.

86 O'Reilly v. Comr., 95 T.C. 646 (1990), rev'd, 973 F.2d 1403 (8th Cir. 1992), rem'd, T.C. Memo 1994-61.


are two tests for determining that the tables should not be used: a beneficial interest

test and a mortality test.87

Ordinary annuity, income, remainder or reversionary interests are valued

using the tables, but "restricted beneficial interests" (i.e., interests subject to a

contingency, power or other restriction) may warrant a facts and circumstances fair

market valuation.88

The mortality test recognizes that the tables will not work in situations

where the transferor's life expectancy is not aligned with the assumptions in the tables.

If a taxpayer is terminally ill at the time of the transfer, the rates in the tables are to be

adjusted89 by a special factor.90 A taxpayer is "terminally ill" if there is at least a 50%

probability that he will die within a year of the transaction; however, if he survives at

least 18 months after the transfer, he is deemed not have been terminally ill at the time

of the transfer.

(c) The value of a gift is determined as of the time the transfer is

complete; there is no alternate valuation date for gift tax purposes.

6.2 PUBLICLY TRADED STOCKS AND BONDS

(a) If there is a market for the securities, such as a public stock

exchange, the fair market value of the security is the average of the highest and lowest

selling price on the day of the transfer.91 If there are no sales that day, the value is the

87 Treas. Reg. § 25.7520-3(b).

88 Treas. Reg. § 25.7520-3(b)(1)(ii).

89 Treas. Reg. § 25.7520-3(b)(3).

90 The IRS will provide the special factor upon a request for a ruling. Treas. Reg. § 25.7520-1(c).

91 Treas. Reg. § 25.2512-2.


weighted average of the highest and lowest selling prices on the nearest date before

and the nearest date after the date of the transfer on which there are sales.92

(b) If there are no sales during a reasonable period before and after

the date of the transfer, then the value may be determined by averaging the "bid" and

"asked" prices on the date of the transfer93 or, if there are no bid and asked prices on

that date, on the nearest trading dates before and after the date of the transfer.94

(c) A blockage discount may be applied to gifts of large blocks of

publicly traded stock if the block "is so large in relation to the actual sales on the existing

market that it could not be liquidated in a reasonable time without depressing the

market."95 The size of the discount depends on several factors, including the size of the

block compared with the total outstanding stock of the company, the amount of stock

the market will absorb immediately, and the amount of time needed to liquidate the

stock without depressing the market. When a transferor simultaneously transfers stock

to several transferees, the gift to each transferee must be considered separately.96

Even if the total amount of stock transferred on the date in question could not be sold

without depressing the market, no blockage discount is available if each separate gift

could be sold without affecting the market.97

6.3 CLOSELY HELD BUSINESS INTERESTS

(a) Since closely held business interests, including shares in

corporations, partnership interests and limited liability company membership interests,

92 Treas. Reg. § 25.2512-2(b)(2).

93 Treas. Reg. § 25.2512-2(c).

94 Id.

95 Treas. Reg. § 25.2512-2(e).

96 Id.

97 Calder v. Comr., 85 T.C. 713 (1985).


are sold infrequently, determining the value of an interest depends on the facts and

circumstances of each transfer.98

(b) The IRS identified the following factors for consideration in such

transfers:

(1) The nature of the business and the history of the enterprise

since its inception;

(2) The economic outlook in general and the condition and

outlook of the specific industry in particular;

(3) The book value of the stock and the financial condition of the

business;

(4) The earning capacity of the company;

(5) The dividend-paying capacity of the company;

(6) The company's goodwill or any other intangible value;

(7) Sales of the stock and the size of the block of stock to be

valued; and

(8) The market price of interests in similar businesses traded in

a free and open market.99

(c) Courts have applied various discounts in valuing these interests.

The minority interest (or lack of control) discount is based on the fact that a minority

interest is worth less per share to a willing buyer than a controlling interest. According

to the Tax Court, this discount reflects the fact that a minority interest holder cannot

98 Northern Trust Co. v. Comr., 87 T.C. 349 (1986), aff'd sub nom., Citizens Bank and Trust Co. v. Comr., 839 F.2d 1349 (7th Cir. 1988).

99 Rev. Rul. 59-60. 1959-1 C.B. 237.


compel liquidation of the business and realize his share of the business's net asset

value.100

(1) The Regulations refer to this as "the degree of control of the

business represented by the block of stock to be valued."101

(2) A higher discount applies when a shareholder holds only a

small percentage of stock and consequently has less effective control. A smaller

discount applies if a minority interest gives its holder a swing vote based on the facts

and circumstances. 102

(3) For a long time, the Service asserted that a minority interest

discount is inapplicable when stock of a family-controlled business is transferred to a

family member, but the Service retreated from that position in 1993.103 Now, a minority

interest discount may be applied even if a transferred interest and the other family-

controlled interests constitute a majority interest.

(4) As a corollary to this discount, a block of stock that

represents a controlling interest may be worth more per share than a block of minority

interest, and the value of a controlling block may be increased by a control premium.104

(d) The lack of marketability discount is appropriate if there is no ready

market for the transferred interest.105 This discount is separate from the lack of control

100 Newhouse Est. v. Comr., 94 T.C. 193 (1990).

101 Treas. Reg. § 25.2512-2(f)(2).

102 See generally 831 T.M., Valuation of Corporate Stock.

103 Rev. Rul. 93-12, 1993-1 C. B. 202.

104 Treas. Reg. § 25.2512-2(f)(2).



discount explained above. It reflects the fact that a shareholder of a closely held

business cannot readily sell his interest in the business.106

(e) If a transferred interest is subject to an agreement that limits a

transferee's right to transfer the interest, such as buy-sell agreements and tenancy-in-

common agreements, the value of the transferred interest may be less than fair market

value.107

(f) Federal income tax liability may reduce the value of an interest. If

the value of a corporation is based on the value of its real property, the value may be

reduced by the federal income tax payable upon disposition of the property.108 Current

corporate-level tax liability may also be considered and may lead to a reduction in value

of shares in the corporation (even S-corporations).109

(g) Chapter 14 (IRC §§ 2701 – 2704) was enacted110 to limit gift tax

valuation abuses related to "estate freeze" techniques that relied on transfers of closely-

held business interests. These techniques were designed to shift future appreciation to

younger generations at a low gift tax cost, while reducing the estate tax value of the

interest retained by the older generation. In contrast to prior law, which focused on

estate tax inclusion, Chapter 14 imposes a gift tax on subject transactions.

106 Newhouse Est. v. Comr., 94 T.C. 193 (1990).

107 See, e.g., Harwood v. Comr., 82 T.C. 239 (1984) (partnership interest), and Citizens Bank and Trust Co. v. Comr., 839 F.2d 1249 (7th Cir. 1988) (corporate stock).



110 Omnibus Budget Reconciliation Act 1990, P.L. 101-508 (applying to transfers made after Oct. 8, 1990).


(1) IRC § 2701 applies to the "transfer" of an interest to or for

the benefit of a "member of the transferor's family" by which the transferor or an

"applicable family member" holds an "applicable retained interest" after the transfer.111

A "transfer" includes a direct transfer to or for the benefit of a

member of the transferor's family of an interest in a corporation or partnership following

a redemption, recapitalization, or other change in the capital structure of the entity.112

"Transfer" does not include any shift of rights resulting from a qualified disclaimer under

IRC § 2518 or the exercise, release or lapse of a special power of appointment.113

A "member of the transferor's family" includes the transferor's

spouse, lineal descendants of the transferor or the transferor's spouse, and the spouse

of any such lineal descendant.114

An "applicable family member" includes the transferor's spouse,

any ancestor of the transferor or the transferor's spouse, and the spouse of any such

ancestor.115

An "applicable retained interest" is any interest with which there is

either a right to receive distributions (other than a qualified payment right)116 or an

extraordinary payment right (i.e., any put, call, conversion right or any right to compel

111 Treas. Reg. § 25.2701-1(b)(2)(i)(B)(1).

112 See H.R. Conf. Rep. No. 964, 101st Cong., 2d Sess. 1136-1137 (1990).

113 Treas. Reg. § 25.2701-1(b)(3)(ii), -(3)(iii).

114 IRC § 2701(e)(1).

115 IRC § 2701(e)(2).

116 IRC § 2701(c)(1)(A). A "qualified payment right" includes dividends and any other cumulative distribution payable on a periodic basis (at least annually) if the dividends or other payments are determined at a fixed rate. Treas. Reg. §25.2701-2(b)(6)(i)(A), -(i)(B). A transferor may elect whether to treat other distribution right as either qualified or nonqualified payment rights. IRC § 2701(c)(3)(C)(i), (ii).


liquidation).117 Section 2701 is aimed at discretionary rights that may be ignored (such

as dividends on preferred stock), so it does not apply to any right that must be exercised

at a specific time and at a specific amount.118

Since Chapter 14 focuses on valuation abuses, § 2701 does not

apply to transfers of property for which market quotations are readily available for either

the transferred interest or the retained interest.119 Similarly, it does not apply to

transfers that result in a proportionate reduction of each class of equity interest held by

the transferor and all applicable family members.120

If § 2701 applies, the value of the gift is based on the difference

between the value of all family-held interests before the transfer and the value of

interests held by the transferor or an applicable family member after the transfer.121 IRC

§ 2701 deems the value held by the transferor to be zero in certain circumstances,

making the gift 100% of the value of the transferred property.

(2) IRC § 2702 applies to a "transfer in trust" to or for the benefit

of "family members" if the transferor or an "applicable family member" retains an interest

in the transferred property.

The term "transfer in trust" includes a transfer to a new or existing

trust and an assignment of interest to an existing trust. It does not include the exercise

of a qualified disclaimer under IRC § 2518 or the exercise, release or lapse of a special

power of appointment.122

117 Treas. Reg. § 25.2701-2(b)(2).

118 IRC § 2701(c)(2)(B)(i).

119 IRC § 2701(a)(2)(A).

120 Id.

121 Treas. Reg. § 25.2701-1(a)(2), -3(a).

122 Treas. Reg. § 25.2702-2(a)(2).


The term "family member" includes the transferor's spouse, any

ancestor or lineal descendant of the transferor or the transferor's spouse, the

transferor's siblings, or the spouse of spouse of any ancestor, descendant or sibling

mentioned above.123

The term "interest" must be understood by comparing it to the term

"qualified interest." A qualified interest is a qualified annuity interest, a qualified unitrust

interest, or a qualified remainder interest,124 and such interests are valued under IRC

§ 7520. Other retained interests are valued by § 2702 at zero for gift tax purposes. As

with § 2701, the result is that the gift is 100% of the value of the transferred property.

While § 2702 sounds fearsome, its primary effect is that grantor

retained income trusts ("GRITs") are no longer useful as planning techniques for

transfers in trust between family members (although GRITs remain available to same-

sex couples who are not considered "spouses" under federal law). Grantor retained

annuity trusts and grantor retained unitrusts remain viable options.

(3) IRC § 2703 distinguishes restrictive agreements among

family members from those with bona fide business purposes. It provides that the first

type of agreement will be disregarded in determining the value of an entity for estate,

gift and generation-skipping transfer taxes.

In order for a restrictive agreement to affect the value of the entity,

it must be a bona fide business arrangement, it cannot be a device to transfer property

to a family member for less than full and adequate consideration in money or money's

worth, and it must have terms that are comparable to similar arrangements entered into

123 IRC §§ 2702(e), 2704(c)(2), Treas. Reg. § 25.2702-2(a)(1). This definition is significantly broader than the one under IRC § 2701.

124 IRC § 2702(b). See Treas. Reg. § 25.2702-2(a)(6), -3(b), (d) (qualified annuity interest); § 25.2702-2(a)(7), -3(c), (d) (qualified unitrust interest); and § 25.2702-2(a)(8), -3(f) (qualified charitable remainder interest).


at arm's length.125 In cases where family members own part of the entity, the

requirements are met if more than 50% of the value of the property subject to the

agreement is owned directly or indirectly by non-family members.126

6.4 PARTIAL INTERESTS

(a) The value of a gift of a partial interest is determined using an

interest rate equal to 120% of the federal mid-term rate.127 Taxpayers are allowed to

choose the rate in effect for the month in which the transfer occurs or in either of the two

preceding months.128

(b) The value of a life estate is the present value of the income interest.

The value of the transferred property is multiplied by a factor representing the income

interest.129 Income factors can be found in Table S of Publication 1457 for the month of

the transfer.

(c) The value of a term of year is determined the same way a life

estate is valued.130 Income factors for term of year gifts can be found in Table B of

Publication 1457 for the month of the transfer.

(d) The value of a remainder or reversionary interest is the present

value of the remainder or reversionary interest. The value of the transferred property is

multiplied by a factor representing the remainder interest.131 Factors for remainder or

125 Treas. Reg. § 25.2703-1(b)(4)(i).

126 Treas. Reg. § 25.2703-1(b)(3).

127 IRC § 7520.

128 Treas. Reg. § 25.7520-2(a)(2).

129 Treas. Reg. § 25.2512-5T(d)(2)(iii).

130 Id.

131 Treas. Reg. § 25.2512-5T(d)(2)(ii).


reversionary interests can be found in Table B of Publication 1457 for the month of the

transfer.

(e) The value of a private annuity is determined by multiplying the

aggregate amount payable annually by an annuity factor.132 Annuity factors for a term-

of-years annuity can be found in Table B of Publication 1457 for the month of the

transfer, and factors for a lifetime annuity can be found in Table S of Publication 1457.

If the payment is to be made more frequently than annually, an adjustment must be

made using factors found in Table K of Publication 1457.133 If the payment is to be

made at the beginning of the payment period, an adjustment must be made using

factors found in Table J of Publication 1457.134

6.5 LIFE INSURANCE AND ANNUITIES

(a) New Policies/Contracts

If a new life insurance policy135 is transferred, the value is the cost of the

policy.136 The same rule applies to a commercial annuity contract, which means "an

annuity issued by a company regularly engaged in the selling of contracts of that

character."137

132 Treas. Reg. § 25.2512-5T(d)(2)(iv).

133 Treas. Reg. § 25.2512-5T(d)(2)(iv)(B).

134 Treas. Reg. § 25.2512-5T(d)(2)(iv)(C).

135 "New" means only the first premium has been paid. See Phipps v. Comr., 43 B.T.A. 790 (1941).

136 Treas. Reg. § 25.2512-6(a).

137 Treas. Reg. § 25.2512-6(a).


(b) Paid-Up Insurance Policies

The value of a policy on which no future premium payments are to be

made is the replacement cost of the policy at the time of transfer.138 Replacement cost

is the cost of a single-premium policy of the same face amount on the life of a person

the same age as the insured.139

(c) Permanent Policies With Additional Premium Payments Due

The value of a permanent policy on which additional premium payments

are due is the "interpolated terminal reserve" of the policy plus the proportionate amount

of the last premium payment that covers the period extending beyond the date of the

gift.140 The interpolated terminal reserve is obtained directly from the insurance

company.

6.6 BELOW-MARKET INTEREST RATE LOANS

(a) A loan that bears less than market rate interest gives the borrower

an economic benefit that is treated as a taxable gift.141 IRC § 7872 applies to loans

made after June 6, 1984, and provides the method for determining the amount of the

gift in such a situation.

(b) Under IRC § 7872, if the value of the property transferred (the

amount loaned plus the amount of foregone interest) exceeds the consideration

received and if the transaction is not made in the ordinary course of business, then a

below-market rate loan is treated as a gift loan.

138 Treas. Reg. § 25.2512-6(a).

139 Treas. Reg. § 25.2512-6(a).

140 Treas. Reg. § 25.2512-6(a).

141 Dickman v. Comr., 465 U.S. 330 (1984).


(c) If IRC § 7872 applies, two transfers are imputed: a gift transfer

from the lender to the borrower in an amount equal to the foregone interest, and

payment of interest by the borrower to the lender.

(d) If the loan is a demand loan (one that is payable at any time on

demand of the lender142), the lender is treated as having transferred (by gift) the

difference between the amount of interest payable during the calendar year if the

interest had accrued at the AFR using semiannual compounding and the interest

payable on the loan for that year.143 This calculation is run every year the loan remains

outstanding, and the lender is deemed to have made the calculated gift amount on

December 31 of the year.144 If the loan remains outstanding for a period that involves

multiple AFRs, the calculation is made using a blended annual rate.145

(e) If the loan is not a demand loan, then it is deemed a term loan by

IRC § 7872(f)(6). With regard to a term loan, the lender is treated as having transferred

(by gift) the difference between the amount of the loan and the present value of all

payments due under the loan.146 The present value is computed using the AFR in effect

on the day the loan was made, and interest is treated as if compounded semiannually.

(f) There is a de minimis exception to § 7872 that prevents the Section

from applying if the aggregate principal amount of all outstanding loans (both below-

market rate loans as well as market-rate loans) from one lender to one borrower is less

than $10,000.147

142 IRC § 7872(f)(5).

143 IRC § 7872(e)(2).

144 IRC § 7872(a)(2).

145 Prop. Treas. Reg. §1.7872-13(a)(1),

146 IRC § 7872(b)(1).

147 IRC § 7872(c)(2).


6.7 ENCUMBERED GIFTS

(a) When property secures a debt of the transferor and the transferor

transfers the property by gift, the amount of the gift is the excess of the unencumbered

fair market value of the property over the amount of indebtedness.148

(b) Generally, the donor is liable for payment of the gift tax,149 and the

payment of the tax does not reduce the value of the gift. But if the donor and donee

agree that the donee must pay the tax out (either from his own assets or from the

transferred property), the result is a "net gift," and the value of the gift is the excess of

the fair market value of the transferred property over the amount of the gift tax paid by

the donee.150 The facts must show that the donee's obligation to pay the gift tax is a

condition of the transfer.151

6.8 VALUATION PENALTIES

(a) If tax is underpaid as a result of a substantial valuation

understatement, then the penalty is equal to 20% of the underpayment.152 A substantial

valuation understatement occurs when the value of the property reported on a gift tax

return is 50% or less of the amount determined to be correct.153

(b) If tax is underpaid as a result of a gross valuation understatement,

then the penalty is equal to 40% of the underpayment.154 A gross valuation

148 See, e.g., Laughinghouse v. Comr., 80 T.C. 425 (1983).

149 IRC § 2502(c).

150 See, e.g., Harrison v. Comr., 17 T.C. 1350 (1952), acq. 1952-2 C.B. 2.

151 Rev. Rul. 75-72, 1975-1 C.B. 310.

152 IRC § 6662(b)(5).

153 IRC § 6662(g)(1).

154 IRC § 6662(h)(1).


understatement occurs when the value of the property reported on a gift tax return is

40% or less of the amount determined to be correct.155

(c) Both penalties can be abated if there was a reasonable cause for

the understatement and the taxpayer acted in good faith.156

155 IRC § 6662(g)(1). 40% is the test for returns field after Aug. 17, 2006. For earlier returns, 25% was the threshold for a gross valuation misstatement.

156 IRC § 6664(c).


ARTICLE VII

EXCLUSIONS FROM GIFT TAX

7.1 EXCLUSIONS GENERALLY

The amount of any net gift is reduced by any available exclusions.157

7.2 ANNUAL EXCLUSION GIFTS

IRC Section 2503 provides for a $10,000 per donor, per donee per year

annual exclusion adjusted for inflation. The adjusted annual exclusion for 2012 is

$13,000 per donor, per donee per year.158

(a) The annual exclusion is only available for gifts of present interests.

(1) Present interest is defined as follows:159

(A) The donee must have an unrestricted right to the

immediate use, possession, or enjoyment of property or the income from property;

(B) The donee must be identifiable; and

(C) The value of the gift must be presently ascertainable.

(b) Crummey powers

(1) A transfer to a beneficiary in trust that would not otherwise

qualify as a gift of a present interest may qualify if the beneficiary is granted Crummey

powers.

(2) A Crummey power is a power given to a person (i.e., a trust

beneficiary) to withdraw amounts transferred to the trust for a period of time (i.e., thirty

157 IRC § 2503.

158 Rev. Proc. 2011-52.

159 See Treas. Reg. § 25.2503-3(b).


days) following the transfer. This process was established by Crummey v.

Commissioner.160

(3) The right of withdrawal must be respected by the Trustee in

order for the trust transfers to qualify for the annual exclusion.161

(4) The withdrawal power is a general power of appointment in

the hands of the beneficiary. If the beneficiary does not exercise this power, it lapses

and the beneficiary makes a gift, subject to the “five and five” rule discussed above.

(c) Methods for maximizing annual exclusion

(1) Maximizing donors. Gifts of community property are gifts

by two donors if spouses elect gift splitting under IRC § 2513.

(2) Maximizing donees. A gift to a husband and wife is

considered a gift to two donees, not one.

(3) Installment gift, i.e., forgiveness of a loan over a period of

years. Each cancellation is a gift of a present interest. However, care should be taken

before a client is advised to do this because loan forgiveness may trigger income tax

gain.

Example: Dad establishes irrevocable life insurance trust for the

benefit of his children. Husband makes annual transfers to the trust in an amount equal

to the premiums due on the life insurance owned by the trust. The trust does not

provide that his children have Crummey powers. Will the transfers qualify for the annual

exclusion?

NO. If the children do not have Crummey powers, then the

transfers to the trust will not qualify as annual exclusion gifts. Dad will need to file gift

tax returns and use gift tax exemption to cover the transfers.

160 397 F. 2d 82 (9th Cir. 1968).

161 See Rev. Rul. 83-108, 1983-2 C. B. 167.


7.3 TUITION AND MEDICAL CARE

(a) Amounts paid on behalf of a donee for tuition or medical care are

not subject to gift tax, and there is no limit to the exemption.162

(b) Payments for tuition or medical care must be made directly to the

medical care provider.

(c) The exclusion for medical care is lost if the donee is compensated

by insurance.

(d) The exclusion for payments toward medical care applies

irrespective of whether the donor is legally required to support the donee.163

Example: Grandparents give granddaughter $10,000 to pay for books

and other college incidentals. Does this gift qualify for the tuition and medical care

exclusion?

NO. This gift will not qualify under IRC § 2503(e) because the payment

was not made directly to the educational provider.

Example: Grandparents wish to assist granddaughter with her college

education. Grandparents write a check to the UC Regents to help granddaughter with

her college expenses. Will this gift qualify for the tuition and medical care exclusion?

YES. This gift will qualify under IRC § 2503(e) because grandparents

made the payment directly to the educational provider.

162 IRC § 2503(e).

163 Treas. Reg. § 25.2503-6.


7.4 GIFTS TO MINORS

(a) Gifts to minors can pose a problem because a minor cannot, in

most cases, own legal title to property until the age of majority. IRC § 2503(c) is

designed to counteract this problem.

(b) IRC § 2503(c)(2) provides that a gift to a minor will qualify for an

annual exclusion if the following conditions are met:

(1) The gift may be expended by, or for the benefit of, the donee

before the donee attains the age of 21 years, and

(2) The gift will to the extent not so expended--

(A) pass to the donee on his or her attaining the age of 21

years, and

(B) In the event the donee dies before attaining the age of

21 years, be payable to the estate of the donee or as he or she may appoint under a

general power of appointment as defined in IRC § 2514(c).

(c) The guardian, custodian or trustee must have broad discretionary

powers on behalf of the beneficiary. The exclusion is lost if the fiduciary’s powers are

limited, i.e., a support trust.164

(d) The amount of the annual exclusion for minors under IRC § 2503(c)

is the same as the annual exclusion for gifts under IRC § 2503(b).

164 See Treas. Reg. § 25.2503-4(b)(1) and Rev. Rul. 69-345.


ARTICLE VIII

MARITAL DEDUCTION

8.1 UNLIMITED MARITAL DEDUCTION

(a) IRC § 2523 states that an unlimited marital deduction is available

for gift transfers between spouses.

(b) Requirements for the unlimited marital deduction:

(1) The donee must be married to the donor at the time of the

gift.165

(2) The gift must not be a gift of a terminable interest, discussed

below.

8.2 TERMINABLE INTEREST RULE

(a) A terminable interest is an interest that might fail, expire or

terminate on the occurrence of a certain event.

(b) No deduction is permitted for transfers of terminable interests,

except as discussed in Section 8.3 below.

8.3 EXCEPTIONS TO TERMINABLE INTEREST RULE

(a) Tenancy by the Entirety. This is a form of ownership whereby

spouses are considered a single legal entity. A transfer to a tenancy by the entirety will

qualify for the marital deduction even though it is possible that the interest will fail if the

donee spouse predeceases the donor spouse. California does not recognize tenancy by

the entirety ownership.166

165 IRC § 2523(a).

166See IRC § 2523(e).


(b) Power of Appointment Trust. IRC § 2523(e) allows a deduction

for a transfer to a power of appointment trust if the following requirements are satisfied:

(1) The donee spouse must be entitled to all of the income,

payable at least annually, and/or sole possession of the property for the spouse’s

lifetime.

(2) The donee spouse must have a general power of

appointment over the trust (i.e., the power to appoint the property in favor of the spouse,

the spouse’s estate, the spouse’s creditors or the creditors of the spouse’s estate).

(3) No individual other than the donee spouse has the power of

appointment described in Section 8.3(b)(2) above.

(c) QTIP Transfer. A qualified terminable interest property (“QTIP”)

transfer will qualify for the unlimited marital deduction if the following requirements are

met:167

(1) The donee spouse must be entitled to all of the income,

payable at least annually, and/or sole possession of the property for the spouse’s

lifetime.

(2) The donor spouse must elect that the transfer qualify for the

marital deduction. This will cause the transferred property to be included in the estate

of the donee spouse for estate tax purposes pursuant to IRC § 2044.

(3) No person (including the donee spouse) has the power to

appoint any of the QTIP property to anyone other than the donee spouse.

(d) Charitable Remainder Trust. A transfer to a spouse for life, with

the remainder to charity, will qualify for the marital deduction as to the donee spouse’s

income interest.168

167 See IRC § 2523(f).

168 IRC § 2523(f).


8.4 DONEE SPOUSE NOT U.S. CITIZEN

IRC § 2523(i) states that gifts to a spouse who is not a citizen at the date

of gift are subject to U.S. gift tax to the extent the gift exceeds $100,000, indexed for

inflation. In 2012, the exemption is $139,000.169

8.5 IRC SECTION 2519 – TRANSFER OF INCOME INTEREST

(a) If a donee spouse decides to make a gift of the donee spouse’s

income interest under a QTIP trust, there is a gift of the income interest AND a deemed

transfer by the donee spouse of all other interests in the property.170

(b) The donee spouse is entitled to recover from the QTIP trust the

amount of gift tax attributable to the application of IRC Section 2519.171

(c) If the donee spouse does not exercise the right of recovery granted

under IRC Section 2207A, then the foregone reimbursement is considered a separate

gift by the donee spouse.172

169 Rev. Proc 2011-52.

170 IRC § 2519.

171 See IRC § 2207A.

172 IRC § 2207A(b).


ARTICLE IX

CHARITABLE DEDUCTION

9.1 AMOUNT OF DEDUCTION

(a) IRC § 2522 provides that there is a charitable deduction for gift tax

purposes.

(b) The deduction cannot exceed the value of the gift.173

9.2 GIFTS OF PARTIAL INTERESTS

Certain gifts of partial interests qualify for the charitable deduction.

(a) Nontrust transfers

(1) Remainder interest in a residence or farm. A donor gives

her residence to a charity and retains a life estate, which is the right to live in the

residence for her lifetime. The donor is entitled to a charitable deduction equal to the

present value of the charity’s remainder interest.

(2) Undivided interest in donor’s entire interest in property.

A donor owns 100% of Blackacre. The donor gives an undivided 25% interest in

Blackacre to charity. The donor is entitled to a charitable deduction equal to the value

of a 25% undivided interest in Blackacre.

(3) Qualified Conservation Easement. Easement granted to

charity for charitable use of land.

(b) Charitable remainder trusts. Trust whereby donor (or another

person) is given an income interest for life, with remainder to charity.

(1) Charitable remainder annuity trust. Income interest is a

set as a fixed amount per year.174

173 IRC § 2503(a).

174 IRC § 664(d)(2).


(2) Charitable remainder unitrust. Income interest is fixed

right to receive certain percentage of the corpus, valued annually.175

(c) Charitable lead trusts. The charity receives an income interest

(annuity or unitrust) for a term of years, remainder to one or more noncharitable

beneficiaries. The donor receives a charitable deduction for the value of the income

interest distributed to charity.176

(d) Pooled income funds. A charitable remainder trust managed by a

charity with multiple donors. Any donor may reserve to himself or herself, or other

donors, an income interest. Contributions to a pooled income fund qualify for the gift tax

charitable deduction.177

9.3 GIFT TAX RETURNS FOR CHARITABLE GIFTS

(a) The best practice is to file a gift tax return to report a gift to charity,

even if the gift is 100% deductible.

(b) As discussed in the Gift Tax Procedure Section below, a gift tax

return must be filed to claim a charitable gift tax deduction for split interest gifts to

charity.

(c) As also discussed below, a significant benefit of filing a gift tax

return is that the filing starts the tolling of the statute of limitations.

175 IRC § 664(d)(1).

176 See IRC § 642(c)(2).

177 See IRC § 642(c)(5).


ARTICLE X

GENERATION SKIPPING TRANSFER TAX

10.1 OVERVIEW

The generation-skipping transfer tax applies only to “generation skipping”

transfers that occur with respect to the following:

(a) Transfers by will or inter vivos trust where the decedent died after

December 31, 1986 (or where the decedent died before that time but the will or trust

was executed after October 21, 1986).

(b) Inter vivos (lifetime) transfers other than transfers to revocable

trusts (i.e., outright gifts) after September 25, 1985.

10.2 RELATIONSHIP TO GIFT TAX

(a) The generation-skipping transfer (“GST”) tax is an additional tax on

top of the gift tax.

(b) If a gift is subject to gift tax and generation-skipping transfer tax, the

amount of generation-skipping transfer tax paid by the donor is considered an additional

gift subject to gift tax.

Example: Donor makes a taxable gift of $100. The gift is also subject to

GST. If the gift tax and GST tax rate is 35%, then the donor will incur gift and GST tax

as follows:

GST Tax: $35 (35% of $100)

Gift Tax: $47.25 (35% of $135)

10.3 TYPES OF GENERATION SKIPPING TRANSFERS

There are three (3) types of generation-skipping transfers:

(a) Direct skip transfer: This type of skip occurs upon a transfer,

either outright or in trust, where all of the donees are at least two (2) generations below

the transferor.


(1) If a direct skip occurs, it will be imposed in addition to the gift

tax at the time of the transfer.

(2) Common direct skips

(A) Outright gift to a grandchild.

(B) Gift in trust for the benefit of donor’s grandchild or

grandchildren (i.e., an educational trust).

(b) Taxable Distribution: Transfer from a trust or trust equivalent

(i.e., arrangement involving annuities, life insurance, employee death benefits) where

the beneficiary receiving the distribution is at least two generations below the donor.

The creation of the trust (or trust equivalent) is subject to gift tax but not generation-

skipping transfer tax. Generation-skipping transfer tax will not be imposed until all

beneficial interests in the trust are held by a generation at least two generations below

the grantor.

(c) Taxable Termination: Occurs upon the termination of any interest

in a trust, but only if (i) no non-skip person (defined below) has an interest in the trust,

and (ii) after the termination distributions will be made to skip persons.178 A trust may

suffer generation-skipping transfer tax at successive generations.

Example: John creates a trust for son for life, with income to grandson for

life following son’s death and income to great-grandchildren following grandson’s death.

The deaths of son and grandson create taxable terminations.

(d) Exception for taxable distribution or taxable termination

subject to estate or gift tax: If a taxable termination or taxable distribution is also

subject to estate tax or gift tax, then the GST tax will not apply, and the transfer will just

be subject to the estate tax or gift tax.

178 IRC § 2612(b)(1).


Example: Father establishes trust for the benefit of his son. Following

son’s death, son has a general power of appointment over the trust estate. If son does

not exercise the general power of appointment, the trust estate passes to son’s children,

the grandchildren of father. Son dies and does not exercise the power of appointment,

so the trust estate passes to son’s children. Is the taxable termination subject to

generation-skipping transfer tax?

NO. The trust estate will be subject to estate tax in son’s estate because

son held a general power of appointment over the assets. Thus, the taxable termination

is not subject to generation-skipping transfer tax.

(e) A GST transfer that involves a skip over more than two generations

is considered one skip for GST purposes. Thus, a transfer to a great-grandchild is one

taxable event.179

10.4 GENERATION-SKIPPING TRANSFER TAX RATE

(a) The tax rate is the maximum estate tax rate multiplied by the

inclusion ratio.180

(b) Inclusion Ratio: The inclusion ratio with respect to any property

transferred in a generation-skipping transfer is the excess (if any) of 1 over--

(1) except as provided in subparagraph (2), the applicable

fraction determined for the trust from which such transfer is made, or

(2) in the case of a direct skip, the applicable fraction

determined for such skip.181

179 IRC § 2653(a).

180 IRC § 2641.

181 IRC § 2642(a)(1).


(c) Applicable Fraction: A fraction--

(1) The numerator of which is the amount of the GST exemption

allocated to the trust (or in the case of a direct skip, allocated to the property transferred

in such skip), and

(2) The denominator of which is--

(A) The value of the property transferred to the trust (or

involved in the direct skip), reduced by

(B) the sum of--

(i) any Federal estate tax or State death tax

actually recovered from the trust attributable to such property, and

(ii) any charitable deduction allowed under § 2055

or § 2522 with respect to such property.182

Example: Mark makes an outright gift to his grandson of cash in the

amount of $1,000,000 in 2010. What is the GST tax rate for this gift?

The denominator of the applicable fraction is $1,000,000, because that is

the value of the property. There are no deductions for estate tax or State death tax

recovered or a charitable deduction. $1,000,000 will be allocated toward this gift. Thus,

the applicable fraction is $1,000,000/$1,000,000 = 1. The inclusion ratio will be zero,

because the applicable fraction does not exceed 1. Accordingly, the transfer will not

bear GST tax.

10.5 DEFINITION OF “TRANSFEROR”

(a) “Transferor” refers to the person who transfers property during life

or at death, such that (i) the initial transfer is subject to estate or gift tax, and (ii) a GST

182 IRC § 2642(a)(2).


transfer occurs either at the time of the transfer or will or may occur later as the result of

a taxable distribution or a taxable termination.

(1) A beneficiary who possesses a general power of

appointment is deemed to be the “transferor” of that property at death, irrespective of

whether the power is exercised or whether the beneficiary made the initial transfer of

property. Thus, the son in the example in Section 10.3(d) is considered the transferor,

which is why the taxable termination is not subject to generation-skipping transfer tax.

(2) A surviving spouse is deemed to be the transferor of a QTIP

Trust established by the surviving spouse’s spouse where a QTIP election is made, and

the QTIP Trust is subject to gift or estate tax with respect to the surviving spouse.

(A) The transferor spouse who established the QTIP

Trust can make what’s called a “reverse QTIP election”, which is effective for

generation-skipping transfer tax purposes only. In that event, the transferor spouse,

and not the surviving spouse, will be treated as the “transferor” for generation-skipping

transfer tax purposes.

(B) A transfer is subject to estate or gift tax if it is included

in the transferor’s gross estate (for estate tax purposes) or it is treated as part of the

gross gift made by the transferor (for gift tax purposes), even if there is no actual estate

or gift tax paid because of exclusions, deductions or credits.

(3) Gifts of community property and gifts subject to a gift splitting

election under IRC § 2513: Each spouse is deemed to be the transferor of one-half

(1/2) of the gift.

10.6 SKIP PERSONS VS. NON-SKIP PERSONS

Skip persons and non-skip persons are defined in IRC § 2613.

(a) A “skip person” is any individual who is two or more generations

below the transferor. The most common skips occur between grandparents and

grandchildren.

(b) A “skip person” includes a trust in which all of the beneficial

interests are held by skip persons, OR


(1) There is no person holding an interest in such trust, and

(2) At no time after such transfer may a distribution (including

distributions on termination) be made from such trust to a nonskip person.

(c) A non-skip person is anyone who isn’t a skip person. Charities and

qualified charitable remainder trusts can’t be skip persons.

10.7 GENERATION ASSIGNMENTS

The generation assignment rules are set forth in IRC § 2651.

(a) Spouses, former spouses and charities are deemed to be in the

same generation as the transferor.

(b) Relatives of the transferor are assigned generations according to

lineal relationship and not age.

(1) Relationships by half-blood are treated as whole-blood

relationships for purposes of these rules.

(2) Relationships based on adoption are treated as whole-blood

relationships for purposes of these rules.

(3) Relationships by marriage (i.e., step-parent and step-child)

are measured by lineal relationship and not age.

(c) Individuals who are not lineal descendants

(1) An individual born not more than 12 ½ years after the

transferor is considered a member of the transferor’s generation.

(2) An individual born more than 12 ½ years but not more than

37 ½ years after the transfer is assigned the first generation younger than the

transferor.

(3) Similar rules for a new generation every 25 years.

(d) Planning for same sex couples. Same sex marriage is

recognized in several states, but it is not recognized by California or the federal

government.


(1) What if a partner wants to make a gift to a child of the other

partner? Do the lineal relationship rules apply? It is unclear under California domestic

partnership law whether certain familial relationships based on the partnership (i.e.,

step-relatives and in-laws) will be recognized.

(2) Best practice: Follow the rules for individuals who are not

lineal descendants and count the years until the laws are clarified.

(e) Move-up-a-generation rule: A grandchild of the transferor will be

deemed the child of the transferor if the grandchild’s parent who is the child of the

transferor predeceased the transfer. In that event, the grandchild will not be considered

a skip person.183

10.8 EXCLUSIONS FROM GENERATION-SKIPPING TRANSFER TAX

(a) Gifts that are direct payments of tuition or medical care expenses

are not subject to generation-skipping transfer tax.184

(b) If a gift is exempt from gift tax due to IRC § 2503(b) (annual

exclusion gift) or IRC § 2503(c) (gift to minor), then the gift will not be subject to

generation-skipping transfer tax.

(c) Gifts in trust, even if they are exempt from gift tax pursuant to IRC

§ 2503(b) or IRC § 2503(c), will be subject to generation-skipping transfer tax unless:

(1) Only the beneficiary can receive income or principal during

the beneficiary’s lifetime; and

(2) Any amount remaining at the beneficiary’s death is includible

in the beneficiary’s estate for estate tax purposes (i.e., the beneficiary has a general

power appointment as defined under IRC § 2041, or an interest in the property pursuant

to IRC § 2033).

183 IRC § 2651(e).

184 IRC § 2611(b)(1).


(d) A transfer is exempt if the property transferred was subject to a

prior generation-skipping transfer.

(e) As discussed above, taxable terminations and taxable distributions

that are subject to estate tax or gift tax are not subject to generation-skipping transfer

tax.

10.9 EFFECT OF DISCLAIMERS ON GENERATION-SKIPPING TRANSFER

TAX

If an individual makes a qualified disclaimer under IRC § 2518, the

disclaiming individual is not the transferor for gift tax purposes. However, the transfer

could be a generation-skipping transfer.

Example: Dad gives property to daughter, who makes a timely disclaimer

such that grandchild takes the property. This results in a direct skip from Dad to

grandchild.

10.10 ALLOCATION OF GST EXEMPTION

(a) Direct skips: GST exemption is automatically allocated to direct

skips. However, the donor can opt out of automatic allocation185.

(b) Indirect skips: Indirect skips are gifts currently subject to gift tax

that may be subject to GST later (i.e., taxable termination or taxable distribution). The

donor does not have to affirmatively elect to allocate GST to these transfers186.

185 See IRC § 2632(b) and Form 709, Schedule A, Part 2. 186 See IRC § 2632(c) and Form 709, Schedule A, Part 3.


10.11 SAMPLE NOTICE OF GST ALLOCATION

Attached to and made a part of

United States Gift (and Generation-Skipping Transfer) 2010 Tax Return (Form 709)

JOHN DOE Social Security No. 123-45-6789

NOTICE OF ALLOCATION

TRUST:

Doe Family Life Insurance Trust (Item 1 on taxpayer’s Form 709 for 2010), Jane

Doe, Trustee

(Address)

EIN____________

[Copy of the Trust is attached hereto as Exhibit A]

NET VALUE FOR GST EXEMPTION ALLOCATION PURPOSES:

$10,000

AMOUNT OF GST EXEMPTION ALLOCATED:

The taxpayer allocates to the Trust the smallest amount of the taxpayer’s

GST exemption necessary to produce an inclusion ratio (as defined in Internal

Revenue Code Section 2642(a)) for the Trust that is closest to or, if possible,

equal to zero. This is a formula election which will change if values are changed

on audit. Based on values as returned this allocation will result in $10,000 of GST

exemption allocated to the Trust, computed as described below.


ARTICLE XI

COMPUTATION OF GIFT TAX

11.1 STEP 1 – COMPUTATION OF TAX IN CURRENT YEAR AND PRIOR

YEARS

(a) Determine the tentative tax on all taxable gifts through the current

year and gifts for prior years.187

(b) The amount of GST tax paid in the current year is added to the

base of the taxable gifts for that year. In other words, the donor pays gift tax on any

GST tax paid.

(c) Marital and charitable deductions are applied to determine the tax

base upon which the tentative tax is calculated.

11.2 STEP 2 – SUBTRACTION OF PRIOR TAX PAID

The gift tax on all taxable gifts made prior to the current taxable year is

subtracted.188

11.3 STEP 3 – APPLICATION OF UNUSED GIFT TAX CREDIT

Any unused gift tax credit is applied. It is used on a first come, first served

basis. This is the only credit applied against gift tax.189

11.4 EXAMPLE

Dad made a gift to his son of $500,000 in 2011. What is Dad’s gift tax

liability, if any, in 2011?

187 IRC § 2502(a).

188 IRC § 2502(a)(2).

189 IRC § 2505(a).


(a) STEP 1: Calculate tentative tax on current gifts plus prior gifts.

The tax on $500,000 is $155,800. The tax base does not include GST paid because

these are not GST gifts.

(b) STEP 2: Subtract the tentative tax on prior gifts. That is $0

because there are no prior taxable gifts.

(c) STEP 3: The gift tax is 0 because the gift tax credit exceeds the

gift, but the available credit under IRC § 2010(c) is reduced.


ARTICLE XII

GIFT TAX PROCEDURE

12.1 GIFT TAX RETURNS

(a) Form

Federal gift tax returns are filed on Form 709, United States Gift (and

Generation-Skipping Transfer) Tax Return.

(b) When Return Required

(1) Any individual U.S. citizen or resident who transfers a

present interest by gift is required to file a gift tax return (regardless of whether gift tax is

due) for the calendar year in which the gift is made unless the gift is excluded by:

(A) The annual exclusion;

(B) The gift tax marital deduction;

(C) The gift tax exclusion for qualified tuition or medical

expenses; or

(D) The gift tax charitable deduction. 190

(2) Joint gift tax returns by spouses are not allowed; instead,

gifts may be split by the spouses as discussed above.

(3) Even if no tax is due on a transfer to a spouse, a return may

be required to make a QTIP election.

(4) The gift tax charitable deduction does not cover split interest

gifts to charity, so gift tax returns are required to report gifts to charitable remainder

190 IRC § 6019.


trusts, charitable lead trusts, and any other charitable gift of less than the donor's entire

interest.191

(c) Filer

(1) Generally, the donor must file a gift tax return.

(2) If a donor dies before filing a required return, the executor or

administrator of the estate must file the return.192

(3) If a donor cannot file a required return due to illness,

absence, or nonresidence, the donor's guardian must file the return.193 If an agent files

a return, a statement explaining the circumstances must accompany the return, and the

fact that filing a return is inconvenient for the donor is not enough to allow an agent to

file the return.194 A return filed by an agent must be ratified by the donor within a

reasonable time after the taxpayer becomes able to do so; otherwise, the return is not

considered complete.195

(d) Where to File

Gift tax returns are filed with the Internal Revenue Service Center,

Cincinnati, Ohio 45999.

12.2 TIME TO FILE

(a) Generally, gift tax returns are filed on a calendar year basis,196 and

a required return must be filed by April 15th of the year following the year in which the

191 IRC § 6019(3).

192 Treas. Reg. § 25.6019-1(g).

193 Treas. Reg. § 25.6019-1(g).

194 Treas. Reg. § 25.6019-1(h).

195 Treas. Reg. § 25.6019-1(h).

196 IRC § 6019.


gift is made.197 If the due date falls on a weekend or a legal holiday, the return is due

the next day that is not a weekend or a legal holiday.198

(b) If the donor dies during the calendar year in which a gift is made,

the gift tax return must be filed by the earlier of the due date for the donor's estate tax

return (regardless of whether that return is extended) or April 15th of the year following

the year in which the gift was made.199 If no estate tax return is required, the gift tax

return is due April 15th of the following year.200

(c) The time for filing a gift tax return may be extended by six months

by filing either Form 4868, Application for Automatic Extension of Time To File U.S.

Individual Income Tax Return (which automatically extends the due date for a gift tax

return required for the same calendar year), or Form 8892, Application for Automatic

Extension of Time To File Form 709, before the original due date.201 Extending the time

to file does not extend the time to pay any gift tax, so payment of the estimated tax must

be made by the original due date.202

(d) The automatic six-month extension is generally the only extension

allowed for the time to file gift tax returns.

197 IRC § 6075(b)(1).

198 Treas. Reg. § 25.6075-1(d).

199 IRC § 6075(b)(3).

200 Treas. Reg. § 25.6075-1(b)(2).

201 IRC § 6075(b)(2).

202 Treas. Reg. § 25.6161-1(a)(3).


12.3 PAYMENT OF TAX

(a) The gift tax must generally be paid at the original time for filing the

gift tax return, regardless of any extension of time to file the return.203

(b) The IRS may extend the time to pay if the taxpayer shows that

payment on the due date will result in undue hardship that amounts to a substantial

financial loss, such as the sale of property at a "sacrificial" price.204

(c) A taxpayer may request an extension of the time to pay in

writing.205 The request should include documentation supporting the undue hardship, a

statement of the taxpayer's assets and liabilities, and an itemized list of all receipts and

disbursements for each of the three immediately preceding months. The request should

be sent to the Department of the Treasury, Internal Revenue Service, Cincinnati, Ohio

45999.

(d) Six months is generally the longest the time to pay may be

extended.206 A longer period may be given to a person who is abroad.207

(e) Even if the time to file is extended, interest will accrue on any

unpaid tax from the original due date until the date the tax is paid.208

203 IRC § 6161(a); Treas. Reg. § 25.6161-1(a)(3).

204 IRC § 6161(a)(1).

205 Treas. Reg. §25.6161-1(c).

206 IRC § 6161(a)(1).

207 Treas. Reg. § 25.6161-1(a)(1).

208 Treas. Reg. § 25.6161-1(d).


12.4 STATUTE OF LIMITATIONS

(a) Timely filing a gift tax return starts a three-year period for

assessment of additional taxes with respect to the calendar year covered by the

return.209

(b) The statute of limitations does not begin running on any gift that

was not disclosed on the gift tax return in a manner that adequately informs the IRS of

the nature of the transaction.210 Before the adequate disclosure rules, the statute of

limitations did not begin if no gift tax was assessed, so taxpayers had little protection

against future adjustments by the IRS.

(1) The adequate disclosure rules first applied only to gifts

subject to §§ 2701 or 2702, but the rules were extended in 1997 to apply to all gifts.211

(2) Under these rules, the value of a gift is fixed for gift tax

purposes if the gift was reported on the gift tax return in a manner adequate to inform

the IRS of the nature of the transaction and the statute of limitations has run.

(3) A gift tax return adequately discloses a transfer if it contains

all of the following:

(A) A description of the transferred property and any

consideration received by the transferor;

(B) The identity of and relationship between the transferor

and the transferee;

209 IRC § 6501.

210 IRC § 6501(c).

211 1997 Taxpayer Relief Act, P.L. 105-34 (eff. for gifts made after Aug. 5, 1997).


(C) If property is transferred in trust, the trust's taxpayer

identification number must be given along with a description of the trust terms or a copy

of the trust;

(D) A detailed description of the method used to

determine the value of the property transferred; and

(E) A statement describing any position taken on the

return that is contrary to any regulation or revenue ruling published at the time.212

(c) No statute of limitations prevents the assessment of additional tax

at any time if a false or fraudulent return is filed with the intent to evade tax.

212 Treas. Reg. § 301.6501(c)-1(f)(2)(i) through (v).


ARTICLE XIII

COMMON GIFT STRATEGIES

13.1 IRREVOCABLE LIFE INSURANCE TRUST

(a) Grantor establishes irrevocable life insurance trust and either

(i) acquires a new policy (preferred) or (ii) transfers an existing policy to the trust.213

(b) Grantor makes gifts to the trust in the amount of the premiums.

The Trustee then pays the premiums with the cash gifts.

(c) ILITs usually include Crummey powers so that the grantor can use

the grantor’s annual exclusion to shield the cash gifts from gift tax.

13.2 QUALIFIED PERSONAL RESIDENCE TRUST

(a) Grantor makes a gift of a property interest to a Qualified Personal

Residence Trust (“QPRT”) for a term of years. At the end of the term, the property

passes to beneficiaries (typically descendants).

(b) The value of the gift is the present value of the remainder interest.

(c) The beneficiaries receive the grantor’s cost basis because it is a

lifetime gift.

(d) If the grantor survives the term, the grantor may continue to reside

in the residence, but the grantor must pay the beneficiaries fair market rent. Otherwise,

the grantor runs the risk that the IRS will determine that the grantor did not relinquish

dominion and control and determine that the residence is includible in the grantor’s

estate for estate tax purposes. However, there are options for paying rent so that it is

not paid monthly (i.e., quarterly payments, automatic deposit).

213 See IRC § 2035. If the grantor transfers an existing policy to the trust and dies within three years of the transfer, the policy will be includible in the grantor’s estate for estate tax purposes. This “three-year rule” does not apply to a new policy acquired by the trust.


(e) If the grantor does not survive the term, the property is includible in

the grantor’s estate for estate tax purposes.

(f) Because QPRT assets are includible in the grantor’s estate until the

term ends, GST cannot be allocated to QPRT assets until the end of the term.

(g) A QPRT is considered a grantor trust, which means that the grantor

is treated as the owner for income tax purposes and can continue to claim property tax

deductions during the term.

(h) Some clients are reluctant to consider QPRTs because of the fear

that the client can be kicked out of his or her home by the remainder beneficiaries

(usually children). However, the grantor is the sole beneficiary during the term, and the

term is usually based on life expectancy. Thus, this fear is usually unfounded.

13.3 GRANTOR RETAINED ANNUITY TRUST/GRANTOR RETAINED

UNITRUST

(a) A Grantor Retained Annuity Trust (“GRAT”) is a transfer of property

to a trust for a term of years, during which the grantor retains an annuity interest (the

right to receive a fixed annuity, at least annually). A Grantor Retained Unitrust is a

transfer of property to a trust for a term of years, during which the grantor retains a

unitrust interest (right to receive a fixed percentage of principal, values annually).

(b) Typically, the grantor acts as trustee of his or her own

GRAT/GRUT.

(c) The value of the gift is the present value of the remainder interest

passing to the beneficiaries at the end of the term. The longer the term, and the larger

the annuity/unitrust interest, then the lower the value of the gift. “Zeroed-out GRATs”

use the annuity amount and term to reduce the value of the remainder interest to zero.

(d) If the grantor does not survive the term, then the GRAT/GRUT is

included in the grantor’s estate for estate tax purposes.

(e) Because GRAT/GRUT assets are includible in the grantor’s estate

until the term ends, GST cannot be allocated to GRAT/GRUT assets until the end of the

term.


13.4 SALE TO INTENTIONALLY DEFECTIVE GRANTOR TRUST (“IDIT”)

(a) A sale of a grantor’s assets to an intentionally defective irrevocable

trust (“IDIT”) is a way for a grantor to freeze asset value in the grantor’s estate in a way

that is ignored for income tax purposes.

(b) Grantor establishes an irrevocable grantor trust. Grantor makes a

gift to the trust, usually at least ten percent (10%) of the seed money of the purchase.

(c) An asset, usually an appreciated, income producing asset, is sold

to the IDIT. The purchase price is (i) the seed money, and (ii) a promissory note.

(d) The asset purchased by the IDIT is excluded from the grantor’s

estate because it is a sale.

(e) The grantor does not recognize income tax (i.e., capital gain) on the

sale because the grantor and the IDIT are treated as the same taxpayer for income tax

purposes.

(f) Income of the IDIT is taxed to the grantor.

(g) Only gift is the initial gift of the seed money. Any unpaid balance of

the promissory note is includible in the grantor’s estate at the grantor’s death. Thus, the

note should be for a term within the grantor’s actuarial life expectancy.

(h) If the grantor fails to survive the IDIT term, it is unclear whether

remaining gain on sale from the note is accelerated and recognized by the grantor’s

heirs. Current capital gains tax rates are lower than estate tax rates. It is not

uncommon for a grantor to obtain additional life insurance to pay the capital gains tax if

this occurs.

(i) IRS review of sales to IDITs is aimed at establishing commerciality.

Thus, it is common to use (i) a ten percent (10%) seed gift and (ii) a pledge of the

interest to secure the debt in order to present a bona fide transaction.


ARTICLE XIV

PRESIDENT OBAMA’S FEBRUARY 2012 BUDGET PROPOSAL

14.1 INTRODUCTION

President Obama’s proposed budget for 2013 was released in February

2012. The proposed budget includes several changes to the estate tax, generation-

skipping transfer tax (“GSTT”) and gift tax regime.

14.2 RESTORE 2009 ESTATE, GIFT AND GSTT TAX REGIME

(a) President Obama’s proposed budget would restore the estate, gift

and GSTT regime in effect in 2009. In that event, the Basic Exclusion Amount214 would

be reduced to $3,500,000, and the top tax rate would be 45%.

(b) The portability of a spouse’s unused Exclusion Amount would be

made permanent.

14.3 REQUIRE CONSISTENCY IN VALUATION

(a) IRC § 1014 provides that the basis of property acquired from a

decedent is the fair market value as of the decedent’s date of death. For estate tax

purposes, the property included in the decedent’s estate is valued the same way, but

current law does not explicitly require that the recipient’s basis in the property be the

same as the value of the property reported for estate tax purposes.

(b) President Obama’s proposed budget would require the basis in

property received from a decedent to equal the value of the property for estate tax

purposes.

(c) The proposed budget would require the executor of a decedent’s

estate and the donor of a lifetime gift, respectively, to provide the IRS and the gift

recipient with valuation and basis information.

214 IRC § 2010(c)(2).


14.4 MODIFY RULES ON VALUATION DISCOUNTS

(a) IRC §§ 2701-2704, which are discussed above, were enacted to

prevent the reduction of taxes due to certain transactions (i.e., estate freezes) between

family members. IRC § 2704(b) provides that certain “applicable restrictions” are to be

ignored for interests in family-controlled entities if those interests are transferred to other

family members. However, case law and certain state law has had the effect of

recharacterizing these restrictions such that they no longer fall within the definition of an

“applicable restriction.”

(b) President Obama’s proposed budget would create an additional

category of restrictions that could be ignored in valuing an interest in a family-controlled

entity if, after the transfer, the restriction will lapse or may be removed by the transferor

and/or the transferor’s family.

14.5 REQUIRE MINIMUM TERM FOR GRANTOR RETAINED ANNUITY

TRUSTS

(a) A Grantor Retained Annuity Trust (“GRAT”) is an irrevocable trust

in which the grantor retains an annuity interest for a term of years. At the end of the

term, the remaining trust assets are transferred to the trust beneficiaries, who are

generally family members of the grantor. The tax benefit of a GRAT is that if the grantor

survives the term, the appreciation of the assets escapes estate tax. The discounted

value of the remainder interest is reportable as a gift in the year the grantor establishes

the GRAT.

(b) Estate planners often use short terms to reduce the risk that the

grantor will die during the term and cause trust assets to be included in the grantor’s

estate for estate tax purposes. In addition, significant annuity interests are used to

reduce the value of the remainder interest to zero (a “zeroed out GRAT”).

(c) President Obama’s proposed budget would impose a requirement

that a GRAT have a minimum term of ten years and a maximum term of the life

expectancy of the annuitant plus ten years. The proposal would also include a

requirement that the remainder interest have a value greater than zero at the time the


interest is created and would prohibit any increase in the annuity during the trust term.

The proposal would apply to trusts created after the date of enactment.

14.6 LIMIT DURATION OF GSTT EXEMPTION

(a) GSTT is imposed on gifts and bequests to transferees who are two

or more generations younger than the transferor.

(b) GSTT exemption can be allocated to gifts in trust, and the

allocation exempts from GSTT the amount of trust assets equal to the allocation, but

also all appreciation and income on that amount during the existence of the trust.

(c) Several states have repealed their “rule against perpetuities” laws,

which means several states now permit trusts of unlimited duration.

(d) President Obama’s budget proposal would provide that the GSTT

exclusion allocated to a trust would terminate on the 90th anniversary of the creation of

the trust. This would be achieved by increasing the inclusion ratio215 of the trust to one,

which would cause the entire trust to be “nonexempt” for GSTT purposes.

14.7 COORDINATE INCOME AND TRANSFER TAX RULES APPLICABLE

TO GRANTOR TRUSTS

(a) A grantor trust is a trust of which an individual is treated as the

owner for income tax purposes. A grantor trust can be revocable or irrevocable.

(b) For income tax purposes, a grantor trust is taxed as if the deemed

owner and the trust are the same person. Thus, transactions between the trust and the

deemed owner are ignored.

(c) For transfer tax purposes, the trust and the deemed owner are

separate persons, and if the deemed owner has relinquished all dominion and control

and made a completed gift to the grantor trust, then the assets of the trust are not

includible in the deemed owner’s estate for estate tax purposes. 215 IRC § 2642.


(d) President Obama’s proposed budget would change the grantor

trust rules as follows:

(1) Assets of a grantor trust would be includible in the grantor’s

estate for estate tax purposes.

(2) Distributions from a grantor trust during the grantor’s life

would be subject to gift tax.

(3) If a trust ceases to be a grantor trust during a grantor’s

lifetime, the remaining trust assets would be subject to gift tax at that time.

(4) The proposal would also apply to any non-grantor who is

deemed to be an owner of the trust and who engages in a sale, exchange or

comparable transaction with the trust that would have been subject to capital gains if the

person had not been a deemed owner of the trust. In that event, transfer tax would be

imposed on the portion of the trust attributable to the property received by the trust in

the transaction, including all retained income therefrom, appreciation thereon, and

reinvestments thereof less the amount of consideration received by the person in the

transaction. The transfer tax would be payable by the trust.


United States Internal Revenue Service (IRS) Circular 230 disclosure:

To ensure compliance with requirements imposed by the IRS, we inform

you that, unless and to the extent we otherwise state, any U.S. federal tax advice

contained in this communication (including any attachments) is not intended or

written to be used, and cannot be used, by any taxpayer for the purpose of

(i) avoiding penalties under the Internal Revenue Code or (ii) promoting,

marketing or recommending to another party any transaction or matter addressed

herein.

It should be understood that presentations of this nature are for purposes

of discussion and necessarily involve simplification and compression.

Descriptions of tax law in this presentation should be the subject of additional

and more detailed analysis before compliance or planning is implemented in

reliance thereon.

fundamentals of gift tax

Documents

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