michael a. dalton thomas p. langdon - the tax professor's corner

Michael A. Dalton Thomas P. Langdon

s o l u t i o n s m a n u a l

ME-Estates 5th INT 1P.indd 4 1/21/09 11:00:52 AM

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Copyright© 2009 by ME. All rights reserved.

No part of this publication may be reproduced or transmitted in any form or by any means, electronic or mechanical,including photocopy, recording, or any other information storage and retrieval system, without prior permission inwriting from the publisher. Requests for permission to make copies of any part of the work should be mailed to:Permissions Department, ME, 1000 Riverbend Blvd., Suite A, St. Rose, LA 70087.

This publication is designed to provide accurate and authoritative information in regard to the subject matter covered.It is sold with the understanding that the publisher, authors and contributors are not engaged in rendering legal,accounting, tax, financial planning, or other professional services. If legal advice, tax advice, or other professionalassistance is required, the services of a competent professional should be sought.

CFP®, CERTIFIED FINANCIAL PLANNERTM, and CFP (with flame logo)® are certification marks owned byCertified Financial Planner Board of Standards Inc. These marks are awarded to individuals who successfully completeCFP Board’s initial and ongoing certification requirements.

Printed in the U.S.A.

ISBN-10: 0-9801299-5-8ISBN-13: 978-0-9801299-5-3Custom Edition for The College for Financial Planning ISBN-10: 0-9801299-4-x Custom Edition for The College for Financial Planning ISBN-13: 978-0-9801299-4-6

Library of Congress Card Number: 2009921181

PREFACE V

ABOUT THE AUTHORS

Michael A. Dalton, Ph.D., JD, CFP®

• Principal of Cobalt Financial Solutions, L.L.C.• Former Chair of the Board of Dalton Publications, L.L.C.• Associate professor of Accounting and Taxation at Loyola University in New Orleans, Louisiana.• Adjunct faculty in Financial Planning at Georgetown University in Washington, D.C.• Former Senior Vice President, Education at BISYS Group.• Ph.D. in Accounting from Georgia State University.• J.D. from Louisiana State University in Baton Rouge, Louisiana.• MBA and BBA in Management and Accounting from Georgia State University.• Former board member of the CFP Board’s Board of Examiners, Board of Standards, and Board of Governors. • Former member (and chair) of the CFP Board’s Board of Examiners.• Member of the Journal of Financial Planning Editorial Advisory Board and Editorial Review Board.• Member of the LSU Law School Board of Trustees (2000 - 2006).• Author of Dalton Review for the CFP® Certification Examination: Volume I – Outlines and Study Guides, Volume II – Prob-

lems and Solutions, Volume III - Case Exam Book, Mock Exams A-1 and A-2 (1st - 8th Editions).• Author of Retirement Planning and Employee Benefits for Financial Planners (1st - 5th Editions).• Co-author of Income Tax Planning for Financial Planners (1st - 2nd Editions).• Co-author of Dalton CFA® Study Notes Volumes I and II (1st - 2nd Editions); Co-author of Dalton’s Personal Financial

Planning Series – Personal Financial Planning Theory and Practice (1st - 3rd Editions) and Personal Financial Planning Casesand Applications (1st - 4th Editions).

• Co-author of Cost Accounting: Traditions and Innovations published by West Publishing Company.• Co-author of the ABCs of Managing Your Money published by National Endowment for Financial Education.

Thomas P. Langdon, JD, LL.M., CFA, CFP®

• Associate Professor of Business Law, Gabelli School of Business, Roger Williams University, Bristol, RI.• Principal, Langdon & Langdon Financial Services, LLC (Connecticut-based tax planning & preparation firm).• Former Professor of Taxation at The American College, Bryn Mawr, PA.• Former Adjunct Professor of Insurance and Economics at The University of Connecticut Center for Professional Develop-

ment.• Former Member (and Chair) of the CFP Board’s Board of Examiners.• Master of Laws (LL.M.) in Taxation from Villanova University School of Law.• Juris Doctor, from Western New England College School of Law.• Master of Science in Financial Services from The American College.• Master of Business Administration from The University of Connecticut.• Bachelor of Science in Finance from The University of Connecticut, Storrs, CT.• Chartered Financial Analyst (CFA), Certified Financial Planner (CFP), Chartered Life Underwriter (CLU), Chartered

Financial Consultant (ChFC), Accredited Estate Planner (AEP), Certified Employee Benefits Specialist (CEBS), Char-tered Advisor in Senior Living (CASL), Registered Employee Benefits Consultant (REBC), Registered Health Under-writer (RHU), Associate in Life & Health Claims (ALHC), and Fellow of the Life Management Institute (FLMI).

• Co-author of Income Tax Planning for Financial Planners (1st - 2nd editions).

VI PREFACE

ABOUT THE CONTRIBUTOR

Phyllis Duhon made a significant contribution to this text by her thoughtful and meticulous reading, rewriting, andediting throughout the book. She provided many valuable suggestions to both the text and instructor materials thatsignificantly improved this edition. We are extremely grateful for her contributions. Phyllis received her J.D. fromLoyola University New Orleans College of Law and a B.S. in Business Administration/Finance from the University ofNew Orleans.

ABOUT THE REVIEWERS

We owe a special thanks to several key professionals for their significant contribution of time and effort with this text.These reviewers provided meticulous editing, detailed calculation reviews, helpful suggestions for additional content,and other valuable comments, all of which have improved this edition.

Allison Dalton McCammon is an attorney and personal financial planner specializing in Small Business Planning andEstate Planning. She received her J.D. from Georgetown University Law Center, an Executive Certificate in FinancialPlanning from Georgetown University, and a B.A. in International Studies from Rhodes College. She is a contributor toprevious editions of this text and to Money Education’s Retirement Planning and Employee Benefits for Financial Plannersand Income Tax Planning for Financial Planners.

Kristi M. Tafalla is an attorney and personal financial planner specializing in income tax and estate planning. Sheteaches estate planning, income tax planning and comprehensive case courses through various CFP Board-RegisteredPrograms as well as comprehensive reviews for the Certified Financial Planner designation. She is a contributor toprevious editions of this text and to Money Education’s Retirement Planning and Employee Benefits for FinancialPlanners.

Chris White teaches the financial planning program to financial service professionals, attorneys, insurance agents,CPAs, and others working to attain their CFP® certification at Xavier University in Cincinnati. He is also the VicePresident of Financial Planning at Provident Financial Advisors, a member of the Financial Planning Association and aninstructor for the BISYS Review for the CFP® Certification Examination. Mr. White has an MBA with a concentrationin Taxation from Xavier University and a B.S. in Accounting from the University of Cincinnati. After using the 2ndEdition in his estate planning course, he provided invaluable feedback on where improvements could be made for the3rd edition.

TABLE OF CONTENTS VII

Table of ContentsTable of Contents

Discussion Questions.................................................................................................... 1

Multiple-Choice Problems ............................................................................................ 3

Discussion Questions.................................................................................................... 9

Multiple-Choice Problems .......................................................................................... 12

Discussion Questions.................................................................................................. 19






1. INTRODUCTION TO ESTATE PLANNING

2. BASIC ESTATE PLANNING DOCUMENTS

3. TYPES OF PROPERTY INTERESTS

4. THE PROBATE PROCESS

5. GIFT TAX

VIII TABLE OF CONTENTS

Discussion Questions .................................................................................................. 55








Discussion Questions ................................................................................................ 101

Multiple-Choice Problems ........................................................................................ 110







6. ESTATE TAX

7. TRANSFERS DURING LIFE & AT DEATH

8. TRUSTS

9. CHARITABLE GIVING

10. THE UNLIMITED MARITAL DEDUCTION

11. LIFE INSURANCE IN ESTATE PLANNING

12. SPECIAL ELECTIONS & POST MORTEM PLANNING

13. GENERATION-SKIPPING TRANSFERS

DISCUSSION QUESTIONS 1

1Introduction to Estate

PlanningIntroduction to Estate

Planning

1. Define estate planning.Estate planning is the process of the accumulation, management, conservation, andtransfer of wealth considering legal, tax, and personal objectives.

2. Explain the estate and generation-skipping transfer ramifications of the EconomicGrowth and Tax Relief Reconciliation Act of 2001.The Economic Growth and Tax Relief Act of 2001 repeals the estate and generation-skipping transfer tax in 2010. The repeal is phased in over a nine year period (2001-2009). After 2010, the estate and generation-skipping transfer tax comes back in fullforce as it was in 2001.

3. What is an effective transfer?An effective transfer occurs when the person’s assets are transferred to the person or insti-tution intended by the client.

4. What is an efficient transfer?An efficient transfer occurs when transfer costs are minimized consistent with the great-est assurance of effectiveness.

5. List three common goals of estate planning.The following are goals of estate planning:• Fulfill client’s property transfer wishes.• Minimize transfer taxes.• Minimize transfer costs.

6. List some of the reasons people avoid estate planning.The following are reasons people avoid estate planning:• Some find contemplating their own death too morbid.• Some are simply unaware of the total fair market value of their assets.• Some are unaware of the transfer costs.

DISCUSSION QUESTIONS

2 CHAPTER 1: INTRODUCTION TO ESTATE PLANNING

7. Discuss some of the risks associated with failing to plan for estate transfer.The following are risks associated with failing to plan for estate transfers:• Client’s property transfer wishes go unfulfilled.• Transfer taxes are excessive.• Transfer costs are excessive.• Client’s family not properly provided for financially.• Insufficient liquidity to cover client’s debts, taxes, and costs at death.

8. List the six basic steps of the estate planning process.The six basic steps to the estate planning process are:1. Establish the client/planner relationship.2. Gather client information, including the client’s current financial statements and estab-

lish the client’s transfer objectives, including family and charitable objectives.3. Determine the client’s financial status. 4. Develop a comprehensive plan of transfers consistent with all information and objec-

tives.5. Implement the estate plan.6. Review the estate plan periodically and update the plan when necessary (especially for

changes in family situations).

9. What is usually the most important client objective?Usually the most important client objective is to transfer assets according to the client’swishes.

10. List the members of the estate planning team and describe their roles.The members of the estate planning team and their roles are:• A licensed attorney is almost always a part of the team, as the process requires drafting

numerous legal documents. • A CPA is usually involved as a member of the estate planning team because the process

requires the identification of assets, the calculation of the adjusted basis of assets, andother tax issues.

• An insurance specialist is usually involved to help assure asset protection and liquidity atdeath.

• The financial planner may serve as the team captain and assist in data collection, analy-sis, and investment decisions.

• The trust officer manages the assets of any trusts involved in the estate plan.

11. Why must a financial planner be concerned with the unauthorized practice of law?Some of the situations that financial planners become involved with require someone to bea licensed attorney in the jurisdiction where the practice is occurring. For example, financialplanners are often involved with reviewing wills, powers of attorney, and trust documents,all documents that must be drafted by a licensed attorney. The financial planner must becareful not to draft, amend, or create these documents on his own, or give legal advice.

MULTIPLE-CHOICE PROBLEMS 3

1. Which of the following is included in the definition of estate planning?

1. Asset management.

2. Accumulation of wealth.

3. Asset preservation.

a. 1 only.

b. 1 and 2.

c. 2 and 3.

d. 1, 2, and 3.

The correct answer is d.All of the items listed are included in the definition of estate planning. Estate planning isthe process of accumulation, management, conservation, and transfer of wealth consideringlegal, tax, and personal objectives.

2. Which of the following statements is the best definition of estate planning?

a. Estate planning is the process of accumulation, management, conservation, andtransfer of wealth considering legal, tax, and personal objectives.

b. Estate planning is the management, conservation, and transfer of wealthconsidering estate tax transfer costs.

c. Estate planning is the management, conservation, and transfer of wealthconsidering legal, tax, and personal objectives.

d. Estate planning is the process of accumulation, management, conservation, andtransfer of wealth considering estate and generation-skipping transfer tax costs.

The correct answer is a.The best definition of estate planning includes the accumulation of wealth and the consid-eration of all legal, tax, and personal objectives. Estate planning is the process of accumula-tion, management, conservation, and transfer of wealth considering legal, tax, and personalobjectives.

3. Which of the following does not need estate planning?

a. Charles, age 30, married with two minor children, and a net worth of$375,000.

b. Sheila, age 35, never been married, one severely disabled son.

c. Cynthia, age 45, single, has a net worth of $450,000 and two dogs.

d. All of the above need estate planning.

The correct answer is d.All of the people listed need a will, a plan for incapacity, and a plan for dependents and/orto care for animals.

MULTIPLE-CHOICE PROBLEMS


4. The first step in the estate planning process includes:

a. Meeting with the client and discussing the client’s assets, family structure, anddesires.

b. Prioritizing the client’s goals.

c. Developing a formal written estate plan.

d. Identifying key areas of concern in relation to the client’s plan - taxes, cash onhand, etc.

The correct answer is a.Initially, a financial planner must meet with the client and discuss the client’s assets, familystructure, and desires. Without this information, the financial planner cannot properlybegin the estate planning process. Next, the financial planner would prioritize the client’sgoals. Based on the information gathered during the initial meeting, the financial plannerwould identify key areas of concern and utilize this information during the remainder of theestate planning process. Finally, the financial planner would develop a formal written estateplan. The financial planner would review the formal written estate plan with the client toensure that the client’s goals have been properly identified and that the formal written estateplan includes the transfer of all of the client’s assets.

5. Of the following, who should be a member of the estate planning team?

1. Attorney.

2. Certified Public Accountant (CPA).

3. Life insurance consultant.

4. Loan officer.

a. 1 and 2.

b. 1 and 4.

c. 1, 2, and 3.

d. 1, 2, 3, and 4.

The correct answer is c.A loan officer is not included in the estate planning team. The estate planning team consistsof an attorney, CPA, life insurance consultant, trust officer, and financial planner.

6. Who on the estate planning team usually calculates the adjusted basis of assets and addressestax issues?

a. Licensed attorney.

b. Certified Public Accountant (CPA).

c. Financial planner.

d. Trust officer.

The correct answer is b.A CPA is generally involved as a member of the estate planning team because the processrequires the identification of assets, the calculation of the related adjusted basis, and othertax issues.


7. Which of the following tasks is typically performed by a financial planner who is not alicensed attorney or accountant?

a. Drafting wills, trust documents, and powers of attorney.

b. Calculating asset basis.

c. Preparing financial statements.

d. Collecting data and assisting with investment decisions.

The correct answer is d.The financial planner generally assists in collecting data, analysis, and investment decisions.If the financial planner is also a licensed attorney or a CPA, the financial planner may takeon the role of the attorney or CPA as well.

8. Joe is a financial planner in the state of Iowa. Although he attended one year of law school,Joe is not a licensed attorney. Which of the following actions would be considered thepractice of law?

a. Drafting wills, trust documents, and powers of attorney.

b. Reviewing wills, trust documents, and powers of attorney.

c. Directing a client to seek legal advice from a licensed attorney.

d. Acting as trustee for a client’s trust.

The correct answer is a.Drafting legal documents is considered practicing law. Any of the other actions would notbe considered practicing law. (Note: This varies according to state law and could be differ-ent in some states.)

9. Which of the following statements correctly describes the impact of the Economic Growthand Tax Relief Reconciliation Act of 2001 (EGTRRA 2001)?

a. EGTRRA 2001 repeals the estate tax after 2010.

b. EGTRRA 2001 repeals the estate and generation-skipping transfer tax before2010.

c. EGTRRA 2001 repeals the estate and generation-skipping transfer tax during2010.

d. EGTRRA 2001 repeals the estate and generation-skipping transfer tax after2010.

The correct answer is c.EGTRRA 2001 phases in the repeal of the estate and generation-skipping transfer tax overthe nine year period beginning 2001. At the end of the nine year phase out period, 2010,the estate and generation-skipping transfer taxes are completely repealed. After 2010, theestate and generation-skipping transfer taxes come back in full force as they were in 2001.


10. Which of the following statements concerning the practice of law is correct?

a. The practice of law is defined by each state.

b. Special circumstances are sometimes given to financial planners to enable themto draft wills, trust documents, and other legal documents.

c. Reviewing wills to ensure client goals are being addressed is consideredpracticing law.

d. A licensed attorney can give anyone the right to practice law as their agent.

The correct answer is a.The practice of law is defined on a state-by-state basis. All of the other statements are false.A financial planner cannot be given any special rights to draft legal documents, but a finan-cial planner can review documents without practicing law. Licensed attorneys cannot giveanyone else the right to practice law - only a state can license an attorney to practice law.

11. Joann contacts you on the phone. She is 65 and has accumulated over $3,000,000 in assets.She informs you that she is not married, and wants to leave all of her assets equally to herthree adult children. She agrees to come meet with you, but asks what she should bring.Which of the following items would be least important for her to bring if the topic ofdiscussion is estate planning?

a. Copy of her will and any codicils.

b. Copy of children’s birth certificates.

c. Copy of life insurance policies.

d. Copy of latest bank statements.

The correct answer is b.To develop her estate plan, you would not need copies of her children’s birth certificates.You would need all of the other items.

12. Jimmy would like to meet with you regarding his estate plan. Jimmy is 55 years old, andcurrently has an estate that would be subject to estate tax. His wife died of lung cancer lastyear. Jimmy has three children, ages 23, 26, and 32, and one grandchild, age 4. He does nothave any dependents. Which of the following options would be the least likely reason forJimmy to have an estate plan?

a. Minimize estate and transfer taxes.

b. Minimize costs.

c. Plan for his children.

d. Plan for his incapacity.

The correct answer is c.Planning for children generally refers to planning for minor or dependent children. Becauseall of Jimmy’s children are of the age of majority, Jimmy may not need to plan for his chil-dren. All of the other options are reasons Jimmy should have an estate plan.


13. Don does not want to write a will. It upsets him to contemplate his own death and hesimply desires to avoid the estate planning process. All of the following are risks Don’s estatemay face due to Don’s inaction, except:

a. Don’s property transfers contrary to his wishes.

b. Don’s estate may face liquidity problems.

c. Don’s estate faces increased estate administration fees.

d. Don’s estate faces increased debt payments for outstanding debts at death.

The correct answer is d.Don’s inaction will cause him to die intestate and be subject to the intestacy laws of hisstate. Don’s inaction will also cause him to die without an estate plan. There is no risk thathis estate will be subject to increased debt payments for outstanding debts at death simplybecause he dies intestate or without an estate plan. All of the other options are risks whensomeone dies intestate or without an estate plan.

14. Which the following is a risk of failing to plan for the estate?

1. Property transfers contrary to the client’s wishes.

2. The client’s family may not be provided for financially.

3. The estate suffers liquidity problems at the client’s death.

4. The estate may bear higher transfer costs.

a. 2 only.

b. 2 and 3.

c. 1, 3, and 4.

d. 1, 2, 3, and 4.

The correct answer is d.All the risks listed are risks of not planning for the estate. Proper estate planning can transferproperty per a decedent’s desires, develop a plan for continued family support, create liquid-ity at death, and potentially reduce transfer costs.

Basic Estate Planning Documents

Basic Estate Planning Documents


2

1. List the basic documents used in estate planning.The basic documents used in estate planning include wills, codicils, side instruction let-ters, durable powers of attorney for health care or property, living wills or advancedmedical directives, and Do Not Resuscitate orders.

2. What problems arise for someone who dies intestate?To die intestate is to die without a valid will or with a will that does not dispose of allproperty. In this case, the decedent’s property will be transferred according to state law,which may not reflect the decedent’s desires. Intestacy may also require the state toappoint an administrator who will have to furnish a surety bond, thereby increasing thecosts of administration.

3. Briefly define the types of wills.• Holographic wills are handwritten. The material provisions of the will must be in the

testator’s handwriting. The will must be dated and signed by the testator, and doesnot generally need to be witnessed.

• Nuncupative/oral wills are dying declarations made before sufficient witnesses. Theuse of nuncupative wills is fairly restricted and is not valid in most states.

• Statutory wills are generally drawn by an attorney, complying with the statutes forwills of the domiciliary state. They are usually signed in the presence of the state’srequired number of witnesses and generally notarized.

4. List the common provisions in a valid will.• An introductory clause to identify the testator (will-maker).• The establishment of the testator’s domicile and residence.• The identification of the spouse and children of the testator.• A declaration that this is the last will and testament of the testator.• A revocation of all prior wills and codicils by the testator.


10 CHAPTER 2: BASIC ESTATE PLANNING DOCUMENTS

• The identification and selection of the executor/executrix and successor executor/execu-trix by the testator.

• A directive for the payment of debts clause.• A directive for the payment of taxes clause.• A disposition of tangible personal property clause.• A disposition of real estate clause (that is, residence).• Clauses regarding specific bequests of intangibles and cash.• A residuary clause (the transfer of the balance of any other assets to someone or to some

institution). Note that the failure to have a residuary clause will result in the risk of hav-ing intestate assets (that is, assets accumulated after the making of the will) which passthrough probate. Also, taxes will generally be paid from the residuary unless specificallydirected otherwise.

• A clause regarding who will pay taxes on bequests.• An appointment and powers clause, naming fiduciaries, guardians, tutors, trustees, etc.• A testator’s signature clause.• An attestation clause, or witness clause.• A self-proving clause.

5. Briefly list and define at least three other additional clauses found in wills.Some other clauses in a will are as follows:• Simultaneous death clause – In the event that two people die simultaneously, this clause

provides an assumption of which person died first.• Survivorship clause – This clause provides that the beneficiary must survive the decedent

for a specified period in order to receive the inheritance or bequest. This clause preventsproperty from being included in two different estates in rapid succession.

• Disclaimer clause – This clause simply reminds heirs that disclaiming inheritances maybe an effective tool in estate planning. A disclaimer allows property to pass as if the dis-claiming party predeceased the testator.

• No-contest clause – This clause discourages heirs from contesting the will by substan-tially decreasing or eliminating their bequest if they file a formal, legal contest to thewill.

6. What is a living will?A living will is a document detailing an individual’s last wishes regarding sustainment of life.

7. Why should a living will be prepared in advance?A living will is prepared in advance to explicitly state the client’s wishes and to avoid theneed to seek court approval regarding the use of life sustaining measures.

8. Identify a reason to use a living will.An individual who has been diagnosed with lung cancer and has undergone several invasive,expensive medical treatments may write a living will directing the medical institution tosuspend the use of any life-sustaining medical treatments or devices. Often people in thesesituations are suffering greatly and the expenses incurred have far surpassed any medicalinsurance coverage. The living will is used to curtail pain and suffering, and to avoid incur-ring additional expenses.


9. What is a power of attorney?A power of attorney is a legal document that gives someone else (power holder) the right toact on behalf of a principal.

10. Identify and discuss the parties to a power of attorney.There are two parties to a power of attorney:• Power Holder/Agent – Person to whom powers are given.• Principal – Person who gives power to the power holder.

11. Identify a reason to use a power of attorney.An individual serving in the military will give a power of attorney to a family member sothe family member can handle any circumstances that arise while the individual is activelyserving. Most commonly, the family member only uses the power to sell assets, cars, homes,etc.

12. What is a durable power of attorney?A durable power of attorney is a power of attorney that survives (remains in force) after theincapacity or disability of the principal. Note that a durable power of attorney does not sur-vive the death of the principal.

13. What is a springing durable power of attorney?A springing durable power of attorney does not become active until a certain defined pointin time or event (the trigger). Often, the power will spring upon disability or incapacity.

14. What is a side instruction letter?A side instruction letter details the testator’s wishes regarding the disposition of tangiblepossessions, the disposition of the decedent’s body, and funeral arrangements. The sideinstruction letter exists separately from the will.

15. Identify some examples of instructions included in a side instruction letter.The side instruction letter usually includes burial, funeral, and other similar type instruc-tions. It sometimes also includes information related to debts, safety deposit box locations,and other personal type information that the executor will need during the administrationof the estate.


1. Carl is married and owns and manages several rental properties. He is concerned that if hebecame incapacitated, the properties would not be properly managed and his tenants wouldbe upset. Of the following arrangements, which one could fulfill Carl’s desire to plan for themanagement of his rental properties in the case of his unanticipated physical or mentalincapacity?

a. A durable power of attorney.

b. Owning the property as joint tenancy.

c. Owning the property as tenancy by the entirety.

d. All of the above.

The correct answer is d.Any of the methods can be used to plan for asset management in the case of incapacity. Adurable power of attorney would give the power-holder the ability to manage the property ifCarl becomes incapacitated. If the property is owned joint tenancy or tenancy by theentirety, the joint tenant could manage the property in the event of Carl’s incapacity.

2. Donald drafted his own will utilizing the “Will-Maker” software that he purchased at thelocal office supply store and sends it to you for a review. In your first review of the will, youlook for which of the following most common provisions?

a. A left-over clause.

b. A statement of the domicile of the testator.

c. A primary clause.

d. A specific bequest of property owned tenancy by the entirety.

The correct answer is b.A well-drafted will contains the statement of the domicile of the testator.Both a left-over clause and a primary clause are made up terms. Property owned tenancy bythe entirety transfers to the surviving spouse by state law and should not be included in thewill.

3. After listening to a popular radio financial planning talk show, Deborah decided to grant adurable power of attorney to her neighbor, Jimmy. All of the following statements regardingthe durable power of attorney are correct except?

a. At the creation of the durable power of attorney, Deborah must be at least 18years old and competent.

b. The power can spring at a certain age or event.

c. After Deborah’s death, the power remains in force.

d. If Deborah becomes disabled, the power remains in force.

The correct answer is c.A durable power of attorney does not remain in force after the death of the principal, but adurable power of attorney does remain in force after the disability or incapacity of the prin-cipal. All of the other statements are true.



4. Claudette’s cousin John gave her a general power of appointment over his assets.Disregarding any fidicuary problems, which of the following is not true regarding thepower?

a. Claudette can pay for her own groceries with her cousin’s money.

b. Claudette can pay for John’s groceries with John’s money.

c. Claudette’s gross estate will include John’s assets if Claudette dies before John.

d. The general power of appointment only allows Claudette to appoint John’sassets for expenditures related to health, education, maintenance, or support.

The correct answer is d.A holder of a general power of appointment can appoint the assets of the grantor for anyreason, and to anyone, including herself. The holder of a general power of appointmentmust also include the value of the assets over which the power has been granted in her grossestate if she dies before the principal. A special power of appointment, which restricts theability of the power holder to appoint the assets to herself, would not cause the value of theassets to be included in the power holder’s gross estate if the power holder died before theprincipal.

5. Which of the following documents appoints a surrogate decision-maker for health care?

a. Durable power of attorney for health care.

b. General power of appointment.

c. Life insurance beneficiary designation.

d. All of the above.

The correct answer is a.A durable power of attorney for health care appoints a surrogate decision-maker for healthcare decisions. A general power of appointment gives the power holder the ability toappoint the principal’s assets to anyone and for whatever reason. It does not give any powersrelated to health care decisions. A life insurance beneficiary designation only designates thebeneficiary of life insurance proceeds.

6. Which type of will is handwritten and does not generally require a witness?

a. Holographic.

b. Oral.

c. Nuncupative.

d. Statutory.

The correct answer is a. Holographic wills are handwritten. The material provisions of the will must be in the testa-tor’s handwriting. The will must be dated and signed by the testator, and does not generallyneed to be witnessed.


7. Which type of will complies with the statutes of the domiciliary state and is drawn by anattorney?

a. Holographic.

b. Oral.

c. Nuncupative.

d. Statutory.

The correct answer is d.Statutory wills are generally drawn by an attorney, complying with the statutes for wills ofthe domiciliary state. They are usually signed in the presence of two witnesses.

8. While he was in the hospital, Emile told his wife that if he died he wanted to give his fishingtackle to his son, Joseph; his golf equipment to his son, Joshua; his truck to his daughter,Abigail; and everything else to her (his wife). Emile died the next day without writinganything that he told his wife, but a nurse and another patient were in the room and heardhis declarations. What type of will does Emile have, if any?

a. Holographic.

b. Nuncupative.

c. Statutory.

d. Emile does not have a will.

The correct answer is b.Emile has an oral/nuncupative will - oral dying declarations made before sufficient wit-nesses. An oral/nuncupative will may or may not be valid in Emile’s state of domicile.

9. Of the following, which is not a clause commonly found in a will?

a. Introductory clause.

b. Payment of debts clause.

c. Payment of taxes clause.

d. Conclusory clause.

The correct answer is d.A conclusory clause does not exist so it is not a clause commonly found in a will. An intro-ductory clause identifies the testator. A payment of debts clause directs which heirs/assetswill bear the debts of the estate. A payment of taxes clause directs which heirs/assets willbear the taxes of the estate.


10. Which of the following clauses are commonly found in a will?

1. Residuary clause.

2. Secondary clause.

3. Witness attestation clause.

4. Simultaneous death clause.

a. 1 only.

b. 2 and 3.

c. 1, 3, and 4.

d. 1, 2, 3, and 4.

The correct answer is c.A secondary clause does not exist so it is not a clause commonly found in a will. A residuaryclause directs the transfer of the balance of any assets not already bequeathed. A witnessattestation clause is a declaration that the will was signed in front of witnesses. A simulta-neous death clause provides an assumption of which person died first in the event that twopeople die simultaneously.

11. Which of the following clauses in a will would detail the required amount of time abeneficiary must live following the death of the decedent to receive a bequest?

a. Survivorship clause.

b. Living clause.

c. Remaining life clause.

d. Simultaneous death clause.

The correct answer is a.A survivorship clause provides that the beneficiary must survive the decedent for a specifiedperiod in order to receive the inheritance or bequest. Neither a living clause nor a remaininglife clause exists. A simultaneous death clause provides an assumption of which person diedfirst in the event that two people die simultaneously.

12. Jenny’s will leaves her car to her brother, her boat to her sister, and her vacation home to hercousin. Her will directs the remainder of her assets to be divided equally among her twochildren. Jenny’s will directs all debts and taxes to come from the children’s assets. Of thefollowing, which are included in Jenny’s will?

1. Residuary clause.

2. Specific bequests.

3. Payment of debts and taxes clause.

a. 1 only.

b. 3 only.

c. 1 and 3.

d. 1, 2, and 3.


The correct answer is d.Jenny’s will includes all of the listed items. The residuary clause directs the remainder ofJenny’s assets transfer to her children. Specifically listing the property and the person towhom she is leaving the property, as with her brother, sister, and cousin, are specificbequests. Jenny also directs the payment of debts in her will.

13. Glen’s will leaves all of his property to his wife. If she does not survive him by more thaneight months, the property will transfer to Glen’s only son. Glen dies on April 13 and hiswife dies the following January 12. Of the following statements, which is true?

a. Glen’s property will transfer to his son.

b. Glen’s property will not transfer to his wife.

c. Glen’s property will transfer to his wife, but the property will not be eligible forthe unlimited marital deduction in Glen’s estate.

d. Glen’s property will transfer to his wife and the property will be eligible for theunlimited marital deduction in Glen’s estate.

The correct answer is c.Glen’s will contains a survivorship clause requiring his wife to survive him by more thaneight months to receive his property. Glen’s wife dies nine months after Glen and doesreceive his property. However, if a will contains a survivorship clause, the clause cannot bewritten to require the spouse to outlive the decedent by more than six months to qualify forthe unlimited marital deduction. In this case, the survivorship clause requires eight months,so Glen’s wife will receive the property, but the property will not qualify for the unlimitedmarital deduction.

14. Jorge spent four hours with his attorney drafting his will and ensuring that the willaccounted for everything. The will was signed, witnessed, and notarized before it was filedaway in the attorney’s safety deposit box. Two years later, Jorge reviews the will anddetermines that he had forgotten to account for grandchildren not yet born at the time thewill was written. Which of the following would be the least expensive way for Jorge to addin this new language?

a. Write a codicil.

b. Add a generation-skipping transfer clause to his current will.

c. Revoke the prior will and write a new will.

d. Issue a disclaimer indicating his intentions.

The correct answer is a.Jorge has the option of writing a codicil to amend the will. This would be the least expen-sive and probably easiest way to amend the will. Jorge could also revoke the prior will andwrite a new will, but writing a codicil would certainly be less expensive. Neither a genera-tion-skipping transfer clause nor a disclaimer amends a will.


15. Maxine is terminally ill. Her doctors gave her twenty-four months to live thirty-six monthsago. Maxine has decided that she does not want to be placed on life support. Whichdocument will direct Maxine’s doctors to refrain from putting her on life support?

a. Living will.

b. Power of attorney.

c. Durable power of attorney.

d. General power of appointment.

The correct answer is a.Only a living will would give the doctors the ability to refrain from placing her on life sup-port. A living will, also known as an advance medical directive, is an individual’s written lastwishes regarding sustaining life. It establishes the medical situations and circumstances inwhich the individual no longer wants life-sustaining treatment. Neither a power of attorneynor a durable power of attorney would give the ability to end life-sustaining treatment.

16. Donald agreed to sell his house to his brother, but could not attend the closing date of thesale (act of sale). Of the following options, which would allow Donald’s mother to attendthe closing and sign the necessary documents on Donald’s behalf?

a. Living will.

b. Advanced real estate directive.

c. Power of attorney.

d. Side instruction letter.

The correct answer is c.Donald could give his mother a power of attorney to sign the documents at the closing dateof the sale. None of the other options would be appropriate in this case. An advanced realestate directive does not exist.

17. As part of his military duties, Matthew has been called to active duty. Six years ago, inanticipation of being called to service, Matthew gave his brother a power of attorney over allof his property that should only be effective when Matthew is on active duty. Of thefollowing, what should this power of attorney include?

1. Springing powers.

2. Durable powers.

3. Limited powers.

4. General powers.

a. 4 only.

b. 1 and 2.

c. 3 and 4.

d. 1, 2, and 3.

The correct answer is d.The power Matthew gives to his brother should include springing provisions, should belimited, and should be durable. The power should spring to force only when Matthewbecomes active in the military. The limited powers would restrict Matthew’s brother’s abili-


ties to appoint the property to himself. It would also keep the value of Matthew’s assets outof his brother’s gross estate, if his brother were to die before him. Including a durability fea-ture in the power would keep the power of attorney in force even if Matthew becomes inca-pacitated or disabled. Remember, however, that no power of attorney survives death.

18. Martin has given his father, Edward, a springing durable power of attorney over his realestate holdings. The power of attorney springs if Martin is ever out of the country. Of thefollowing statements regarding this power, which is not true?

a. If Martin becomes disabled while travelling in Italy, Edward can continuemaking decisions regarding the real estate.

b. If Martin dies while travelling in Taiwan, Edward can continue makingdecisions regarding the real estate under the power of attorney.

c. Martin can revoke the power at any time.

d. Edward can do anything that Martin can do with respect to the real estate.

The correct answer is b.No power of attorney survives death. If Martin dies, the executor of Martin’s estate or thecourt appointed administrator of Martin’s estate, controls the property and will act in Mar-tin’s place. All of the other options are correct with regard to the power of attorney.

19. Bob has been a party animal his entire life. Many times, after his late night partying, Bobhas been heard telling his friends that when he dies he wants his friends to throw a party inhis honor. He tells them that he has even set aside some funds in his estate to pay for theparty. If Bob is serious, in what document should he include this type of information?

a. Will.

b. Living will.

c. Side instruction letter.

d. Durable power of attorney.

The correct answer is c.Bob should include this information in a side instruction letter. A side instruction letterdetails the testator’s wishes regarding the disposition of tangible possessions, the dispositionof the decedent’s body, and funeral arrangements. This type of information should not beincluded in the will because it may create confusion, the will might not be located timely,and if the testator wants to change his desires, it is much easier to change the side instruc-tion letter. The other options are not appropriate for these details.

20. Match the following characteristics:

A durable power of attorney survives incapacity. Neither a durable power of attorney nor anondurable power of attorney survives death. Both a durable power of attorney and a non-durable power of attorney can be revoked by a competent party.

A Survives incapacity A. Durable power of attorneyD Survives death B. Nondurable power of attorneyC Can be revoked by a competent party C. Both

D. Neither

Types of Property Interests

Types of Property Interests


3

1. List and define the three major types of property.• Real property - land and buildings; • Tangible property- property that is not realty and may be touched such as cars, cloth-

ing, and jewelry; and• Intangible property- property that cannot truly be touched such as stocks, bonds,

patents, and copyrights.

2. List at least three types of property ownership.Fee simple, tenancy in common, joint tenancy, tenancy by the entirety, communityproperty, life estates, usufructs, and interests for term.

3. Define fee simple property ownership.Fee simple is the complete individual ownership of property with all rights associatedwith outright ownership, such as the right to use, sell, gift, convey, or bequeath.

4. Discuss what happens when a person dies owning property fee simple.When someone dies owning property fee simple, the property passes to the decedent’sheir(s) through the probate process by direction of the will or state intestacy law. Thefair market value of the property is included in the owner’s gross estate for federal estatetax purposes.

5. Define tenancy in common.Tenancy in common is a joint interest in property between two or more related or unre-lated persons called tenants in common.

6. Discuss what happens at the death of a tenant in common.When someone dies owning property tenancy in common, the decedent’s interest willpass through the probate process for retitling per the direction of the will or state intes-tacy laws. The decedent’s interest is included in his federal gross estate at the fair marketvalue as of his date of death or the alternate valuation date, if elected.


20 CHAPTER 3: TYPES OF PROPERTY INTERESTS

7. Can a tenancy in common be partitioned? If so, how?Yes, a tenancy in common can be partitioned. If all of the tenants in common agree, theproperty can be divided according to the interest of each tenant in common. If all tenants incommon do not agree to sever, a court can grant the partition.

8. Discuss the consequences of two people owning property as a tenancy in common withequal interests, but one contributes 70% to the initial purchase price.If two people purchase property as a tenancy in common with equal interests, and one con-tributes 70% of the purchase price, the tenant in common contributing 70% has made agift of 20% to the other tenant in common.

9. Define joint tenancy.Joint tenancy is an interest in property held by two or more related or unrelated personscalled joint tenants. Each person holds an undivided, equal interest in the whole property.The right of survivorship is normally implied.

10. Define right of survivorship.Right of survivorship means that at the death of one joint tenant, the decedent’s interest istransferred to the other joint tenants.

11. Can a joint tenancy by partitioned?Yes, a joint tenancy can be partitioned with or without the consent of the other joint ten-ants.

12. Discuss the contribution rule and how it affects inclusion in the decedent’s gross estate.The contribution rule states that at a joint tenant’s death, his executor does not necessarilyinclude the value of his proportion of ownership, but includes the value in proportion tothe joint tenant’s original and subsequent (if any) contributions.

13. Define community property.Community property is a regime, derived from Spanish law, in which married individualsown an equal undivided interest in all property accumulated, utilizing either spouse’s earn-ings, during their marriage.

14. List three common ways to own separate property in a community-property state.Separate property may be acquired prior to marriage, acquired by gift during marriage, oracquired by inheritance during marriage.

15. Which states recognize community property?Arizona, California, Idaho, Louisiana, Nevada, New Mexico, Texas, Washington, and Wis-consin all have a community property presumption. Alaska allows individuals to elect com-munity property status. Puerto Rico, a commonwealth, is also a community propertyjurisdiction.


16. Discuss what happens at the death of the first spouse to die when property is held as com-munity property.At the death of the first spouse to die, the decedent’s half of the community property willpass through the probate process for retitling per the direction of the will or the state intes-tacy law. The decedent’s half of the community property is also included in the decedent’sgross estate and will receive a step-to fair market value. The surviving spouse’s basis in herhalf of the community property also receives a step-to fair market value at the death of thefirst spouse.

17. How can a married couple convert community property into separate property when prop-erty is held as community property?To convert community property to separate property, one spouse must gift his half interestin the property to the other spouse. After this gift, the donee spouse will own the propertyas separate property.

18. Discuss the implications when a married couple moves from a community-property state toa common law (separate property) state.When a married couple moves from a community property state to a common law (separateproperty) state, property acquired before the move that is community property generallyretains its community property status.

19. What is quasi-community property?Quasi-community property is a property type recognized by a few community propertystates relating to property owned by people who move into community property states fromcommon law (separate property) states. The quasi-community property is property thatwould have been community property had the couple been living in the community prop-erty state at the time of acquisition. Quasi-community property is treated just like commu-nity property at the death of the first spouse to die, or at the time of divorce. Before eitherone of these occurrences, the quasi-community property is treated as separate property.

20. Define life estate.A life estate is an interest in property that ceases upon the death of the owner of the lifeestate.

21. Define usufruct.A usufruct is a Louisiana device that provides the holder with the right to use property and/or the right to income from a particular property.

22. Who is a remainderman?A remainderman is the person who receives the property at the end of a life estate, usufruct,or interest for term.

23. Define interest for term.An interest for term is an interest for a specified number of years.


1. Twenty-two years ago, James and Kevin began dating, and 19 years ago, they began livingtogether. Last year, James inherited over $9,000,000 from his grandfather. He wants toensure that if he dies first, Kevin will be taken care of for the rest of his life. Despite yourinsistence, James does not have a will, and you have advised him previously that stateintestacy laws do not protect same-sex partners. Which of the following asset ownershipoptions would fulfill James’ goal of transferring assets to Kevin at his death?

a. Community property.

b. Tenancy in common with each other.

c. Joint tenancy with rights of survivorship.

d. Tenancy by the entirety.

The correct answer is c.When one owner dies owning property held as a joint tenancy with the right of survivor-ship, his interest is transferred to the other remaining property owners. In this case, if Jamesand Kevin own property JTWROS, Kevin will inherit James’ interest in the property ifJames dies first. When property is owned JTWROS, the property does not pass throughprobate and the transfer is automatic at death. Kevin and James cannot own property viacommunity property or tenancy by the entirety as they are not a married couple. Tenancy incommon does not have an automatic survivorship feature and would not accomplish James’and Kevin’s goals.

2. Jim has been married to Rebecca for six years. They are about to buy their first home andhave come to you with some questions that they have regarding titling of the home. In yourexplanation of the different property ownership arrangements, which of the followingtitling structures can only be entered into by spouses?

a. Tenancy by the entirety.

b. Tenancy in common.

c. Joint tenancy with rights of survivorship.

d. Fee simple.

The correct answer is a.Of the property ownerships listed, tenancy by the entirety is the only one limited to marriedcouples.

3. Which of the following statements regarding joint tenancy with rights of survivorship iscorrect?

a. Each tenant may bequeath their interest in the property at their death.

b. Joint tenancy with rights of survivorship is the same as community property.

c. Only spouses can establish joint tenancies.

d. Each tenant under a joint tenancy with rights of survivorship has an undividedinterest in the property.



The correct answer is d.Only answer d is a correct statement. Answer a is incorrect because a joint tenant in aJTWROS can transfer his interest during life, but at death the interest is automaticallytransferred to the surviving tenants. Answer b is incorrect because JTWROS is not the sameas community property. Community property can only be entered into between marriedcouples and does not provide an automatic right of survivorship. Answer c is incorrectbecause anyone can own property JTWROS, and at the death of one joint tenant, his inter-est will transfer automatically to the surviving joint tenants.

4. Which of the following statements regarding joint tenancy with rights of survivorship is notcorrect?

a. At the death of a joint tenant, his interest in the property will transfer to thebeneficiary listed in his will.

b. Property owned JTWROS transfers by operation of law.

c. Each tenant owns the same fractional share in the property.

d. During his life, each joint tenant has the right to sever his interest in theproperty without consent.

The correct answer is a.Answer a is the only incorrect statement because the property will pass to the surviving ten-ants by operation of law, without regard to any provisions contained in a will.

5. Which of the following statements regarding community property is not correct?

a. If one spouse inherits property during the marriage, that property is generallynot considered community property.

b. Assets acquired by either spouse before marriage generally become communityproperty upon their marriage.

c. Community property assets are included in probate.

d. If one spouse utilizes his paycheck from work performed during the marriage topurchase property, the property is community property.

The correct answer is b.Answer b is the only incorrect statement because assets acquired before marriage remainseparate property.

6. Of the following types of ownership, which is available for married couples?

1. Tenancy by the entirety.

2. Tenancy in common.

3. JTWROS.

4. Tenants by marriage.

a. 1 only.

b. 1 and 3.

c. 1, 2, and 3.

d. 1, 2, 3, and 4.


The correct answer is c.Of the property types listed, tenancy by the entirety is an ownership form exclusive to mar-ried couples. Tenants in common and JTWROS are available to anyone, including marriedcouples. Tenants by marriage is not a form of property ownership.

7. At the death of either partner, a same-sex couple would like to ensure that all property,insurance policies, and retirement plans transfer to the surviving partner. Which of thefollowing will NOT accomplish the couple’s goal?

a. Each partner is listed as the beneficiary of the other partner’s life insurancepolicy.

b. Each partner is listed as the beneficiary of the other partner’s qualified pensionplan.

c. Each partner is a joint tenant in all of the couple’s property owned joint tenancywith rights of survivorship.

d. State intestacy laws.

The correct answer is d. State intestacy laws usually do not provide for asset transfers to non-related parties, includ-ing the surviving partner in a same-sex couple. The designated beneficiary of a life insur-ance policy will receive the proceeds of the life insurance policy by state contract law. Thedesignated beneficiary of a qualified pension plan will also receive the assets by state con-tract law. A joint tenant of property held JTWROS will also receive the decedent joint ten-ant’s interest per the state contract law.

8. Kim and Tommy have lived in Arizona since their marriage. Kim received an inheritancefrom her father during their marriage. Kim and Tommy are moving to Massachusetts for anew job and have some questions regarding their move to a common law (separateproperty) state from a community-property state. Which of the following statements iscorrect?

a. When a couple moves from a community-property state to a common law(separate property) state, separate property will generally remain separateproperty.

b. When a couple moves from a common law (separate property) state to acommunity-property state, separate property will generally become communityproperty.

c. Community property avoids probate at the death of the first spouse andautomatically passes to the surviving spouse by operation of law.

d. To get the step-to fair market value in basis at the death of the first spouse, acouple who lives in a common law (separate property) state can elect to treattheir separate property as community property.

The correct answer is a.Answer a is the only correct statement. When a couple moves from a community propertystate to a common law (separate property) state, separate property will generally remain sep-arate property. Answer b is incorrect because separate property does not generally becomecommunity property when a married couple moves from a common law state to a commu-


nity property state. Answer c is incorrect because community property may be disposed ofby will and does not automatically pass to the surviving spouse by operation of law. Finally,answer d is incorrect because couples living in common law states cannot elect communityproperty treatment at the death of the first spouse in order to get a step-up in basis.

9. Dara has owned 100% of the stock of Dara’s Baked Goods, a corporation, for 22 years. Inthe current year, she gifted 50% of the business to her daughter, Sheila, who lives inCalifornia. Sheila does not work at the business and reinvests any income in the company.With respect to the transfer of the business interest, which of the following statements is/arecorrect?

a. Sheila’s 50% interest in Dara’s Baked Goods is community property, ownedequally by Sheila and her husband.

b. If Sheila’s husband dies tomorrow, both his share of Dara’s Baked Goods andSheila’s share of Dara’s Baked Goods would receive a step-to fair market value inbasis.

c. Sheila owns 50% of Dara’s Baked Goods outright, and the interest will not beconsidered community property.

d. If Sheila dies tomorrow, the executor of her estate would include 25% of thevalue of Dara’s Baked Goods in her gross estate.

The correct answer is c.Answer c is correct because gifted property is generally considered separate property. Answera is incorrect because gifted property is generally considered separate property unless Sheilaelected to treat the property as community property, or commingled the assets. In this case,Sheila does not commingle the assets and the problem does not mention that she electedcommunity property status over the assets. Answer b is incorrect because Sheila’s interest inDara’s Baked Goods will not be included in her husband’s gross estate. Separate property isonly included in the gross estate of the separate property owner. Because the interest is notin her husband’s gross estate, it does not receive a step-to fair market value. Answer d isincorrect because if Sheila dies tomorrow she must include 100% of the value of all of herassets owned as separate property (thus 50% of Dara’s Baked Goods).

10. If Paula died with the following property interests, which would not be included in herprobate estate?

a. Community property.

b. Property held tenants in common.

c. Death proceeds of life insurance payable to her daughter.

d. Property owned fee simple.

The correct answer is c.All except option c are included in a decedent’s probate estate. Life insurance and otherdeath proceeds are included in the decedent’s gross estate, but not in the decedent’s probateestate.


11. Which of the following statements regarding joint tenancy is correct?

a. Joint tenancies may only be established between spouses.

b. Tenancy by the entirety is a special form of joint tenancy only available toresidents of Louisiana.

c. Joint tenancies can only be severed with the permission of a court.

d. Each joint tenant in a joint tenancy has an undivided, equal interest in theproperty.

The correct answer is d.Each joint tenant in a joint tenancy owns an equal, undivided interest in the property.Answer a is false because joint tenancies can be established by any persons, related or unre-lated. Answer b is false because tenancy by the entity is available in other states. Answer c isfalse because joint tenancies can be partitioned at the request of one joint tenant. Courtapproval is not required to sever a joint tenancy.

12. Which of the following is considered real property?

1. Stocks.

2. Automobile.

3. House.

4. Land held for investment.

a. 3 only.

b. 1 and 2.

c. 3 and 4.

d. 1, 2 and 3.

The correct answer is c.Real property is land and buildings. The nature of the property in the hands of the owner(investment, personal, inventory) does not affect the type of property. Stocks are intangibleand automobiles are tangible.

13. Which of the following is considered tangible property?

1. Stocks.

2. Automobile.

3. Rental house.

4. Land.

a. 2 only.

b. 1 and 2.

c. 3 and 4.

d. 1, 2, 3, and 4.

The correct answer is a.Tangible property is property that may be touched and is not realty. An automobile is tangi-ble property. Stocks are intangible property. A rental house and land are realty.


14. Which of the following is considered intangible property?

1. Stocks.

2. Patents.

3. Bonds.

4. Land held for investment.

a. 4 only.

b. 1 and 2.

c. 2 and 4.

d. 1, 2, and 3.

The correct answer is d.Realty is not intangible property. Stocks, bonds, patents, and copyrights are common exam-ples of intangible property. Land held for investment is real property.

15. Which of the following statements regarding fee simple ownership is not true?

a. Fee simple ownership is the complete individual ownership of property with allrights associated with outright ownership.

b. Property owned as fee simple passes through probate at the death of the owner.

c. Property owned as fee simple is excluded from the federal gross estate of theowner.

d. Fee simple ownership allows the owner to use, sell, gift, alienate, convey orbequeath the property without others’ approval.

The correct answer is c.The question asked what is NOT true regarding property owned as fee simple. Propertyowned as fee simple is included in the gross estate of the decedent. All of the other state-ments regarding property owned fee simple are true.

16. Erica has come to you for estate planning advice. She has been in a long-term relationshipwith Judy. Because Erica’s family is not aware of the relationship between Judy and Erica,Erica is concerned that at her death, Judy will be overlooked by Erica’s family. Of thefollowing recommendations, which would you least likely recommend to fulfill Erica’s goalof transferring assets to Judy at Erica’s death?

a. Transfer the ownership of Erica’s real estate investments into Tenancy by theEntirety.

b. Name Judy as the beneficiary of Erica’s retirement plan.

c. Advise Erica against creating a will, specifically bequeathing her property toJudy.

d. Name Judy as the beneficiary of Erica’s life insurance policy.

The correct answer is a.As Erica’s financial planner, you would not advise her to transfer the ownership of her prop-erty to a tenancy by the entirety as it is an ownership option only available to married indi-viduals.You would advise Erica to name Judy as the beneficiary of her retirement plans andlife insurance policies as the beneficiary designation would ensure payment of the proceeds


to Judy without the delay of probate and challenges to the will. Advising Erica to create awill and specifically bequeath assets to Judy would fulfill Erica’s goal of transferring herassets to Judy, but it also allows for Erica’s family to challenge the will. A challenge to thewill may create delays, increase the costs of estate administration, and potentially couldcause the assets to be distributed to someone other than Judy.

17. Three years ago, brothers Darren and Andy, purchased real property and titled it as jointtenancy with right of survivorship. At the time of the purchase, Darren did not have anycash, so Andy paid the $50,000 purchase price himself. Over the next five years, Darren andAndy allocated the income and expenses of the property equally, and luckily for them thevalue of the property increased to $350,000. If Andy dies this year, how much will hisexecutor include in his federal gross estate as the value of this real property?

a. $50,000.

b. $175,000.

c. $300,000.

d. $350,000.

The correct answer is d.The contribution rule applies to property owned as a joint tenancy with right of survivor-ship. Because Darren did not contribute any amount towards the original purchase price ofthe property, Andy’s executor must include the full fair market value of the property inAndy’s gross estate for federal estate tax purposes.

18. Three years ago, Jack and Mary, having been married for 3 years, agreed to purchase somereal property and titled it as joint tenants with right of survivorship. At the time of thepurchase, Mary did not have any cash, so Jack paid the $50,000 purchase price himself.Over the next five years, Jack and Mary allocated the income and expenses of the propertyequally, and luckily for them the value of the property increased to $350,000. If Jack diesthis year, how much will his executor include in his federal gross estate as the value of thisreal property?

a. $50,000.

b. $175,000.

c. $300,000.

d. $350,000.

The correct answer is b.When a married couple owns property joint tenancy with right of survivorship, there is anautomatic assumption that each spouse contributed 50% to the original purchase price. Inthis case, the contribution rule will deem that each would include 50% of the value of theproperty in the decedent’s federal gross estate. At Jack’s death, his executor will include 50%of the value of the property or $175,000 (50% x $350,000) in Jack’s federal gross estate.


19. Mike travels quite often and wants his daughter to have access to his checking accountwhile he is out of town. For this reason, on October 3, 2006, Mike deposited $100,000 in achecking account. Several years passed and Mike used the funds for normal living expenses,but his daughter never accessed any of the funds. On May 2, 2009, Mike’s daughter neededan extra $35,000 to purchase the car of her dreams so she made a withdrawal from theaccount with full intentions of reimbursing the account. At what date has Mike made a giftto his daughter?

a. October 3, 2006.

b. December 31, 2006.

c. May 2, 2009.

d. May 31, 2009.

The correct answer is c.In the situation of a joint interest in a bank account, the contributing joint account owner isnot deemed to have made a gift until the non-contributing joint account owner makes awithdrawal for his own benefit. In this case, Mike’s daughter did not make a withdrawaluntil May 2, 2009.

20. Timmy and Bryan agree to purchase a condo at the beach for $200,000 as tenants incommon. Bryan will contribute $150,000 of the price, and Timmy will contribute theremaining $50,000. They have agreed to split all income and expenses at 75%/25%, thesame as their ownership percentages. What is the gross gift from Bryan to Timmy for theyear relating to this property?

a. $0.

b. $50,000.

c. $150,000.

d. $200,000.

The correct answer is a.Bryan is not deemed to have made a gift to Timmy relating to this property because theyhave contributed amounts equal to their ownership percentages. When the property isowned tenancy in common, a gift occurs if one tenant in common owns a greater propor-tional share than his pro rata contribution. In this case, Timmy and Bryan contributedamounts equal to their proportional share.


4The Probate ProcessThe Probate Process

1. Describe the probate process.The probate process is a legal proceeding that serves to prove the validity of any existingwill, supervise the orderly distribution of the decedent’s assets to the heirs, and protectcreditors by ensuring that valid debts of the estate are paid. Probate is also the legal pro-cess for the surviving heirs to obtain legal title to their inherited property.

2. Describe at least three advantages and three disadvantages of the probate process.Advantages• Protects creditors.• Provides clear title to heirs.• Improves the likelihood that parties of interest will receive notice and the opportu-

nity to be heard.• Provides for an orderly administration of the decedent’s assets.Disadvantages• May be costly.• Can result in delays.• Open to public scrutiny.

3. Identify alternatives to probate regarding the disposition of property.• Property held tenancy by the entirety or joint tenancy with right of survivorship.• Property held within a revocable living trust.• Property held within an irrevocable trust.• Proceeds of an insurance policy with named beneficiary.• Pay-on-death (POD) or transfer-on-death (TOD) accounts for bank and investment

accounts.

4. Discuss the main differences between an executor and an administrator.The main differences between an executor and an administrator are that the decedentchooses the executor while the probate court names the administrator. While the admin-


32 CHAPTER 4: THE PROBATE PROCESS

istrator must post a bond, that requirement can be waived for the executor by the decedentin the will.

5. List the duties of the executor and/or administrator.Executor• Locates and proves the will.• Locates witnesses to the will.• Receives letters testamentary from court.Administrator• Petitions court for his or her own appointment.• Receives letters of administration.• Posts the required bond.Both• Locate and assemble property.• Safeguard, manage, and invest property.• Advertise in legal newspapers that the person has died in order to put creditors and other

interested parties on notice.• Locate and communicate with potential beneficiaries.• Pay the expenses of the decedent.• Pay the debts of the decedent.• File tax returns, such as forms 1040, 1041, 706, and 709, and make tax payments.• Distribute assets to beneficiaries according to the will or the laws of intestacy.

6. Define pay-on-death and transfer-on-death accounts.Pay-on-death (POD) and transfer-on-death (TOD) accounts are bank (POD) or invest-ment (TOD) accounts with listed beneficiaries. Because the accounts have listed beneficia-ries, the assets within the account transfer by virtue of contract law and do not pass throughprobate.

7. Identify assets that pass outside of probate by contract law.Assets that transfer by contract are assets with listed named beneficiaries other than thedecedent. The following assets transfer by contract: life insurance, pension plans, IRAs,annuities, pay-on-death accounts, and transfer-on-death accounts.

8. Identify assets that pass outside of probate by titling or trust law.The following assets transfer by trust and titling law: joint tenancy with right of survivor-ship (JTWROS), tenancy by the entirety, and all trust accounts.


1. If Paula died with each of the following property interests, which will be excluded from herprobate estate?

a. Property owned as community property.

b. Property held tenancy in common.

c. Death proceeds of life insurance payable to a living stranger.

d. Property owned fee simple.

The correct answer is c.All except c are included in a decedent’s probate estate. Life insurance and other death pro-ceeds are included in the decedent’s gross estate, but are not included in the decedent’s pro-bate estate.

2. Many planners believe that the best estate plan excludes as many assets as possible from theprobate estate. Which of the following statements justifies these planners’ belief?

a. The probate assets are not subject to creditors.

b. The probate estate is filed with the court and can become public knowledge.

c. The more excluded assets from the probate estate, the more expensive theadministration is likely to be.

d. The more assets that go through the probate process, the faster the heirs arelikely to receive the assets.

The correct answer is b.The probate estate becomes public knowledge, thus eliminating the privacy of the deceased.

3. Which of the following is generally included in a decedent’s probate estate?

a. Revocable trust with a named living beneficiary.

b. Fee simple ownership specifically bequeathed in a decedent’s will.

c. Life insurance with a named living beneficiary.

d. Transfer-on-death investment account with a named living beneficiary.

The correct answer is b.Any property owned fee simple would be included in the probate estate. Generally, theother options listed will avoid probate as long as the listed beneficiary is alive to receive theproceeds of the policy/account or trust. If the beneficiaries have predeceased the decedent,or if beneficiaries have not been named, the proceeds will revert to the decedent’s estate andpass through probate.



4. Craig’s attorney has advised him to set up trusts to avoid probate. Which of the followingstatements regarding the probate process is not correct?

a. The distribution of probate assets can be delayed.

b. Through the probate process heirs and/or legatees are given clear title to theproperty.

c. Creditors are protected through the probate process.

d. The probate process is confidential.

The correct answer is d.The probate process is not confidential. Certain information is required to be filed with thecourt and becomes public information. Answers a, b, and c are true statements.

5. Which of the following property interests of a decedent will avoid probate?

a. Proceeds of life insurance payable to the decedent’s estate.

b. Community property.

c. Property owned tenants in common with decedent’s father.

d. Proceeds of life insurance payable to the decedent’s living son.

The correct answer is d.Proceeds of a life insurance policy payable to the decedent’s living son will avoid probate.Answers a, b, and c will be included in the probate estate.

6. Which of the following is a disadvantage of the probate process?

a. The decedent’s heirs and/or legatees are given clear title to property.

b. The probate process requires several court filings.

c. The probate process provides for an orderly distribution of the decedent’s assets.

d. The decedent’s creditors are protected.

The correct answer is b.The probate process requires several court filings which create additional costs and becomespublic information. This is a definite disadvantage to the probate process. Answers a, c, andd are all advantages of the probate process.

7. Which of the following is considered an advantage of the probate process?

a. The probate process creates delays.

b. The probate process is costly.

c. Heirs receive property with clear title.

d. Information that is filed with the court becomes public information.

The correct answer is c.A definite advantage to the probate process is that the heirs are able to secure clear title toassets. Answers a, b, and d are all disadvantages to the probate process.


8. Ramona inherited the property listed below from her father upon his death. Which of thefollowing property interests passed to her through probate?

a. A 2005 Porsche titled and held within a revocable living trust.

b. Ramona’s father’s community property share of a vacation property.

c. A $300,000 distribution to Ramona, as listed beneficiary, from her father’s401(k) plan.

d. Title to a Manhattan condo previously owned within a trust with Ramonalisted as the beneficiary at her father’s death.

The correct answer is b.Community property passes through probate. Property held within a revocable living trusttransfers per the trust document, thus avoiding the probate process. A distribution to alisted beneficiary of a qualified retirement plan passes per contract law, thus avoiding theprobate process. Real estate included in a trust transfers per the trust document, thus avoid-ing the probate process.

9. Tom died owning the following property. Which would not be included in Tom’s probateestate?

1. A certificate of deposit, in Tom’s name, at the local bank.

2. An interest in commercial investment real estate held tenancy in common with ason of the decedent.

3. Retirement plan proceeds made payable to Tom’s daughter.

4. A mountain vacation home Tom owns jointly (JTWROS) with his wife.

a. 1 only.

b. 3 and 4.

c. 1, 2, and 3.

d. 1, 2, and 4.

The correct answer is b.Items 3 and 4 are not included in Tom’s probate estate. Retirement plan proceeds payable toa listed living beneficiary transfer by contract law, and property owned JTWROS transfersby operation of state law to the surviving joint tenants. Items 1 and 2 are included in Tom’sprobate estate. A certificate of deposit in Tom’s name would be included in Tom’s probateestate. Interest in property held as a tenancy in common does not have an automatic rightof survivorship and thus must transfer through the probate process for retitling.

10. Which of the following items will pass through probate?

a. Retirement plan with someone other than the decedent listed as the beneficiary.

b. Investment real estate held JTWROS.

c. Personal residence held tenancy by the entirety.

d. Life insurance policy with no designated beneficiary.

The correct answer is d.A life insurance policy without a named beneficiary is included in the decedent’s probateestate. Proceeds of a life insurance policy with a listed beneficiary pass to the listed benefi-


ciary by contract law and avoid the probate process. An interest in property held JTWROSpasses by state law to the surviving joint tenants and avoids the probate process. An interestin property held tenancy by the entirety passes by state law to the surviving spouse andavoids the probate process.

11. Carol’s executor has located all of her property. Given the following property listing, what isthe total value of Carol’s probate estate?

a. $24,000.

b. $484,000.

c. $834,000.

d. $1,024,000.

The correct answer is a.Only the automobile, valued at $24,000, would be included in Carol’s probate estate.Because Carol has a named beneficiary, the life insurance and the 401(k) will transfer percontract law to the listed beneficiaries. The property owned tenancy by the entirety willtransfer automatically, per the state law, to Carol’s husband Jim.

12. Krista would like to reduce the risk of public scrutiny of her assets at her death. Which ofthe following would not help Krista accomplish this goal?

a. Place all property in trust.

b. Retitle property so that it is titled with a survivorship feature.

c. Include a specific bequest of each and every item Krista owns in her will.

d. Use items such as annuities, PODs and TODs.

The correct answer is c.Krista must avoid the probate process if she wants to avoid public scrutiny. The probateestate includes any asset that must be retitled, or does not transfer by operation of law ortrust document. Answer c would not help Krista accomplish her goal because even specificbequests are included in the probate estate. Property placed in trust will transfer per thetrust document. Property titled with a survivorship feature will transfer per the operation oflaw. Items such as annuities, PODs, and TODs will transfer per contract law. All of thesemethods will avoid the probate process, thus helping Krista accomplish her goal of avoidingpublic scrutiny.

Life Insurance Face $1,000,000 Beneficiary is James, Carol’s son.

401(k) Balance $350,000 Beneficiary is Carla, Carol’s Daughter

Vacation Home Value $460,000 Titled Tenancy by Entirety with Jim

Automobile Value $24,000 Owned by Carol


13. Eric owns the following property:

Which of the following is included in Eric’s probate estate?

a. Home and stock in ABC Corp.

b. Home, beach house, and checking account.

c. Stock in ABC Corp and checking account.

d. Home only.

The correct answer is a.Eric’s home and his tenancy in common interest in the ABC Corp stock owned with hisbrother will be included in his probate estate. Eric owns the home outright and the propertywill have to pass through probate for retitling. An interest held as a tenancy in commondoes not have an automatic right of survivorship, and as such, must pass through probatefor retitling. The beach house owned tenancy by entirety with his wife, Rebecca, has anautomatic right of survivorship to his wife. The property will pass by operation of state lawand will not pass through the probate process. The checking account with the POD benefi-ciary designation will transfer to Eric’s son per contract law and will not pass through theprobate process.

Property Joint Owner Titling

Home None Fee Simple

Stock in ABC Corp Brother, Jim Tenancy in Common

Beach House Wife, Rebecca Tenancy by the Entirety

Checking Account None Pay-on-Death to Son


5Gift TaxGift Tax

1. Explain the Gift and Estate Tax reforms created by EGTRRA 2001.EGTRRA 2001 eliminated the unified transfer tax system by increasing the applicablecredit amount for transfers at death between 2001 and 2010, while the applicable creditamount for lifetime gifts remains level. This difference in the applicable credit amountsallows an individual to transfer more assets, without incurring transfer tax, at death thanduring life. Effectively, this may cause the transfer cost of transferring assets during lifeto be more expensive than transfers at death.

2. List the elements of a gift.The elements of a gift are:• The donor must have the intent to make a voluntary transfer.• The donor must be competent to make the gift.• The donee must be capable of receiving the gift.• The donee must take delivery.• The donee must accept the property.

3. List and define the various types of gifts.The various types of gifts are:• Direct Gift - A direct payment of cash or transfer of property to a donee.• Indirect Gift - An indirect transfer on behalf of a donor for the benefit of the donee.• Complete Gift - A gift of property where the donor has not retained any interest and

the donee can be identified at the date of the gift.• Incomplete Gift - Any transfer that includes a revocable beneficiary designation or a

transfer to a revocable trust. Incomplete transfers are not considered gifts for gift taxpurposes.

• Reversionary Interest - An interest that has transferred and subsequently will revertback to the transferor.

• Net Gift - A gift of property that requires the donee to pay the gift tax.


40 CHAPTER 5: GIFT TAX

4. List the imputed interest rules for no-interest loans and below-market loans.

5. How is the creation of a joint bank account where one party contributes the entire amounttreated for gift tax purposes?The creation of a joint bank account is different than most types of gifts because the gift isnot complete, and therefore not taxable, until the noncontributing party withdraws moneyfor their own benefit.

6. Discuss the requirements and limitations of the annual exclusion.The annual exclusion allows each individual to transfer up to $13,000 (for 2009) per yearper donee gift tax free. To be eligible for the annual exclusion the gift must be of a presentinterest. The annual exclusion perishes each year and does not carryover to successive years.

7. Explain the advantage of using the election to split gifts.If an individual gifts separate property, utilizing his annual exclusion, only $13,000 (for2009) per year per donee will be excluded from gift tax. The gift splitting election allowsthe donor’s spouse to consent to split the gift and, in essence, treat one-half of the giftedproperty as her property, and eligible for her annual exclusion. After the gift splitting elec-tion, $26,000 for 2009 (both spouse’s annual exclusion) of the donor’s separate propertygift will avoid gift tax.

8. Explain the use of the Crummey provision.A Crummey provision is included in a trust document to create a present interest gift, eligi-ble for the annual exclusion, out of what otherwise would be a gift of a future interest. TheCrummey provision usually gives the beneficiary of a trust the right to withdraw the lesserof the annual contribution to the trust or the annual exclusion.

9. Qualified transfers allow certain indirect gifts to be excluded from gift taxation. Explainthese gifts and the requirements to exclude them from gift taxation.A qualified transfer is a payment directly to a qualified educational institution for tuition,excluding room and board, or a payment made directly to a medical institution for thequalified medical expenses of someone else. To be a qualified transfer, exempt from gift tax,the payment must be paid directly to the educational or medical institution.

Loan Imputed Interest

$0 ≤ $10,000 $0

$10,001 ≤ $100,000 The lesser of:• Net investment income, or• Interest calculated using AFR less interest calculated

using stated rate of the loanIf borrower’s net investment income < $1,000, $0 imputedinterest

> $100,000 Interest calculated using AFR less interest calculated usingstated rate of the loan.


10. How are gifts to spouses treated for gift tax purposes?As long as the spouse is a United States citizen, a gift to a spouse is not taxable because ofthe marital deduction. If the spouse is not a United States citizen, then a special annualexclusion is available ($133,000 for 2009).

11. What is the due date to file Form 709, the United States Gift (and Generation-SkippingTransfer) Tax Return?The original filing deadline is April 15 of the year after the gift is made. The original filingdeadline can be extended as late as October 15 of the year after the gift is made. The pay-ment for gift tax, however, is due at the original filing deadline. If the donor died in the yearof the gift, the gift tax return must be filed before or at the same time as the estate tax return(Form 706).

12. Who must file Form 709, the United States Gift (and Generation-Skipping Transfer) TaxReturn?Any donor in a calendar year who makes a gift must file a gift tax return, unless all of thegifts are less than or equal to the annual exclusion, or are not subject to gift tax. If a split giftelection is made, a gift tax return must be filed by the spouse who makes the gift, or bothspouses if both make a gift, even if, after the split, the gift is under the annual exclusion.Individuals in a community property state do not split gifts when using community fundsas the amount is deemed to be one-half owned by each spouse. Thus, they would not needto file a return if the total joint gift is less than or equal to $26,000 for 2009.

13. List the steps in calculating the gift tax.1. Sum the “total gifts” for the calendar year;2. Deduct the total exclusions and deductions (annual exclusions, marital deduction, char-

itable deductions);3. Add the donor’s taxable gifts for the calendar year (Sum of #1 and #2) to the donor’s pre-

vious taxable gifts for all prior calendar years;4. Calculate the gift tax from the unified estate and gift tax rate schedule;5. Reduce the gift tax by the gift tax deemed paid and the lesser of the applicable gift tax

credit ($345,800 for all years until 2010) or the calculated gift tax.

14. A donee’s adjusted basis of gifted property is generally the donor’s basis. List the two cir-cumstances when this is not true.1. When a donor gifts property with a fair market value at the date of the gift less than his

adjusted basis, the donee must follow the double-basis rule. In such a case, the doneeuses the fair market value at the date of the gift as the loss basis, the donor’s adjustedbasis as the gain basis, and if the property sells for a value between the fair market valueand the adjusted basis, the donee uses that value as his adjusted basis.

2. When a donor gifts property and pays gift tax on the transfer, the portion of the gift taxpaid attributable to the appreciation in the fair market value of the gift is included in thedonee’s basis.


15. List three advantages of making lifetime gifts as compared to transfers at death.1. Any appreciation on a gifted asset occurring after the date of the gift is excluded from

the donor’s gross estate. 2. Any gift tax paid on a taxable gift is excluded from the donor’s gross estate if the gift was

made more than three years prior to the donor’s death.3. Gifts, unlike bequests, can utilize the annual exclusion which transfers at most $13,000

free of transfer taxes. 4. Any gift of income producing property transfers the income from the donor to the

donee after the date of the gift and reduces the donor’s gross estate.5. Donors can transfer property during life that is taking up needed space or that they no

longer wish to maintain. 6. Finally, payments of support and the expenses that would be considered qualified trans-

fers during life are excluded from the calculation of gift tax. The estate tax calculationincludes the transfers for future support and for reasons that would otherwise be a qual-ified transfer.


1. Grandmother Jones contributed $2,500,000 to a revocable trust. She has a life expectancyof 24 years and she will receive an 8% per year annuity from the trust. At her death, thecorpus will be paid to her granddaughter, Lisa. What is Grandmother Jones’ taxable gift?

a. $0.

b. $2,094,752.

c. $2,489,000.

d. $2,500,000.

The correct answer is a.Because Grandmother Jones reserves the right to revoke the trust, she has not made a com-pleted transfer to Lisa and thus she does not have a taxable gift.

2. Crystal loans Holly $650,000, so that Holly can buy a home. Holly signs a note, with aterm of 5 years, promising to repay the loan. The home is the collateral, but because Crystaland Holly have been friends since childhood, Crystal does not charge Holly interest. Of thefollowing statements which is true?

1. The imputed interest is considered a taxable gift from Crystal to Holly.

2. The imputed interest is taxable income on Crystal’s income tax return.

3. The imputed interest is an interest expense deduction for Crystal.

4. Holly can deduct the imputed interest on her income tax return.

a. 2 only.

b. 2 and 4.

c. 1, 2, and 4.

d. 1, 2, 3, and 4.

The correct answer is c.The loan is greater than $100,000 and does not meet any of the exceptions to imputinginterest. Crystal will have imputed interest income based on the applicable federal rate andthe imputed interest will also be considered a taxable gift to Holly. Because the loan issecured by Holly’s personal residence, Holly will also have an itemized deduction equal tothe imputed interest. Crystal does not have an interest expense.

3. Timothy made the following transfers to his only daughter during the year:

1. A bond portfolio with an adjusted basis of $130,000 and a fair market value of$140,000.

2. 2,000 shares of RCM Corporation stock with an adjusted basis of $126,000 and afair market value of $343,000.

3. An auto with an adjusted basis of $15,000 and a fair market value of $9,000.

4. An interest-free loan of $2,000 for a personal computer on January 1st. Theapplicable federal rate for the tax year was 8%.



What is the value of Timothy’s gross gifts for this year?

a. $271,000.

b. $492,000.

c. $494,000.

d. $498,000.

The correct answer is b.The total of gross gifts is the fair market value of all gifted property before any deductionsfor gift-splitting, the marital deduction, or the annual exclusion. Because the loan in state-ment 4 is less than $10,000, it meets one of the exceptions of the imputed interest rules.The fact that the basis in Statement 3 is higher than the FMV is ignored for purposes of cal-culating the total gross gifts. The double-basis rule will apply to the donee in a subsequentsale. $140,000 + 343,000 + 9,000 = $492,000.

4. In the current year, Jerry loaned his daughter, Charisse, $15,000 to purchase a new car. Theloan was payable on demand, but there was no stated interest rate. The applicable federalrate for the current year was 10%, and Charisse had $900 of net investment income for theyear. For gift tax purposes with regards to this loan, how much has Jerry gifted Charisseduring the current year?

a. $0.

b. $900.

c. $1,500.

d. $15,000.

The correct answer is a.Because the loan is for less than $100,000 and Charisse has less than $1,000 in net invest-ment income, Jerry does not have to impute any interest on the loan and, as such, has notmade a gift of interest to Charisse during the current year.

5. Pedro has begun a program of lifetime gifting. All of the following statements regardinglifetime gifts are true, except?

a. Appreciation on property after the date of the gift will not be subject to gift taxand will not be included in the donor’s gross estate.

b. Payments directly to his grandchildren for their education over the annualexclusion amount will not be taxable.

c. Annual exclusion gifts will not be subject to the gift tax and will not beincluded in the donor’s gross estate.

d. The donee of income producing property will have to recognize the post-giftincome from the property on the donee’s income tax return.

The correct answer is b.Only option b is false. Payments to Pedro’s grandchildren for education will be taxablebecause they were not made directly to the institution and thus are not qualified transfers.All of the other statements are true.


6. Carlos would like to make a gift to his son, but does not want the value of the gift and theassociated gift tax to total an amount greater than $100,000. Carlos’ cousin has told himabout the net gift, but Carlos has come to you for clarification. Which of the followingstatements from Carlos’ cousin is correct?

a. A net gift does not qualify for the annual exclusion because it is a gift of a futureinterest.

b. Carlos must prepay the gift tax due when he makes a net gift.

c. A net gift requires Carlos’ son to disclaim the interest in the gift.

d. Carlos will have taxable income to the extent the gift tax paid is greater than hisadjusted basis in the gifted property.

The correct answer is d.Option d is a correct statement. As long as the gifted property is a gift of a present interest,a net gift qualifies for the annual exclusion. Also, Carlos does not have any obligation toprepay the gift taxes. The gift taxes are due April 15th of the year after the gift. A net giftdoes not require the donee to disclaim the gift.

7. Which of the following is eligible for the annual exclusion?

a. Frank designates his daughter, Holly, beneficiary of his 401(k) plan.

b. Frank designates his wife, Betty, as beneficiary of his life insurance policy.

c. Frank funds an irrevocable trust with $1,100,000 for the benefit of his son. Theterms of the trust allow a payout at the discretion of the trustee.

d. Frank funds an irrevocable life insurance trust with the amount necessary to paythe premiums of the policy. The beneficiaries can take a distribution equal tothe contribution each year.

The correct answer is d.If the beneficiaries of a trust are given the right to take a withdrawal during the year, thecontribution is eligible for the annual exclusion. Options a and b are not completed giftsand therefore do not qualify for the annual exclusion. The transfer to the trust in option c isa gift of a future interest and is not eligible for the annual exclusion.

8. After reading an estate planning article in a popular magazine, Vaughn has decided to takeaction to reduce his gross estate by making annual gifts to his 4 kids, 8 grandchildren, and 4great-grandchildren. Vaughn has discussed the gifting strategy with his wife, Rebecca, andprovided it does not result in use of any of her applicable gift tax credit, she has agreed tosplit each gift. Vaughn does not want to use his applicable gift tax credit either. If Vaughncarries the plan out for 5 years, how much can he gift in total while meeting Rebecca’srequirement? (Assume the 2009 exclusion amounts.)

a. $208,000.

b. $1,040,000.

c. $2,080,000.

d. $3,120,000.


The correct answer is c.

Vaughn has 4 kids, 8 grandchildren, and 4 great-grandchildren for a total of 16 people thathe can make annual exclusion gifts.

16 x $13,000 (annual exclusion) = $208,000

Gift Splitting with his wife would allow $416,000 ($208,000 x 2)

If Vaughn and his wife made these transfers each year for the next 5 years, he could transfer$2,080,000 ($416,000 x 5 years = $2,080,000) without incurring any gift tax liability.

9. Mary and Emile would like to give the maximum possible gift that they can to their sonwithout having to pay gift tax. Mary and Emile have never filed a gift tax return and live ina community-property state. How much can they transfer in 2009 to their son free of gifttax?

a. $26,000.

b. $345,800.

c. $1,013,000.

d. $2,026,000.

The correct answer is d.Mary and Emile can each transfer $1,000,000 tax free during their lifetimes. Mary andEmile can also make a gift of $13,000 each during the year to qualify under the annualexclusion. In total to their son, Mary and Emile can transfer $2,026,000 (($1,000,000 x2)+($13,000 x 2)=$2,026,000.

10. Celeste and Raymond have been married for 29 years. Last year, Raymond sold hisextremely successful automotive repair shop and his net worth now exceeds $10 milliondollars. Celeste and Raymond have twin daughters, Kelly and Shelly, who will be 35 nextmonth. Celeste and Raymond, neither of whom have given any gifts in the past, would liketo give their daughters the maximum amount of cash possible without paying any gift tax.How much can Celeste and Raymond give to Kelly and Shelly during 2009?

a. $13,000.

b. $26,000.

c. $1,026,000.

d. $2,052,000.

The correct answer is d.

$26,000 (for 2009) per child (annual exclusion for both parents) = $52,000

$1,000,000 (for 2009) per parent (applicable gift tax credit equivalency) = $2,000,000

Total that can be gifted without paying gift tax $2,052,000


11. Deborah provides the following list to her CPA who is preparing her gift tax return. Whichof the following will Deborah’s CPA include as a taxable gift on Deborah’s gift tax return?

a. Payment to grandmother of $20,000 to help her with her medical bills.

b. Payment to Doctor’s Hospital for $35,000 to cover the medical bills of a friend.

c. Payment to Northshore Medical School for $17,000 to cover nephew’s tuition.

d. Payment to child of $6,000 that represents legal support.

The correct answer is a.Deborah’s CPA will include the payment made to Deborah’s grandmother as a taxable gift.A payment must be paid directly to the health care provider or educational institution to bea qualified transfer. Options b and c represent qualified transfers and are not taxable gifts.Option d is a payment of legal support and is not considered a gift for gift tax purposes.

12. Celeste made the following transfers during 2009:

1. Her friend, Paul, needed $23,000 to begin law school. Celeste gave Paul the cash.

2. An alimony payment of $14,000 to her ex-husband.

3. She paid $15,000 to Diamond Shores Hospital for her friend Jackie’s medical bills.

What is the amount of Celeste’s taxable gifts?

a. $10,000.

b. $12,000.

c. $27,000.

d. $50,000.

The correct answer is a.

1. The payment to Paul is for his tuition, but to be a qualified transfer thepayment must be made directly to the educational institution. Thepayment is therefore a gift of $23,000 which will be reduced by theavailable $13,000 annual exclusion (2009).

$10,000

2. Alimony payments are deductible for income tax purposes by the payor,and included in the recipient’s taxable income. Alimony payments arenot taxable gifts.

$0

3. A payment directly to a medical institution for the medical treatment ofanyone is a qualified transfer not subject to gift taxes.

$0

Taxable Gifts $10,000


13. While completing Joelle’s tax returns, Joelle’s CPA asked her if she made any gifts during theyear. Joelle faxed her the following information. Of the following, which would not requirethe filing of a gift tax return?

a. Joelle created a revocable trust under the terms of which her son is the incomebeneficiary for his life and her grandson is the remainder beneficiary. Joellecreated the trust with a $6,000,000 contribution and the trust made an incomedistribution in the current year.

b. Joelle opened a joint checking account in the name of herself and her sister with$75,000. The day after Joelle opened the account, her sister withdrew $35,000to purchase a car.

c. Joelle created an irrevocable trust giving a life estate to her husband and aremainder interest to her daughter. Joelle created the trust with a $1,000,000contribution.

d. Joelle gave her husband one-half of an inheritance she received from her uncle.The inheritance was $3,000,000.

The correct answer is d.The transfer in option d would qualify for the unlimited marital deduction, so it is not ataxable gift and Joelle would not have to file a gift tax return. All of the other transferswould create taxable transfers and would require a gift tax return to be filed. The transfer inoption a to a revocable trust would still be subject to gift tax reporting because the trust hascurrent beneficiaries, as Joelle’s son received an income distribution in the current year.

14. During 2009, Janice made the following transfers. What is her total taxable gifts for 2009?

1. Janice gave $10,000 to her boyfriend so he could buy a new car.

2. Janice’s neighbor Judy needed $15,000 to pay for her knee surgery. Janice paidDoctors-R-Us Hospital directly.

3. Her nephew began attending Georgetown Law School this year. Janice made theinitial yearly tuition payment of $25,000 directly to Georgetown Law Schoolduring 2009.

a. $0.

b. $13,000.

c. $14,000.

d. $50,000.

The correct answer is a.Statement 1 is the only gift subject to gift tax, but to arrive at the total taxable gifts for theyear the value of the gross gift is reduced by the available annual exclusion. In this case, Jan-ice’s gift to her boyfriend would be eliminated after the application of the $13,000 for 2009annual exclusion. Statements 2 and 3 are transfers not subject to gift tax because they arequalified transfers paid directly to a medical or educational institution.


15. Brent and his wife live in a common law (separate property) state. Each year, Brent makesgifts equal to the annual exclusion to his three children. During the year, he comes to youlooking for a way to transfer more than $39,000 each year to his kids without using hisapplicable gift tax credit or paying any gift tax. All of the following statements regardinggift-splitting, are true, except:

a. If Brent’s wife would agree to elect gift splitting, Brent could transfer $78,000per year to his kids without utilizing his applicable gift tax credit or paying anygift tax.

b. Even if Brent’s wife elected to split gifts, only Brent’s gifts would be split.

c. Even though all of the gifts are less than the annual exclusion, and not taxable,Brent will have to file a gift tax return if his wife agrees to gift split.

d. If a couple elects to split gifts, all gifts made during the year (while the couple ismarried) by either spouse must be split.

The correct answer is b.The question asks which statement is not true regarding gift-splitting. Option b is incorrectbecause a couple that elects to split gifts must split all gifts made during the year. All of theother options are correct statements.

16. During the year, Sean made the following gifts to his daughter:

1. An interest-free loan of $6,000 to purchase an SUV. The applicable federal rate was6%. The loan has been outstanding for two years.

2. A corporate bond with an adjusted basis of $14,000 and a fair market value of$16,000.

3. A portfolio of stock with an adjusted basis of $10,000 and a fair market value of$25,000.

Sean’s wife agrees to elect gift-splitting for the year, but she did not make any gifts of herown. What is the amount of total taxable gifts made by Sean during the year?

a. $7,500.

b. $30,000.

c. $41,000.

d. $41,360.

The correct answer is a.The interest-free loan is not subject to gift tax because the loan is below $10,000 and meetsthe exclusion from imputed interest rules. To calculate Sean’s taxable gifts, first add the fairmarket value of the transfers subject to gift tax and reduce by the annual exclusions and thegift-splitting. The calculation is as follows:Sum of the fair market values of the taxable transfers: $25,000 + $16,000 = $41,000.Allocation for gift splitting: $41,000/2 = $20,500.Reduction for annual exclusion: $20,500 - $13,000 = $7,500.


17. Donna and Daniel have lived in Louisiana their entire marriage. Currently, their combinednet worth is $4,000,000 and all of their assets are community property. After meeting withtheir financial advisor, Donna and Daniel begin a plan of lifetime gifting to reduce theirgross estates. During 2009, they made the following cash gifts:

What is the amount of the taxable gifts to be reported by Donna?

a. $59,000.

b. $94,000.

c. $196,000.

d. $255,000.

The correct answer is b.Because the assets are community property, the gifts are deemed to be made 50% by eachspouse. Gift-splitting is not an issue. The cash payment to the Republican National Com-mittee is not a gift for gift tax purposes. Donna’s taxable gifts are calculated as follows:

18. Jason and his wife, Maria, live in Texas with their two minor children. All of their propertyis owned as community property. During the year, Jason gave his brother a $13,000 car, hisfriend a $4,000 watch, and his dad a $45,000 fishing boat. What is the total amount of giftsattributable to Maria if she elects to split gifts?

a. $0.

b. $16,000.

c. $31,000.

d. $62,000.

The correct answer is a.Because the question asked the amount of gifts attributable to Maria due to gift splitting,the answer is $0. Community property assets are not eligible for gift splitting because theyare viewed as being owned one-half by each spouse. $31,000 (1/2 of the total of the all giftsduring the year) would be attributable to Maria as gifts made by her during the year.

Son $80,000Daughter $160,000Republican National Committee $75,000Granddaughter $15,000

Donna’s Total Gifts

Donna’s Annual

Exclusion

Donna’s Taxable

Gifts

Son $40,000 $13,000 $27,000

Daughter $80,000 $13,000 $67,000

Granddaughter $7,500 $7,500 - 0 -

Total $127,500 $33,500 $94,000


19. Which of the following statements regarding the rules of the federal gift tax return isincorrect?

a. James made a gift to his brother of $20,000 from his separate property. Eventhough Carly, James’ wife, agreed to elect gift-splitting, only James will berequired to file a gift tax return.

b. Carly made a gift to her sister of $18,000 from the community property.Because it is community property, Carly and James are each deemed to havemade a gift of $9,000.

c. A gift tax return is due 3 and 1/2 months (excluding extensions) after the end ofthe donor’s year-end.

d. Carly and James filed an extension to file their federal income tax return. Toextend any gift tax returns due for the year, Carly and James must file a gift taxreturn extension.

The correct answer is d.The gift tax return is extended with the federal individual income tax return - no separateextension is required. All of the other options are true statements.

20. Randy transferred property with a fair market value of $56,000 to his brother, Robbie.Randy’s adjusted basis in the property was $23,000. Of the following statements related tothis transfer, which is correct?

a. Robbie has an adjusted basis in the property of $0.

b. Randy must recognize a capital gain on this transfer of $33,000.

c. If Robbie subsequently sells the property for $60,000, he will have a capitalgain of $4,000.

d. Randy has a taxable gift to Robbie of $43,000.

The correct answer is d.Randy made a taxable gift to Robbie of $43,000. The taxable gift is calculated on the fairmarket value as of the date of the transfer, $56,000, less the annual exclusion available,$13,000 for 2009 ($56,000-$13,000=$43,000). Option a is incorrect because the doneehas a carryover of the donor’s adjusted basis when the fair market value is greater than thedonor’s adjusted basis. If the donor had paid gift tax on the transfer, an allocation of the gifttax attributable to the appreciation of the property would have been added to the donee’sadjusted basis. Option b is incorrect because a donor does not recognize gain on a gift ofappreciated property. Option c is incorrect as Robbie’s adjusted basis will carryover, asdescribed above, and his capital gain would be $37,000 ($60,000 - $23,000). (ProvidedRandy did not pay any gift tax on the transfer.)


21. Stephanie received 100 shares of ZYX Corporation from her aunt with an adjusted basis of$60,000 and a fair market value of $30,000 on the date of the gift. Her Aunt paid $1,500of gift tax. Stephanie sold the stock for $45,000. What is her recognized gain or loss?

a. No gain or loss.

b. $15,000 gain.

c. $15,000 loss.

d. $13,500 loss.

The correct answer is a.When the fair market value of gifted property is less than the donor’s adjusted basis, gift taxon the appreciation is not added to the basis, and the double-basis rule applies. In such acase, the gain basis for the property is the donor’s adjusted basis, and the loss basis is the fairmarket value at the date of the gift. When the sale is between these amounts, there is not again or loss. In this case, Stephanie sold the stock for an amount between the gain and lossbasis and therefore has no gain or loss.

22. Jack gave his nephew, Stephen, 1,000 shares of ABC Corporation. Jack had an adjustedbasis of $10,000 for all 1,000 shares and the fair market value at the date of the gift was$45,000. Jack paid gift tax of $9,000 on the gift to Stephen. If Stephen sells the stock threedays after receiving the gift for $46,000, what is his capital gain/loss? (Assume Jack hadalready made transfers to Stephen during the year to utilize the annual exclusion.)

a. No gain or loss.

b. $1,000 gain.

c. $29,000 gain.

d. $36,000 gain.

The correct answer is c.First calculate Stephen’s adjusted basis at the time of the sale. When the fair market value ofgifted property is greater than the donor’s adjusted basis, the donee’s adjusted basis in thegifted property is equal to the donor’s adjusted basis, $10,000, plus an allocation of gift taxpaid on the appreciation of the property, [($35,000/$45,000) x $9,000] = $7,000. Accord-ingly, Stephen’s adjusted basis is equal to $17,000 ($10,000 + $7,000). To calculateStephen’s gain or loss on the sale of the gifted property subtract his adjusted basis from theproceeds of the sale. $46,000 - $17,000 = $29,000.


23. Landon has several pieces of property valued at $30,000 that he wants to give away. Hewants to make gifts that make sense for both himself and for the recipient. He wants to givegifts to his father, Preston (who is in a low marginal income tax bracket), his sister, Tabitha,his daughter, Kelcie, and to the United Way. Match the properties to the best recipientconsidering he would like to keep one asset.

a. Stock with an FMV of $30,000 and an adjusted basis of $12,000. The stockhas a dividend yield of 3% and is expected to appreciate 9%.

b. Stock with an FMV of $30,000 and an adjusted basis of $25,000. The stockhas a dividend yield of 7% and is expected to appreciate 14%.

c. Stock with an FMV of $30,000 and an adjusted basis of $45,000. The stockhas a dividend yield of 0% and is expected to appreciate 4%.

d. Real Estate with an FMV of $30,000 and an adjusted basis of $27,000. The realestate is expected to appreciate 8%.

e. Bond with an FMV of $30,000 and an adjusted basis of $30,000. The bondhas a dividend yield of 7% and is expected to appreciate 0%.

Property e should be gifted to Landon’s father, Preston, because the property is income-pro-ducing and Landon’s father is likely to be in a lower marginal income tax bracket thanLandon. By default, Property d should be gifted to Landon’s sister, Tabitha. Property bshould be gifted to Landon’s daughter, Kelcie, because the property with the highest poten-tial for appreciation should be donated to the youngest donee. Property a should bedonated to The United Way because it has experienced the greatest appreciation. Landonshould keep Property c because only he can sell Property c and recognize a capital loss.

E Preston (father)

D Tabitha (sister)

B Kelcie (daughter)

A The United Way

C Keep for himself


6Estate TaxEstate Tax

1. List six assets included in a decedent’s gross estate.1. Cash.2. Stocks and bonds.3. Annuities.4. Retirement accounts.5. Notes receivable.6. Residences.7. Other real estate.8. Household goods.9. Automobiles.See Exhibit 6.4 for additional selections.

2. What is a revocable transfer?A revocable transfer is a transfer where the transferor retains the right to alter, amend,revoke, or terminate the transfer.

3. If a decedent owns a life insurance policy on his own life, at what value is it included inhis gross estate?A life insurance policy on the decedent’s life owned by the decedent is included in thedecedent’s gross estate at the face value, or death benefit, of the life insurance policy.

4. What is meant by “incidents of ownership” in a life insurance policy?The term references the right of the insured or his estate to the economic benefits of thepolicy. Thus, it includes the power to change the beneficiary, surrender or cancel thepolicy, assign the policy, revoke an assignment, pledge the policy for a loan, or obtain aloan from the insurer against the surrender value of the life insurance policy.


56 CHAPTER 6: ESTATE TAX

5. What is a straight single life annuity, and to what extent is its value included in a decedentannuitant’s gross estate?A straight single life annuity is an annuity that pays the annuitant until his death. At thedeath of the annuitant, his gross estate does not include any value related to the annuitybecause the annuitant’s interest in the contract terminates at his death.

6. What is a general power of appointment?A general power of appointment is a power in which the holder can appoint the property(subject to the power) to himself, his estate, his creditors, or the creditors of his estate.

7. How is real estate valued for purposes of inclusion in a decedent’s gross estate?Real estate is included in a decedent’s gross estate at the fair market value of the property atthe decedent’s date of death or the alternate valuation date, or the sales price of the realestate if it sold between the date of death and the alternate valuation date (if properlyelected). To obtain these fair market values (other than for a sale), an appraisal is required.

8. How are publicly traded common stocks valued in a decedent’s gross estate?Publicly traded stocks are valued at the average of the high and the low for the day of thedecedent’s date of death. If the decedent died on a Saturday or Sunday, the stock is valued atthe average of the applicable values for the preceding Friday and subsequent Monday.Also, if the stock is a dividend-paying stock, the value should include any dividends if thedecedent died after the X dividend date and before the date of payment.

9. List three valuation discounts.Any three of the following:1. Minority discount.2. Lack of marketability discount.3. Blockage discount.4. Key person discount.

10. What are the requirements for an estate to elect the alternate valuation date?The executor can make the election to value the estate six months after a decedent’s date ofdeath (the alternate valuation date), if such election will decrease both the value of the grossestate and the estate tax liability.

11. List three available deductions from a decedent’s gross estate.Any three of the following:1. Funeral expenses.2. Last medical expenses.3. Administrative costs.4. Debts.5. Losses during estate administration.

12. How is the applicable estate tax credit related to the applicable estate tax credit equivalency?The applicable estate tax credit is the estate tax that correlates to the estate tax credit equiv-alency. For 2009, the estate tax credit is $1,455,800 and the estate tax credit equivalency is$3,500,000.


13. Explain the availability of the credit for tax on prior transfers.A credit is given for estate taxes paid within 10 years of the decedent’s date of death forproperty included in the gross estate of the decedent. The credit is subject to a percentagelimitation that depends upon how long the decedent survived the transferor.

14. Under what circumstances may an estate take a credit for foreign death taxes paid?A credit for foreign death taxes is only allowed for death taxes paid on property situatedwithin the country to which the tax is paid, on property included in the decedent’s grossestate, and with respect to the decedent’s estate. The credit is only allowed for U.S. citizens,and the credit does not include any interest or penalties paid in connection with foreigndeath taxes.

15. When is a decedent’s federal estate tax return due?The federal estate tax return is due nine months after the decedent’s date of death. A six-month extension of time to file is available.

16. What is an heir’s adjusted basis in property inherited before 2010?Generally, the adjusted basis of inherited property is the fair market value of the property atthe decedent’s date of death, or if elected by the executor, the fair market value at the alter-nate valuation date.

17. How is the holding period of inherited property in the hands of the heir calculated?The holding period of property acquired from a decedent is deemed to be long-term. Thisapplies regardless of whether the property is disposed of at a gain or loss and regardless ofthe decedent’s holding period.


1. Charles had been working with an estate planner for several years prior to his death.Accordingly, Charles made many transfers during his life in an attempt to reduce hispotential estate tax burden, and Charles’ executor, Tom, is thoroughly confused. Tomcomes to you for clarification of which assets to include in Charles’ gross estate. Which ofthe following transactions will not be included in Charles’ gross estate?

a. Charles gave $40,000 to each of his three grandchildren two years ago. No gifttax was due on the gifts.

b. Charles purchased a life insurance policy on his life with a face value of$300,000. Charles transferred the policy to his son two years ago.

c. Charles and his wife owned their personal residence valued at $250,000 astenants by the entirety.

d. After inheriting a mountain vacation home from his mother, Charles gifted thevacation home to his daughter to remove it from his gross estate. Charlescontinued to use the property as a weekend getaway and continued allmaintenance on the property.

The correct answer is a.The $40,000 gifts to his grandchildren are excluded from his gross estate because only giftsof life insurance within three years and any gift tax paid on a gift within three years areincluded in a transferor’s gross estate. The life insurance policy included in answer b isincluded in the Charles’ gross estate because transfers of life insurance within three years ofdeath are included in the decedent’s gross estate. Any property owned at the decedent’s dateof death, as in answer c, is included in the decedent’s gross estate. (Do not confuse grossestate inclusion with probate inclusion.) Even though Charles gave the mountain home inanswer d to his daughter, and the value of the property generally would not be included inCharles’ gross estate, the fact that Charles continued to utilize the property each weekendand maintained the property would cause inclusion in his gross estate.

2. The gross estate of a decedent who died in the current year would not include which of thefollowing items?

a. A luxury sedan, valued at $60,000, driven every day by the decedent.

b. Cash of $1,000,000 given to decedent’s daughter two years ago. No gift tax waspaid on the transfer.

c. A bond given to decedent’s cousin last year. Gift tax of $4,000 was paid on thetransfer.

d. A home which the decedent owned as tenants by the entirety with his wife.

The correct answer is b.The $1,000,000 transfer is not included in the decedent’s gross estate because the three yearlook back rule only applies to life insurance. Only the gift tax paid on the transfer in answerc would be included in the decedent’s gross estate. The property listed in answer a andanswer d would be included in the decedent’s gross estate.



3. Despite his efforts to transfer all of his property out of his estate during his life, Gordondied on January 16th still owning the following property:

What is the value of Gordon’s gross estate?

a. $124,500.

b. $128,500.

c. $422,500.

d. $424,500.

The correct answer is c.The personal residence, the rental property, the cruise refund and the cash are all includedat the fair market value at Gordon’s date of death. The rental income is not includedbecause the payment was made after Gordon’s death, and it was not owed to Gordon beforehis death. $320,000 + $80,000 + $4,500 + $18,000 = $422,500. The rental income wouldbe included in the estate’s income tax return (Form 1041).

4. In August of the current year, Jim died of lung cancer. Jim’s son, Doug, has decided toprepare his father’s estate tax return, but has come to you for clarification on whether thefollowing list of items are included in Jim’s gross estate. After reviewing the list, whichitem(s) will you tell Doug to exclude from Jim’s gross estate?

a. A life insurance policy on the life of Jim’s wife owned by Jim.

b. A check from Doctor’s Hospital for the refund of medical expenses that Jiminitially paid, but were subsequently paid for by Jim’s health insurancecompany. The reimbursements were due to Jim before his death.

c. A check from ABC Corporation for dividends in the amount of $15,000declared September 23rd (the month after Jim’s death).

d. A payment of $500,000 from Mutual Life Insurance of America representingthe proceeds of a life insurance policy owned by Jim.

The correct answer is c.Jim died in August. The dividends from ABC Corporation in the amount of $15,000 arenot included in Jim’s gross estate because they were not declared until September. The lifeinsurance policy in answer a is included in Jim’s gross estate as all property owned by thedecedent at his date of death is included in the decedent’s gross estate. The check from thehospital detailed in answer b is included in Jim’s gross estate because the payments were dueto him before his death. The life insurance policy in answer d is included in Jim’s grossestate because life insurance owned or transferred within three years of a decedent’s date ofdeath are included in the decedent’s gross estate.

Adj. Basis FMV

Personal Residence $20,000 $320,000

Rental Property $84,000 $80,000

Rental Income on above property (February payment) $2,000 $2,000

Cancelled vacation cruise refund (check received 12/31 but not cashed) $4,500 $4,500

Cash $18,000 $18,000


5. To avoid inclusion in a power holder’s gross estate, a power should limit the appointment ofproperty to the power holder for the sole purpose of:

a. Pleasure.

b. Support.

c. Wealth.

d. Happiness.

The correct answer is b.A power of appointment which limits the holder’s benefit to support is not included in thepower holder’s gross estate. As a general rule, a power which limits the power holder’s bene-fit to health, education, maintenance, or support (or any combination of those listed) is notincluded in the power holder’s gross estate.

6. Before her death, Alice loaned Jerry $400,000 in return for a note. The terms of the notedirected Jerry to make monthly payments including interest at the applicable federal rate. IfAlice dies before the note is repaid, which of the following affects the valuation for Alice’sgross estate?

1. Jerry’s inability to make payments timely.

2. The market rate of interest.

3. The remaining term of the note.

4. Alice forgives the note as a specific bequest in her will.

a. 1 only.

b. 1 and 2.

c. 1, 2, and 3.

d. 2, 3, and 4.

The correct answer is c.If Alice dies before Jerry repays the note, the note is included in Alice’s gross estate at the fairmarket value of the note plus any accrued interest due at Alice’s date of death. This fair mar-ket value is affected by the interest rate, maturity date, and Jerry’s ability to make the notepayments, but not by Alice’s forgiveness of the note in her will. The forgiveness of the noteis deemed a specific bequest and the fair market value of the note is still included in Alice’sgross estate.


7. Gus dies owning several shares of an infrequently traded stock. If Gus dies on Wednesday,November 7th, and the stock has the following trading information:

Monday, 11/5 $31Thursday, 11/8 $36Monday, 11/12 $28

What is the per share value of the stock on the federal estate tax return?

a. $31.

b. $33.

c. $34.

d. $36.

The correct answer is c.To value an infrequently traded stock, or to find the value on a date which falls in betweentrading dates, we must follow a special formula. First, multiply the first trading price afterthe valuation date by the number of days between the valuation date and the last tradebefore the valuation date. Add to this product, the product of the last trading price beforethe valuation date by the number of days between the valuation date and the first trade afterthe valuation date. Now, divide the total of the two by the total number of days between thetrade before the valuation date and the trade after the valuation date.

8. Of the following expenditures from an estate, which is not a deduction from the gross estateto arrive at the taxable estate?

a. Payment to United Charitable Organization (a 501(c)(3)) to satisfy a specificbequest.

b. Distribution of assets to spouse to satisfy specific bequests listed in will.

c. Payment to Second USA Bank for a credit card balance.

d. A payment to decedent’s friend for $10,000 to satisfy a specific bequest.

The correct answer is d.Payments made to satisfy specific bequests to individuals other than a surviving spouse or acharity are not deductions from the gross estate to arrive at the taxable estate. All of the oth-ers are deductible expenses or transfers.

9. When a U.S. citizen dies and bequeaths property to his U.S. citizen spouse, the maritaldeduction is limited to the following amount:

a. $345,800.

b. $780,800.

c. $1,455,800.

d. The marital deduction is unlimited.

The correct answer is d.For transfers to a U.S. citizen spouse, the marital deduction is unlimited.

2 $36×( ) 1 $31×( )+3

----------------------------------------------------- $1033

------------ $34= =


10. After an extensive hospital stay, Daryl died of heart failure in August of the current year. Incomputing Daryl’s taxable estate, which of the following is not deductible?

a. Payment to Good Insurance representing the past due balance of Daryl’s carinsurance for the month July.

b. Per the will, a payment to Daryl’s friend John.

c. Payment to Brian’s Engraving for Daryl’s tombstone.

d. Payment to Howe & Dewey, LLP, the estate’s attorneys.

The correct answer is b.A specific bequest, as detailed in answer b, is not deductible. All of the other answers aredeductible expenses or transfers.

11. Johnny died eight months ago and his executor is finalizing his estate tax return. Theexecutor has determined that Johnny’s gross estate includes $400,000 of real estate,$750,000 of cash and cash equivalents, and $300,000 of qualified retirement plans. Thetotal gross estate is $1,450,000. As the executor reviews the deductions, which of thefollowing will he deduct from the total gross estate to arrive at the adjusted gross estate onhis Form 706?

a. Income in Respect of Decedent (IRD).

b. Unlimited charitable deduction.

c. Unlimited marital deduction.

d. Executor’s fee.

The correct answer is d.The executor’s fees listed in answer d are deductions from the gross estate to arrive at theadjusted gross estate. The marital deduction and charitable deduction, as listed in answers band c, are deductions from the adjusted gross estate to arrive at the taxable estate. Income inrespect of a decedent, answer a, is a deduction on the estate’s Form 1041 or a beneficiary’sForm 1040, and is not a deduction on the decedent’s Form 706.

12. Jude has begun some estate planning. What is the maximum amount of estate tax Jude canavoid by using the applicable estate tax credit during 2009?

a. $780,800.

b. $1,455,800.

c. $2,000,000.

d. $3,500,000.

The correct answer is b.Jude can shelter estate tax of $1,455,800 using the applicable estate tax credit of$1,455,800. The applicable estate tax credit equivalency amount is $3,500,000 for 2009.


13. If a decedent dies in 2009 with a taxable estate of $4,000,000 and has never used any of hisapplicable estate tax credit, what amount of the decedent’s estate tax will be absorbed by theapplicable estate tax credit amount in 2009?

a. $780,800.

b. $1,455,800.

c. $2,000,000.

d. $3,500,000.

The correct answer is b.The applicable estate tax credit for 2009 is $1,455,800.

14. An estate tax return must be filed for a U.S. resident or a U.S. citizen dying during 2009 ifthe total value of his gross estate plus post-1976 adjusted taxable gifts on his date of death isgreater than:

a. $345,800.

b. $1,000,000.

c. $1,455,800.

d. $3,500,000.

The correct answer is d.This question is asking for the applicable estate tax credit equivalency for 2009, or the fairmarket value of property that can transfer with an estate tax less than or equal to the appli-cable estate tax credit. For 2009, the applicable estate tax credit equivalency is $3,500,000.

15. If an estate pays the funeral expenses of the decedent, on which tax return are these expensesdeducted?

a. The decedent’s final return (Form 1040).

b. The decedent’s estate tax return (Form 706).

c. The income tax return of the decedent’s estate (Form 1041).

d. The surviving spouse’s income tax return (Form 1040).

The correct answer is b.If the funeral expenses are paid by the decedent’s estate, the expenses are deducted on thefederal estate tax return. If the expenses are paid by anyone else (or any other entity), theexpenses are not deductible.


16. Christie’s father has been diagnosed with cancer and has been given one year to live. In anattempt to avoid capital gains tax, Christie transfers her stock with an adjusted basis of$1,000 and a fair market value of $11,000 to her father. Christie’s father dies seven monthsafter the transfer when the fair market value of the stock was $12,000 and Christie’s father’swill leaves her everything, including the stock. Christie subsequently sells the stock for$19,000. What is Christie’s capital gain on the transaction?

a. $7,000.

b. $10,000.

c. $18,000.

d. $19,000.

The correct answer is c.A special rule applies when the donee of property dies within one year of the transfer andthe donee bequeaths the property back to the original donor. In this case, the heir (originaldonor) will not receive a step up to fair market value in the property. Here, Christie willreceive her stock from her father’s estate with her father’s basis - which was her basis beforethe original gift - or $1,000. So, when Christie sells the stock for $19,000, she has an$18,000 capital gain.


Transfers During Life & At DeathTransfers During

Life & At Death

7

1. Explain how an intra-family sale of property can be an advantageous strategy for reduc-ing an individual’s gross estate.An intra-family sale can reduce an individual’s gross estate because the sale of the prop-erty will remove any future appreciation in the fair market value of the sold property andwill remove the future income from the sold property from the individual’s gross estate.

2. List three of the major differences in the gross estate treatment of transfers during lifeand bequests at death.• Transfers during life for support are excluded from the gross estate, whereas transfers

at death for support are included in the individual’s gross estate.• Qualified transfers during life are excluded from the gross estate, whereas transfers at

death for the same “qualified” purposes are included in the gross estate.• The annual exclusion only applies for transfers during life. Transfers at death do not

qualify for the annual exclusion.• Any future appreciation on property transferred during life is excluded from the indi-

vidual’s gross estate. Property transferred at death is included in the gross estate at thefull fair market value at the individual’s date of death.

• Any income on property transferred during life is excluded from the transferor’s grossestate. An individual who transfers property at his death includes all of the incomefrom the property received (or owed) until death in his gross estate.

• The gift tax paid on transfers during life is excluded from the transferor’s gross estate.

3. List the transfer techniques most commonly used with loved ones.SCINS, private annuities, partial sale-gift transactions, outright gifts, gifts in trusts, fam-ily limited partnerships, qualified transfers, and transfers qualifying for the maritaldeduction.

4. What is the term of a private annuity?A private annuity has a term equal to the life of the seller.


66 CHAPTER 7: TRANSFERS DURING LIFE & AT DEATH

5. What is the buyer’s adjusted basis in property purchased through a private annuity?A buyer’s adjusted basis on property purchased through a private annuity is the sum of all ofthe annuity payments.

6. What is the SCIN premium?The SCIN premium is a premium paid by the buyer to the seller which is either built intothe note payment or is added to the sales price of the asset.The SCIN premium gives thebuyer the right to cancel any remaining installment payments if the seller dies before theend of the defined installment sale term.

7. If the seller outlives the term of a SCIN, how is the buyer affected?If the seller outlives the term of the SCIN, the buyer pays all of the installment paymentsplus the SCIN premium for the term of the SCIN, and thus overpays for the propertytransferred by an amount equal to the SCIN premium.

8. What is the buyer’s adjusted basis in property purchased through a SCIN?The buyer’s adjusted basis in property purchased through a SCIN is the agreed upon pur-chase price, including the value of the note.

9. Explain the gift tax consequences of a SCIN and a private annuity.Neither a SCIN nor a private annuity will have any gift tax consequences as long as thepresent value of the expected future payments (excluding the SCIN premium) as of the dateof the sale equals the fair market value of the property sold.

10. What is a Grantor Retained Annuity Trust (GRAT)?A GRAT is an irrevocable trust that pays a fixed annuity to the grantor for a defined term,and at the end of the term pays the remainder of the trust to some noncharitable benefi-ciary.

11. Explain the gift tax consequences of a GRAT.If the annuity payment is paid to the grantor and the remainder paid to a noncharitablebeneficiary, the grantor will have made a gift equal to the present value of the remainderinterest, or the fair market value of the property contributed to the trust less the presentvalue of the retained annuity interest. The gift of the remainder interest is not eligible forthe annual exclusion as it is a gift of a future interest.

12. How does a Grantor Retained Unitrust (GRUT) differ from a GRAT?A GRUT pays a fixed percentage of the trust assets to the grantor each year, instead of afixed annuity.

13. What is a Qualified Personal Residence Trust (QPRT)?A QPRT is a special form of GRAT where instead of receiving an annuity in dollars, thegrantor of the QPRT receives the “use” of a personal residence as the annuity. The remain-der beneficiaries of the QPRT will receive the personal residence at the end of the annuityterm.


14. Explain the gift tax consequences of a QPRT.The transfer of the residence to the QPRT is treated as a gift to the extent that the fair mar-ket value of the residence exceeds the present value of the grantor’s retained interest (theright to use the personal residence).

15. What is the usual primary purpose of establishing a family limited partnership?The primary purpose of establishing a family limited partnership is to transfer assets toyounger generations at reduced gift tax valuations.

16. Discuss the discounts available when valuing the interests of a family limited partnership.The limited partnership interests of a family limited partnership transferred to the youngergenerations is usually subject to many transfer restrictions and the owners of the limitedpartnership interests have little or no control of the partnership. Because of these limita-tions, the limited partnership interests are usually valued with a substantial discount thatcan range between 20% and 40%. By utilizing these discounts, the transferor can transferthe limited partnership interests at reduced transfer costs.

17. List the disadvantages of using a family limited partnership to transfer interest in property.A family limited partnership requires operational costs, such as account fees, attorney fees,accounting fees, and other miscellaneous reporting costs. Also, each time an interest in thepartnership is transferred, an appraisal is required to determine the fair market value of thepartnership interest being transferred.

18. Which property transfers at death by contract law?The following property transfer at death by contract: life insurance, annuities, qualifiedplans, IRAs, TODs, Totten Trusts, and PODs.


1. Which of the following statements regarding installment sales is correct?

a. All payments received by the seller in an installment sale are considered interestincome.

b. At the death of the seller, the principal balance of the installment sale isincluded in the seller’s gross estate.

c. The present value of the expected remainder value of the property sold in aninstallment sale is subject to gift tax at the date of the transfer.

d. An installment sale would never be used with a related party.

The correct answer is b.At the death of the seller, the fair market value of the remaining payments from the install-ment sale is included in the seller’s gross estate. Answer a is incorrect because the paymentsreceived by the seller, depending upon the seller’s adjusted basis in the property, are allo-cated as return of capital, capital gain, and interest income. Answer c is incorrect because aninstallment sale is a sale and does not have an expected remainder value - at the end of theinstallment payments, $0 principal remains on the note. Answer d is incorrect because aninstallment sale may be used to transfer potentially appreciating property to a related party.Even though an installment sale would not create a related party advantage, future incomeand appreciation from the property sold are removed from the seller’s gross estate.

2. In 2009, Roxanne paid Badlaw University $12,000 for her nephew’s tuition and gave hernephew $23,000 in cash. Roxanne is single and did not make any other gifts during theyear. What is the amount of Roxanne’s taxable gifts for the year?

a. $0.

b. $2,000.

c. $10,000.

d. $23,000.

The correct answer is c.The transfer to Badlaw University would be a qualified transfer not subject to gift tax andthe $23,000 cash transfer would be eligible for the annual exclusion of $13,000 ($23,000-$13,000 = $10,000).

3. During the year, Johnson created a trust for the benefit of his six children. The terms of thetrust declare that his children can only access the trust’s assets after the trust has been inexistence for 15 years and the trust does not include a Crummey provision. If Johnsontransfers $72,000 to the trust during the year, what is his total taxable gifts for the year?

a. $0.

b. $12,000.

c. $60,000.

d. $72,000.



The correct answer is d.Because the trust does not include a Crummey provision, the transfer to the trust is a gift ofa future interest not available to be offset by the annual exclusion. As such, the entire trans-fer to the trust for the year is subject to gift tax.

4. Which of the following statements regarding private annuities is correct?

a. If a seller dies before the end of the private annuity term, the buyer continues topay the annuity to the seller’s estate.

b. A private annuity must include a risk premium to compensate the seller for thepossibility of cancellation at the seller’s death.

c. A private annuity cannot give the seller a security interest in the property.

d. With a private annuity, the buyer must make the annuity payments for thelesser of the term of the annuity or the life of the seller.

The correct answer is c.A private annuity cannot give the seller a security interest in the property or the privateannuity treatment is disallowed. Answers a and d are incorrect because a private annuityrequires the buyer to pay the annuity payment for the remaining life of the seller. Answer bis incorrect because the risk for the buyer in the private annuity is that the seller lives longerthan his life expectancy and the buyer overpays. To compensate for this risk, the buyer doesnot have to make the payments if the seller dies before his life expectancy.

5. Perry’s father sold the family business to him using a private annuity. The private annuitywas structured such that Perry would pay his father $40,000 per year plus interest, for theremainder of his father’s life. At the date of the sale, Perry’s father’s life expectancy was 20years and Perry’s father was in great health. After six years, Perry’s father died of a heartattack and Perry sold the business for $2,000,000 six months after his father’s death. Whatis Perry’s capital gain/loss on the transaction?

a. $240,000.

b. $1,760,000.

c. $1,960,000.

d. $2,000,000.

The correct answer is b.A buyer’s adjusted basis of property purchased with a private annuity is equal to the sum ofall annuity payments paid. In this scenario, Perry made six annuity payments of $40,000, ora total of $240,000. Since he sold the property for $2,000,000, his gain is calculated by sub-tracting his basis from the sales price to arrive at $1,760,000 ($2,000,000-$240,000).


6. Which of the following statements regarding self-cancelling installment notes (SCINs) iscorrect?

a. If a seller outlives the SCIN term, the buyer continues to pay the SCINpayment until the seller’s death.

b. If the buyer dies before the end of the SCIN term or the death of the seller, hisgross estate includes a debt equal to the present value of the remainingpayments.

c. A SCIN cannot give the seller a collateral interest in the property sold.

d. If the seller dies before the end of the note term, the seller is deemed to havemade a taxable gift to the buyer equal to the difference between the paymentsmade and total principal payments on the SCIN.

The correct answer is b.If the buyer dies before the end of the SCIN term or the death of the seller, his gross estateincludes a debt equal to the present value of the remaining payments. Answer a is incorrectbecause SCIN payments cease at the earlier of the death of the seller or the end of the SCINterm. Answer c is incorrect because a SCIN can allow the seller to retain a collateral interestin the property sold. Answer d is an incorrect statement.

7. Todd purchased his mother’s home through use of a SCIN. Under the terms of the SCIN,Todd was to pay his mother $20,000, plus interest, and a SCIN premium, per year for 10years. If Todd’s mother died after 4 payments were made, what would be Todd’s adjustedbasis in the home?

a. $0.

b. $80,000.

c. $160,000.

d. $200,000.

The correct answer is d.The buyer’s adjusted basis in property transferred in exchange for a SCIN is the fair marketvalue of the property at the date of the sale regardless of the number of payments made bythe seller. In this case, the fair market value of the property must have been the annual prin-cipal payment times the expected term of the SCIN, or $200,000 ($20,000 x 10).

8. Harry, age 60, owns 400 shares of ABC Corporation, which he expects to increase 300%over the next four years. Harry eventually wants to transfer the stock in ABC Corporationto his son, Billy, but Billy is currently incapable of managing the stock or the income fromthe stock. Harry expects Billy to be responsible in five years. Of the following, whichtransfer method would work best to remove the expected appreciation of the stock fromHarry’s gross estate and protect the property for Billy?

a. Private annuity.

b. SCIN.

c. GRAT.

d. QPRT.


The correct answer is c.The GRAT with a term of five or more years will allow Harry to transfer the stock to Billyat a gift tax cost equal to the current fair market value of the stock (before the 300% appre-ciation) less the sum of the annuity payments that will be paid back to Harry. This transfermethod is not as ideal as a direct gift of the property because the annuity payments willreturn to Harry and will be included in his gross estate. Also, if Harry dies during the termof the GRAT, the full fair market value of the stock, at Harry’s date of death, will beincluded in Harry’s gross estate. Neither a private annuity nor a sale will meet Harry’s goalsbecause both give Billy access to the stock immediately. A QPRT is also not an optionbecause a QPRT is a special GRAT which transfers a personal residence.

9. Which of the following statements regarding a Grantor Retained Annuity Trust (GRAT) iscorrect?

a. The remainder interest of a GRAT is payable to a noncharitable beneficiary.

b. The term of the trust should be set equal to the life expectancy of the grantor.

c. The remainder beneficiary is taxed on the income in the GRAT each year.

d. At the end of the GRAT term, the property reverts to the grantor.

The correct answer is a.The remainder interest of a GRAT is payable to a noncharitable beneficiary. Answer b isincorrect because the term of the GRAT should be less than the grantor’s life expectancybecause if the grantor dies during the term of the trust the full fair market value of the trustassets are included in his gross estate. Answer c is incorrect because the grantor is taxed onthe income in the GRAT each year. Answer d is incorrect because at the end of the GRATterm, the property is payable to the noncharitable beneficiary.

10. Dave transferred $1,500,000 to a GRAT naming his two children as the remainderbeneficiaries while retaining an annuity valued at $500,000. If this is the only transfer Davemade during the year, what is Dave’s total taxable gift for the year?

a. $0.

b. $987,000.

c. $1,000,000.

d. $1,487,000.

The correct answer is c.The remainder interest is a taxable gift from Dave to his children equal to the value of theproperty contributed to the GRAT less the value of the annuity retained, $1,500,000-$500,000 = $1,000,000. Because the remainder interest is a gift of a future interest it is noteligible for the annual exclusion.


11. Of the following statements regarding a Qualified Personal Residence Trust (QPRT), whichis true?

a. At the end of the QPRT term, the residence reverts to the grantor.

b. At creation of the QPRT, the grantor has a taxable gift to the remainderbeneficiary eligible for the annual exclusion.

c. At the end of the QPRT term, the grantor must begin paying rent to theremainder beneficiaries of the QPRT if he continues to live in the residence.

d. A QPRT is ideal for a personal residence that is expected to appreciate at alower rate than the Section 7520 rate.

The correct answer is c.Answer c is a true statement. Answer a is incorrect because the residence transfers to theremaindermen at the end of the QPRT term. Answer b is incorrect because the remainderinterest is not eligible for the annual exclusion. Answer d is incorrect because the QPRT isideal for a personal residence which is expected to appreciate at a higher rate than the Sec-tion 7520 rate.

12. In an effort to keep any of its future appreciation out of her gross estate, Mary, a 73-year-oldwidow, transferred her home into a Qualified Personal Residence Trust (QPRT) naming heronly son as the remainder beneficiary. Which of the following statements regarding aQPRT is false?

a. If Mary has a taxable gift at the date of formation of the trust, the gift is noteligible for the annual exclusion.

b. If Mary outlives the term of the QPRT and continues to live in the house, shemust pay her son rent.

c. At the termination of the QPRT, the personal residence is distributed to Mary’sson.

d. If Mary dies during the term of the QPRT, her gross estate will include thevalue of her home at the date of the transfer to the QPRT.

The correct answer is d.All of the answers are correct with the exception of answer d. If Mary dies during the termof the QPRT, her gross estate will include the value of her home at her date of death.

13. Which of the following statements regarding Family Limited Partnerships (FLPs) is correct?

a. The primary purpose of creating a FLP is to provide joint management of theproperty contributed to the FLP.

b. At the creation of the FLP, the transferring individual will have a capital gainequal to the difference between the fair market value of the property transferredand his adjusted basis in the property.

c. The limited partners in the FLP control all of the day-to-day functions of theFLP.

d. Transfers of the limited partnership interests in the FLP are usually eligible forminority and lack of marketability valuation discounts.


The correct answer is d.Answer d is a correct statement. Answer a is incorrect because the primary purpose of theFLP is to transfer interests in property utilizing various valuation discounts and for the gen-eral partner to retain complete control. Answer b is incorrect because the transfer of prop-erty to a partnership is generally a tax-free exchange. Answer c is incorrect because limitedpartners are barred from participating in the day-to-day operations of the FLP.

14. Which of the following techniques will not help an individual lower his gross estate?

a. Pay-on-Death Arrangement (POD).

b. Grantor Retained Annuity Trust (GRAT).

c. Sale.

d. Self-Cancelling Installment Note (SCIN).

The correct answer is a.A POD is a transfer mechanism that transfers a bank account to a beneficiary according tocontract law. A POD does not reduce an individual’s gross estate as the full value of thePOD bank account is included in the individual’s gross estate. A GRAT, sale, and SCINmay all reduce an individual’s gross estate by removing appreciation and future incomefrom the property transferred.

15. Which of the following does not transfer property at death by operation of law?

a. Property owned JTWROS.

b. Property owned tenancy in common.

c. Intestacy.

d. A revocable living trust.

The correct answer is b.Property owned tenancy in common transfers per the will or the state intestacy laws. All ofthe other options transfer property at death by operation of law

16. Which of the following does not transfer property at death by contract?

a. Tenancy by the entirety.

b. IRAs.

c. Life insurance.

d. POD accounts.

The correct answer is a.Tenancy by the entirety transfers property by operation of state titling law. All of the otheroptions transfer property by contract.


8TrustsTrusts

1. Why are trusts used in estate planning?Trusts are used in estate planning to provide for the management of assets and flexibilityin the operation of the estate plan.

2. What is a trust?A trust is a structure that vests legal title to assets in one party, the trustee, who managesthose assets for the benefit of the beneficiaries of the trust. The beneficiaries hold thebeneficial, or equitable, interest in the trust.

3. List the common parties of a trust.The grantor, trustee, and beneficiary.

4. Who is the fiduciary of a trust?The trustee is the fiduciary of a trust.

5. Explain the legal duties imposed on a fiduciary.The law imposes the duty of loyalty and the duty of care on the fiduciary, or trustee. Thetrustee must be loyal to the beneficiaries of a trust and must make decisions that are inthe best interests of the beneficiaries (and consistent with the terms of the trust) even ifthose decisions result in a loss to the fiduciary. A trustee owes a duty of care to the bene-ficiaries and therefore should make decisions only after engaging in a diligent investiga-tion of the facts and thoughtful consideration of the impact on the beneficiaries.

6. Describe the two most common types of beneficiaries.The income beneficiary is the person or entity who has current rights to income fromthe trust, or the right to use the trust assets. The remainder beneficiary is the individualor entity who is entitled to receive the assets that remain in the trust on the date of itstermination.


76 CHAPTER 8: TRUSTS

7. List three reasons the use of a trust is beneficial to an estate plan.A trust can provide property management or creditor protection. A trust can also be used totake a single property interest and split it up into different interests. Property placed in trustis also not included in a decedent’s probate estate and the appreciation of property placed inan irrevocable trust may avoid estate taxes.

8. What is a spendthrift clause and why is it included in a trust?A spendthrift clause states that the beneficiary of a trust may not anticipate distributionsfrom the trust and may not assign, pledge, hypothecate, or otherwise promise to give distri-butions from the trust to anyone. If such a promise is made, it is void and may not beenforced against the trust. A spendthrift clause protects the assets of a trust from the claimsof the beneficiary’s creditors.

9. How can the creation of a trust reduce estate taxes?First, the creation of a trust can reduce estate taxes because any appreciation of the propertycontributed to an irrevocable trust after the date of the contribution belongs to the benefi-ciaries of the trust and will not be included in the grantor’s estate.Second, the creation of a dynasty trust would allow the beneficiary to benefit from thetrust’s assets, but at his death, would not include the value of the trust’s assets in his grossestate thereby saving transfer taxes. Third, the creation of a grantor trust requires the grantor to pay the income tax on theincome from the property transferred to the trust, thereby further reducing the grantor’sgross estate.

10. What is the effect of the rule against perpetuities?The rule against perpetuities places a limit on the amount of time that property can be heldin trust. The RAP states that all interests in trust must vest, if at all, within lives in beingplus 21 years.

11. Under what circumstances will the fair market value of the assets of an irrevocable trust beincluded in the grantor’s gross estate?The fair market value of the trust’s assets will be included in the grantor’s gross estate if agrantor makes an irrevocable transfer to a trust but retains any of the following interests:• The right to receive income from the trust;• The right to use the trust’s assets;• The ability to exercise voting rights on stock transferred to the trust;• A reversionary interest with a value greater than 5% of the trust’s assets; or• The right to terminate, alter, amend, or revoke the trust.

12. What are the most common reasons for using a revocable trust?A revocable trust is most commonly used to avoid probate and to provide for managementof a grantor’s assets should he become incapacitated.

13. How is a testamentary trust created?A testamentary trust is created after the death of the grantor. The decedent’s will instructsthe executor of the estate to create and fund the trust.


14. Explain the differences between an unfunded trust and a funded trust.A funded trust is a trust that has been drafted and has received a transfer of property fromthe grantor. An unfunded trust has been drafted, but has not received a transfer of propertyfrom the grantor.

15. At the death of the grantor of a revocable trust, what controls the disposition of the trust’sproperty?A revocable trust becomes irrevocable at the death of the grantor, and the trust’s assets aredistributed per the trust document. The grantor’s will does not control the disposition ofthe revocable trust’s assets.

16. Describe a Crummey provision and explain why a trust would contain a Crummey provi-sion.A Crummey provision allows the beneficiaries of the trust to withdraw a contribution madeto the trust within a certain period of time. A trust would contain a Crummey provision sothat any transfer to the trust could qualify for the annual exclusion.

17. List and explain the three methods used to prevent estate tax consequences from the lapsingof a general power of appointment created by a Crummey power.To prevent any estate tax consequences, some trusts will state that the Crummey power islimited to the lesser of the gift tax annual exclusion amount or the greater of 5% or $5,000of the trust corpus.Another method used to prevent the estate tax consequences is to create a hanging power. Ahanging power states that to the extent that a demand beneficiary has a right to withdrawthat does not lapse, the non-lapsing portion will hang over to a subsequent year, when it canlapse under the “5-and-5” standard.A third way of dealing with the lapsing issue is to give the demand beneficiary a continuingright to appoint a portion of the trust equal to the non-lapsing amount.

18. What is the purpose of an Irrevocable Life Insurance Trust (ILIT) and why is it created?The purpose of an ILIT is to prevent an insured party from having ownership of the lifeinsurance policy on his life. Only life insurance policies owned by a decedent are includedin his gross estate. Since the life insurance policy is owned by the ILIT, the death benefit ofthe life insurance policy is excluded from the decedent’s gross estate. Recall, however, that ifthe policy was transferred within 3 years of the decedent’s date of death, the death proceedsof the policy will be included in the decedent’s gross estate.

19. Under what circumstances will the death benefit of a life insurance policy owned by anILIT be included in the insured’s gross estate?If the decedent transferred the policy to the ILIT, or released a retained interest in the ILIT,within three years of the decedent’s date of death, the death benefit of the life insurance pol-icy will be included in the decedent’s gross estate. Also, if the ILIT is required to pay thedecedent’s estate tax, or the executor may request that the ILIT pay the estate tax, the deathbenefit of the life insurance policy will be included in the decedent’s gross estate.


20. In the ideal estate plan, what amount would be transferred to a testamentary bypass trust?A testamentary bypass trust is a trust created at the death of an individual, usually in hiswill. The decedent’s will would direct the executor to fund the bypass trust with assets total-ing the lesser of $3,500,000 (for 2009) or the decedent’s remaining applicable estate taxcredit equivalency.

21. List the various forms of Grantor Retained Income Trusts (GRITs).Grantor Retained Annuity Trusts (GRAT)Grantor Retained Unitrusts (GRUT)Qualified Personal Residence Trust (QPRT)Tangible Personal Property Trusts (TPPT)

22. What is the primary reason to use a GRAT for estate planning purposes?A GRAT is an effective tool to transfer future appreciation on an asset to a third party at areduced gift tax cost. The remainder interest in a GRAT is valued by subtracting the valueof the grantor’s retained annuity from the fair market value of the property contributed tothe GRAT as of the date of the contribution. As such, the gift tax value of the transfer is thevalue of the remainder interest.

23. List the primary difference between a GRAT and a GRUT.A GRUT is a Grantor Retained Unitrust which pays the grantor a fixed percentage of thetrust’s assets as valued at the same point each year, whereas the GRAT pays the grantor afixed dollar amount each year, regardless of the value of the trust’s assets.

24. How is a GRAT more effective in reducing the grantor’s gross estate than a GRUT?Because the unitrust payment from a GRUT is based on the fair market value of the trust’sassets each year, if the value of the trust’s assets appreciates, the payment to the grantorwould increase. A GRAT payment will not change if the underlying value of the GRAT’sproperty appreciates. Once received, the payment from either a GRAT or GRUT becomesthe property of the grantor, and is therefore subject to estate tax at his death; the GRATpayment would keep future appreciation of the trust property out of the grantor’s grossestate.

25. Discuss the consequences of a grantor dying during the term of a TPPT.Because a TPPT is similar to a GRAT with a contribution of tangible personal property,similar consequences occur when the grantor dies during the term of the trust. With bothGRATs and TPPTs, the full fair market value (at the decedent’s date of death) of the prop-erty in the either trust is included in the grantor’s gross estate if the grantor dies within theterm of the trust.

26. What is a dynasty trust and what is its primary purpose?A dynasty trust is a trust that is designed to last for a very long period of time. Its primarypurpose is to avoid transfer taxation at the death of each generation of a family.

27. Who is subject to the income tax on the income of a grantor trust?The grantor of a grantor trust is subject to the income tax on the income of the grantortrust.


28. What is the primary purpose of using a 2503(b) or 2503(c) trust?Using a 2503(b) or 2503(c) trust allows a transfer to a trust for the benefit of a minor to beeligible for the annual gift tax exclusion.

29. List the requirements of a 2503(b) trust.A 2503(b) trust may hold property in trust for the lifetime of the beneficiary, but mustmake income distributions to the beneficiary on an annual basis.

30. Describe a Totten Trust and its benefits.A Totten Trust is a bank account that has a beneficiary clause. A Totten Trust avoids pro-bate but is included in a decedent’s gross estate.


1. Which of the following is not a party to a trust?

a. Trustee.

b. Income beneficiary.

c. Grantor.

d. Principal.

The correct answer is d.The parties to a trust are the grantor, who creates the trust and contributes the property; thetrustee, who manages the trust and holds the legal title to the trust assets; and the benefi-ciary, who holds the beneficial title to the property. The principal of the trust is the propertycontributed to the trust; it is not a party to the trust.

2. Which of the following statements concerning trust formation is correct?

a. The trustee of the trust will receive the trust corpus after paying the income tothe income beneficiary.

b. The remainder beneficiary of a trust receives an annuity payment each year.

c. The grantor of a trust contributes property to a trust which will be managed bythe trustee.

d. The income beneficiary of a trust always receives the trust property at thetermination of the trust.

The correct answer is c.Answer c is a correct statement. Answer a, b, and d are incorrect as the remainder benefi-ciary of a trust receives the trust corpus and the income interest is paid to the income bene-ficiary each year.

3. A trustee is subject to which of the following?

a. Prudent Man Rule.

b. Trustee’s Ethical Code.

c. Uniform Trustee Provisions.

d. Fiduciary Responsibilities Doctrine.

The correct answer is a.A trust fiduciary must follow the Prudent Man Rule demonstrating a duty of loyalty andduty of care on behalf of the trust’s beneficiaries. The Prudent Man Rule specifically statesthat the trustee, as fiduciary, must act in the same manner that a prudent person would actif the prudent person was acting for his own benefit after considering all of the facts and cir-cumstances surrounding the decision. None of the other options are existing codes, provi-sions, or doctrines.



4. Which of the following statements concerning trusts is correct?

a. A trust can have several beneficiaries, including different classes and individuals.

b. When a grantor contributes property to a trust, he must recognize anyunrealized capital gain or loss he has in the contributed property.

c. A trust can only have one trustee.

d. The gift of a remainder interest in a trust is a gift of a present interest.

The correct answer is a.A trust can have several beneficiaries. A trust may have income beneficiaries or remainderbeneficiaries, and within each class can have several individuals of each type.Answer b is incorrect as a grantor does not recognize any unrealized gain in property trans-ferred to a trust. Answer c is incorrect because a trust can have one or several trustees.Answer d is incorrect because the gift of a remainder interest in a trust is a gift of a futureinterest, which is not eligible for the annual exclusion.

5. All of the following statements concerning the income beneficiary of a trust are correct,EXCEPT?

a. An income interest in a trust can be given to the beneficiary, while also namingthe same individual as the remainder beneficiary of the trust.

b. A decedent will commonly create a testamentary trust that names his wife as theincome beneficiary of his property for the rest of her life and his children as theremainder beneficiaries.

c. A dynasty trust only has income beneficiaries. The trust property will never vestwith a remainder beneficiary.

d. When the property is paid to the remainder beneficiary at the termination of atrust, if the income beneficiary is a different individual than the remainderbeneficiary, the income beneficiary is treated as having made a taxable gift tothe remainder beneficiary.

The correct answer is d.Answer d is a false statement. The income beneficiary is not viewed as making a gift to theremainder beneficiary at the termination of a trust. At the formation of the trust, thegrantor of the trust made a taxable gift to the remainder beneficiary equal to the value of theproperty contributed less the value of the income interest payable to the income beneficiary.All of the other statements are true statements.

6. Your son has been studying trusts in his financial planning class. He has come to you formore information. Of the following statements listed below, which do you tell him?

a. Of the many reasons people create trusts, one reason is to provide for assetmanagement.

b. Testamentary trusts are created during the grantor’s life.

c. The property within a revocable living trust is not included in decedent’sprobate or gross estate.

d. The grantor of a trust must include the full fair market value of any propertytransferred to a trust within three years of his death in his gross estate.


The correct answer is a.Answer a is a true statement. Answer b is incorrect because testamentary trusts are created ina grantor’s will. Intervivos trusts are created during the grantor’s life. Answer c is incorrect asproperty within a revocable living trust is not included in a decedent’s probate estate, but isincluded in a decedent’s gross estate. Answer d is an incorrect statement. Only gift tax paidon transfers within three years of a decedent’s death and or the death benefit of a life insur-ance policy transferred within three years of an individual’s date of death are included in thedecedent’s gross estate.

7. Of the following statements regarding trusts, which is false?

a. A trust can provide asset protection for a beneficiary.

b. A trust can provide the grantor with a yearly payment.

c. Property held within a trust will avoid probate.

d. Income within a trust is not taxed until the beneficiary receives a distribution.

The correct answer is d.Answer d is a false statement. A trust will be subject to income tax on any income that is notdistributed during the year. The income that is distributed is taxed to the beneficiary. All ofthe other statements are true statements.

8. A spendthrift clause:

a. Requires the fiduciary of a trust to make small distributions.

b. Protects the trust assets from the claims of the beneficiary’s creditors.

c. Eliminates the problems associated with multiple beneficiaries.

d. Prevents the lapse of a general power of appointment and its subsequent estatetax consequences.

The correct answer is b.Answer b is a correct statement. The remaining answers are false statements.

9. Of the following, which does not reduce a grantor’s federal gross estate?

a. A contribution of highly appreciative property to an irrevocable trust.

b. A contribution of high income, zero growth property to an irrevocable trust.

c. The creation of a grantor trust that requires the grantor to pay income tax onthe trust’s income.

d. A contribution of depreciable personal property to a revocable living trust.

The correct answer is d.A contribution to a revocable living trust does not reduce a grantor’s federal gross estate. Allof the other options would reduce a grantor’s federal gross estate.


10. Which of the following situations would not cause the inclusion of an irrevocable trust in agrantor’s gross estate?

a. The grantor has retained the right to receive the income from the irrevocabletrust.

b. The grantor has retained the right to use the assets contributed to theirrevocable trust for the remainder of his life.

c. The grantor retains an annuity from the irrevocable trust for a term of years lessthan his life expectancy.

d. The grantor retains the right to revoke the trust.

The correct answer is c.If the grantor retains an annuity from an irrevocable trust, this right alone will not cause theinclusion of the irrevocable trust in his gross estate. A GRAT is an irrevocable trust in whichthe grantor retains an annuity from the trust. If the grantor outlives the trust, the assets ofthe irrevocable trust will not be included in his gross estate. All of the other situationswould cause the inclusion of an irrevocable transfer in a grantor’s gross estate.

11. Marcia created an irrevocable trust with no retained powers in 2007 with a contribution of$600,000. She named her only daughter as the sole income and remainder beneficiary andpaid gift tax at the date of the transfer of $25,000. In 2009, Marcia died of lung cancer. Thefair market value of the property in the irrevocable trust was $3,000,000 at the date of herdeath. What amount of the trust is included in Marcia’s gross estate?

a. $0.

b. $600,000.

c. $625,000.

d. $3,000,000.

The correct answer is a.Because the trust was an irrevocable trust and Marcia did not retain any rights to the trust,the value of the trust is not included in Marcia’s gross estate.

12. Stephanie contributed $450,000 to a revocable living trust in 2005. She named herself asthe income beneficiary and her only son as the remainder beneficiary. The term of the trustwas equal to Stephanie’s life expectancy. Stephanie died in 2009, when the fair market valueof the trust’s assets is $2,000,000. How much is included in Stephanie’s probate estaterelated to the revocable living trust?

a. $0.

b. $345,800.

c. $450,000.

d. $2,000,000.

The correct answer is a.The question asks for the amount included in Stephanie’s probate estate. Because a revoca-ble living trust transfers assets per the trust document, $0 of the value of the trust isincluded in Stephanie’s probate estate. Remember, however, that the full value of a revoca-ble living trust is included in a decedent’s gross estate.


13. Phil contributed $300,000 to an irrevocable trust and did not retain any right to the trust’sassets. The income beneficiary of the irrevocable trust was Phil’s nephew, and the remainderbeneficiary of the irrevocable trust was Phil’s niece. At the time of the transfer, Phil paid gifttax of $20,000. Phil died two years later, when the value of the irrevocable trust was$1,200,000. With regard to the transfer to the irrevocable trust, how much is included inPhil’s gross estate?

a. $0.

b. $20,000.

c. $300,000.

d. $1,200,000.

The correct answer is b.The full fair market value of the trust is excluded from Phil’s gross estate because the trans-fer of the trust was irrevocable and Phil did not retain any right to the trust’s assets. How-ever, gift tax paid within three years of Phil’s death is included in his gross estate. In thiscase, the gift tax paid within three years of Phil’s death was $20,000.

14. Of the following, which is not a characteristic of a revocable trust?

a. The grantor can take the property back from the trust.

b. The income of the trust is always payable to the grantor.

c. At the grantor’s date of death, the fair market value of the trust’s assets areincluded in his federal gross estate.

d. At the grantor’s date of death, the fair market value of the trust’s assets areincluded in his probate estate.

The correct answer is d.At the grantor’s date of death, the fair market value of the revocable trust’s assets are notincluded in the grantor’s probate estate. Property within a revocable trust transfers per thetrust document. All of the other statements are characteristics of revocable trusts.

15. A trust created in the will of a decedent is a:

a. Standby trust.

b. Testamentary trust.

c. Trust by will.

d. Decedent’s trust.

The correct answer is b.A testamentary trust is a trust created in a decedent’s will. The decedent includes theinstructions of the trust’s formation and funding in his will. A standby trust is a trust cre-ated during a grantor’s lifetime that is waiting for assets. The options included as answers cand d do not exist.


16. Justin’s grandfather contributed $350,000 to a simple irrevocable trust naming Justin as theincome beneficiary and his brother, Ryan, as the remainder beneficiary. At the time of thetransfer Justin’s grandfather paid $12,000 of gift tax. This year, the trust generated $14,000of taxable dividend income and $3,000 of capital gains. What amount of taxable incomewill Justin include on his federal Form 1040 from this trust this year?

a. $0.

b. $3,000.

c. $12,000.

d. $14,000.

The correct answer is d.Since Justin is the income beneficiary of a simple irrevocable trust, he is taxed on the cur-rent year income of the trust. This year, Justin will include $14,000 on his federal Form1040. Justin is not taxed on the capital gains unless they are distributed to him.

17. Of the following statements, which is not a typical advantage of using a revocable trust?

a. Privacy.

b. Estate tax reduction.

c. Probate avoidance.

d. Reversion of the trust’s assets to the grantor.

The correct answer is b.A revocable trust does not reduce estate taxes. Privacy, probate avoidance, and the ability forthe grantor to take the trust’s assets back from the trust are all advantages of a revocabletrust.

18. A trust created to receive an amount equal to the decedent’s remaining applicable estate taxcredit equivalency at the decedent’s date of death is a:

a. Standby trust.

b. Pourover trust.

c. Bypass trust.

d. Revocable trust.

The correct answer is c.A bypass trust is created, either at death or during the grantor’s life, to receive property witha fair market value equal to the decedent’s remaining applicable estate tax credit equiva-lency. The bypass trust is created to ensure that an individual utilizes his full applicableestate tax credit at his death.


19. In 1999, Maria funded a bypass trust with $675,000, the applicable estate tax creditequivalency at the time. At Maria’s death in 2009, her will included a testamentary bypasstrust and a residual bequest to her U.S. citizen husband. If Maria’s net worth at her deathwas $4,000,000, how much will be transferred to the bypass trust to maximize its benefits?

a. $0.

b. $2,000,000.

c. $2,825,000.

d. $4,000,000.

The correct answer is c.A bypass trust is designed to receive an amount equal to the decedent’s remaining estate taxcredit equivalency at his death. Since Maria had funded a bypass trust during her life with$675,000, and since that funding the applicable estate tax credit equivalency had risen,Maria’s executor funded the testamentary bypass trust with the difference between theapplicable estate tax credit equivalency at Maria’s death (2009 - $3,500,000) and the fund-ing amount of the intervivos bypass trust ($675,000). In this case, the amount would be$2,825,000 ($3,500,000 - $675,000).

20. Of the following statements regarding an Irrevocable Life Insurance Trust (ILIT), which ofthe following is true?

a. A contribution to an ILIT that includes a Crummey power is eligible for thegift tax annual exclusion.

b. Contributions to an ILIT are not taxable gifts until the insured dies and thetransfer is deemed complete.

c. ILITs are designed so the insured retains ownership of the life insurance policy.

d. The grantor of an ILIT is deemed the owner of the life insurance policy to theextent he remains the insured of the life insurance policy.

The correct answer is a.Answer a is a correct statement. Answer b is incorrect as contributions to an ILIT are tax-able gifts, and are not eligible for the annual exclusion without a Crummey provision.Answer c is incorrect because an ILIT is designed to prevent an insured party from havingownership of the life insurance policy on his life. Answer d is an incorrect statement.

21. Which of the following is not a correct statement regarding a power of appointment trust?

a. The trust will qualify for the unlimited marital deduction if the survivingspouse is given a general power of appointment over the trust’s assets.

b. Powers of appointment trusts are irrevocable trusts that can be created eitherduring lifetime or at death.

c. A general power of appointment trust qualifies the grantor’s contributions forthe gift tax annual exclusion if the beneficiary is allowed to take withdrawals athis discretion.

d. A special power of appointment trust that limits the surviving spouse’s right toan ascertainable standard qualifies the trust for the unlimited marital deduction.


The correct answer is d.A special power of appointment trust that limits the surviving spouse’s right to an ascertain-able standard (health, education, maintenance and support) does not qualify the trust forthe unlimited marital deduction. All of the other statements are true statements regardingpower of appointment trusts.

22. Maureen created a Qualified Personal Residence Trust (QPRT) in 1997. The annuity termof the QPRT is ending this year. If Maureen continues to live in the house after this year,how is Maureen’s estate planning affected?

a. The QPRT is automatically null, and the home reverts to Maureen.

b. Maureen must begin to pay the remainder beneficiary of the QPRT a fairmarket value rent.

c. Maureen’s probate estate will now include the value of the home at her date ofdeath.

d. Maureen’s gross estate will now include the fair market value of the home at herdate of death.

The correct answer is b.If Maureen continues to live in the home after this year, she must begin to pay the remain-der beneficiary a fair market value rent. If she does not, the IRS may deem the transactionnull and void and include the value of the home in Maureen’s gross estate. The property willnot automatically revert to Maureen and it will not be included in Maureen’s probate estate,as the property will transfer per the trust document.

23. Of the following statements regarding Tangible Personal Property Trusts (TPPTs), which istrue?

a. A TPPT is designed to utilize temporal discounts to transfer tangible personalproperty at a reduced gift tax cost.

b. Only easy-to-value personal property may be included in a TPPT.

c. Property which is expected to depreciate in value should be transferred to aTPPT.

d. A TPPT is designed to utilize minority and lack of marketability discounts totransfer property at a reduced gift tax cost.

The correct answer is a.Answer a is a correct statement. Like a GRAT or QPRT, a TPPT uses temporal discounts totransfer property, in this case tangible personal property, at a reduced gift tax cost. Answer bis incorrect because any tangible personal property can be contributed to a TPPT. Answer cis incorrect as property which is expected to appreciate should be contributed to the TPPTso that the appreciation occurs in the hands of the beneficiary and not the grantor. Answerd is an incorrect statement.


24. Which of the following statements regarding 2503(b) trusts is correct?

a. The trustee has full discretion to make principal distributions to the beneficiary.

b. All income of a 2503(b) trust must be paid to the beneficiary at least annually.

c. When the beneficiary reaches the age of majority, the principal of a 2503(b)trust must be paid to the beneficiary.

d. No portion of a contribution to a 2503(b) trust qualifies for the annualexclusion.

The correct answer is b.Answer b is a correct statement. Answer a is not correct because the trust document directsthe trustee to make distributions. Answer c is not correct because the trust does not have todistribute the principal of the trust to the beneficiary when he reaches the age of majority.The trust is only required to pay the income annually. Answer d is incorrect because thepresent value of the income interest that the child will receive over the term of the trust iseligible for the annual exclusion.

25. The main difference between a 2503(b) and a 2503(c) trust is:

a. The 2503(b) trust requires the trustee to accumulate income, whereas the2503(c) trust requires the trustee to distribute all income.

b. The 2503(c) trust only allows distributions for the health, education,maintenance, and support of the beneficiary.

c. The 2503(c) trust must terminate, or the beneficiary must have the right toreceive the trust’s assets, when the beneficiary reaches age 21. A 2503(b) trustmay hold property for the lifetime of the beneficiary.

d. The trustee of a 2503(b) trust must distribute the principal of the trust withinfive years of the beneficiary reaching the age of majority. With a 2503(c) trustthe trustee must distribute the principal of the trust at the death of thebeneficiary.

The correct answer is c.The main difference between a 2503(b) and 2503(c) trust is that the 2503(b) trust mayhold property for the life of the beneficiary, whereas the 2503(c) trust must distribute theproperty to the beneficiary when he reaches the age of 21. Answer a is incorrect - the char-acteristics are reversed in each trust. Answers b and d are incorrect statements with no basisof fact.


9Charitable GivingCharitable Giving

1. What factors must an individual consider before making a charitable gift?A donor needs to consider his charitable objectives and the desired timing of the gift, inaddition to the tax consequences of making a charitable donation. The character of theproperty given, the type of donee, the timing of the contribution, and for inter vivos giv-ing, the taxpayer’s adjusted gross income are all factors that can affect the tax conse-quences of charitable giving.

2. Define “charitable organization” as detailed in the Internal Revenue Code.• A state, a possession of the United States, or any political subdivision (contribution

must be solely for public purposes).• A corporation, trust, or community chest, fund, or foundation that is organized in

the U.S. and is operated exclusively for:• religious, charitable, scientific, literary or educational purposes;• fostering national or international amateur sports competition; • preventing of cruelty to animals or children.

• A post or organization of war veterans organized in the United States.• A domestic fraternal society, order or association, operating under the lodge system,

but only if the contribution is to be used for the purposes listed above.• A cemetery company (not deductible if the donation is limited to the maintenance of

a specific cemetery plot).

3. Identify three ways to verify a charitable organization’s qualifying status.• www.irs.gov• IRS Publication 78• www.guidestar.org

4. How does a private operating foundation differ from a private nonoperating founda-tion?


90 CHAPTER 9: CHARITABLE GIVING

Operating foundations spend at least 85% of their adjusted net income on activitiesengaged in for the active conduct of the exempt purpose. To be a private operating founda-tion, the foundation must meet an assets test, endowment test, or support test. If a privatefoundation does not meet the tests to be classified as operating, then it is classified as a non-operating foundation.

5. List at least three examples of deductible out-of-pocket expenses related to donating servicesto a charitable organization.• Direct automobile expenses.• Support for foster children in excess of payments received, if no profit motive exists.• Travel and transportation expenses in connection with attending a convention on behalf

of a qualified organization.• The cost of uniforms required to be worn while performing the charitable service.

6. If ordinary income property is contributed to a charitable organization, what is the maxi-mum deductible amount?The deduction for ordinary income property is equal to the fair market value of the prop-erty reduced by any ordinary income that would have resulted from a sale. In the event thefair market value is less than the adjusted basis, the deduction is equal to the fair marketvalue of the contributed property.

7. What does it mean for a charity to be a “50% organization?”If a charity is a 50% organization, then a donor can deduct charitable contributions to thatcharity up to a limit of 50% of his contribution base. An exception exists for contributionsof appreciated capital gain property, which is subject to a 30% of contribution base ceiling.

8. List the factors a donee must consider when electing to deduct the adjusted basis of donatedproperty as opposed to electing to deduct the fair market value of the property.• The donor’s current and projected adjusted gross income for the next six years.• The fair market value of the donated property.• The adjusted basis of the donated property.• The time value of money.

9. If an individual donates property with a fair market value of $750, what information mustthe donor provide to the IRS and on what tax form is the information provided?When an individual makes a donation of property for more than $500 and less than$5,000, the donor must provide information on how and when the property was acquiredand its adjusted basis. This information along with the donee’s name and address, and thedate of the contribution, must be provided on Form 8283.

10. Why would a donor request a statement of value from the IRS?A donor would request a statement of value from the IRS to assure himself of the value thatthe IRS will allow as a charitable deduction. Without the statement of value, the individualis susceptible to the IRS disallowing or disagreeing with his proposed valuation for severalyears, thereby creating tax penalties and interest on any assessed balance due.


11. If a charitable annuity pays the annuity to the donor, how is the value of the donor’s chari-table income tax deduction calculated?The income tax deduction for an individual who donates property in return for a charitableannuity payable to himself is equal to the value of the property contributed less the value ofthe annuity.

12. Under what circumstances may the donor of encumbered property, donated in return for acharitable annuity, avoid recognizing the ordinary income and capital gain associated withthe annuity in the year of the transfer?The donor does not recognize ordinary income or capital gain in the year of the transfer ifthe annuity is nonassignable and the donor, or his designated survivors’ trust, are the onlyannuitants.

13. Which charitable trusts provide the donor with an income tax deduction in the year theproperty is transferred to the trust?• Pooled income fund.• Charitable Remainder Trust (CRT).• Charitable Lead Trust (CLT).

14. Explain how a pooled income fund benefits a donor.An individual who donates to a pooled income fund receives a current income tax deduc-tion for the present value of the remainder interest of the fund and an allocation of thetrust’s income. A pooled income fund is easy for small investors as it does not require trustdocuments and large creation fees. Also, because a pooled income fund combines the con-tributions from several individuals into one fund, the fund can be more easily diversified.

15. How is a Charitable Remainder Annuity Trust (CRAT) less flexible than a CharitableRemainder Unitrust (CRUT)?• A CRAT does not allow additional contributions after inception. A CRUT can accept

additional contributions.• A CRUT can limit its income payment to the trust’s net income for the year, and allow

for the trust to make up the payment in a year of excess income. A CRAT must make itsannuity payment each year, even if it the payment requires utilizing the CRAT’s princi-pal.

• The CRAT payment is also a fixed amount, whereas the CRUT payment is a fixed per-centage of the trust’s assets. This allows the CRUT payment to vary with the value of thetrust’s assets.

16. If an individual donates the underlying ownership interest of his personal residence to acharity, but retains the right to live in the residence for the remainder of his life, how is thedonor’s charitable deduction calculated?The donor would have a charitable deduction equal to the present value of the remainderinterest - the value of the property less the present value of the right to live in the home forthe donor’s life expectancy.


17. When a donor creates and funds a CLAT under the grantor trust provisions, how is theincome of the trust treated for income tax purposes each year?If a donor creates and funds a CLAT under the grantor trust provisions, the grantor recog-nizes all of the trust’s income in his taxable income.

18. Under what circumstances is a testamentary charitable transfer deductible from a decedent’sadjusted gross estate?• The bequest must be mandatory.• The amount of the bequest must be certain and the asset must be included in the gross

estate.

19. How may a testamentary charitable transfer be more beneficial to a donor than an intervivos charitable transfer?The charitable transfer of potentially appreciating property is more beneficial at death thanduring life because the value of the transfer will be greater as more time passes. Also, if anindividual is in an estate tax bracket which is higher than their individual income tax rate,more overall tax savings will be generated by a gift at death compared with a gift during life.


1. Which of the following statements is not true?

a. A charitable gift during life can reduce estate taxes.

b. A charitable gift during life can reduce income taxes.

c. Only a full, outright donation of property will qualify as a deductible charitablecontribution.

d. The donor of a charitable gift may be required to file a gift tax return includingthe charitable contribution.

The correct answer is c.A donor can transfer an interest in property, other than the full, outright ownership, andreceive a charitable deduction. All of the other statements are true statements. Option d is atrue statement because the donor of a charitable contribution will have to file a gift taxreturn and include the charitable transfer if the contribution is a split interest gift, or if thedonor made other taxable gifts during the year.

2. Which of the following does not qualify as a charitable organization?

a. The state of Kentucky.

b. The city of Los Angeles.

c. A cemetery company organized to maintain cemetery plots in a county.

d. Republican National Committee.

The correct answer is d.Political organizations are not qualifying charitable organizations. The other options areconsidered qualified charitable organizations. Section 170(c) defines which organizationswill qualify for charitable status. They include:• a State, a possession of the United States, or any political subdivision; • a corporation, trust or community chest, fund or foundation that is organized in the

U.S. and is operated exclusively for religious, charitable scientific, literary or educa-tional purposes, fostering national or international amateur sports competition, or pre-vention of cruelty to animals;

• a post or organization of war veterans organized in the U.S.; • a domestic fraternal society, order or association, operating under the lodge system, but

only if the contribution is to be used for the purposes listed above; • a cemetery company.



3. Terrence contributed $15,000 to a foreign charitable organization. At the time of thecontribution, the organization told him that his contribution was tax deductible for incometax purposes. Ignoring any income limitations, how much of the $15,000 contribution isdeductible?

a. $0.

b. $7,500.

c. $10,000.

d. $15,000.

The correct answer is a.Foreign charitable organizations are not qualified charitable organizations and thereforecontributions to such organizations do not qualify for a charitable deduction. It is alwaysthe responsibility of the donee to determine the deductible status of his contribution.

4. The Organization to Prevent Cruelty to Animals receives contributions from the generalpublic to fund programs to prevent cruelty to animals. Of its total support during the year,75% of the funds are from contributions from supporting individuals. What type of charityis The Organization to Prevent Cruelty to Animals?

a. Public Charity.

b. Private Foundation.

c. Private Operating Foundation.

d. Public Nonoperating Charity.

The correct answer is a.To be classified as a public charity, more than 33% of the organization’s support must befrom a combination of gifts, grants, contributions, membership fees, and gross receiptsfrom sales in an activity which is not an unrelated trade or business. Also, to be a publiccharity, not more than 33% of an organization’s support can come from the sum of grossinvestment income plus unrelated business taxable income. Because the information pro-vided tells us that 75% of the organization’s support is from individual contributions, TheOrganization to Prevent Cruelty to Animals passes the first requirement to be classified as apublic charity, and the organization must pass the second requirement because we know lessthan 33% of the contributions are derived from investment income and unrelated businesstaxable income.

5. Which of the following statements is not correct?

a. An organization that spends less than 85% of its adjusted net income onactivities engaged in for the active conduct of its exempt purpose is a publiccharity.

b. Public charities receive broad support from the general public.

c. An organization that is not a public charity and spends 90% of its adjusted netincome on activities engaged in for the active conduct of its exempt purpose is aprivate operating foundation.

d. A public charity can receive up to 33% of its support from its gross investmentincome and its unrelated business taxable income.


The correct answer is a.Option a describes a private nonoperating foundation not a public charity. All of the otherstatements are true.

6. Cathy and Mark paid $400 for two tickets to the United Church’s annual gala ball. Thechurch determined that the fair market value of each ticket was $100. How much canCathy and Mark deduct on their income tax return?

a. $0.

b. $100.

c. $200.

d. $400.

The correct answer is c.The value of any tangible benefit received in return for a contribution is not deductible. Inthis case, Cathy and Mark paid $400 for two tickets and received $200 ($100/ticket) inbenefit. The difference, $200 ($400-$200), is deductible on their income tax return.

7. Doug graduated from the University of Pittsburgh. Each year, season tickets are sold only tothose who make a contribution to the university of $1,000 or more. If Doug contributes$1,000, so that he meets the requirements to purchase season tickets, how much is hisdeductible contribution for the year?

a. $0.

b. $800.

c. $900.

d. $1000.

The correct answer is b.For a contribution to a university where the donor receives the right to purchase tickets toathletic events, only 80% of the contribution will be allowed as a charitable contribution.$1,000 x 80% = $800.

8. Connie cooks and delivers meals for the homeless and the elderly at Thanksgiving. Conniespends $200 on food, she drives 300 miles, and she spends 15 hours of her time (valued at$10/hour) completing the charitable service each year. Of these expenses, how much willConnie deduct on her income tax return for the year?

a. $0.

b. $200.

c. $242.

d. $392.

The correct answer is c.Only the actual money spent on the food and the mileage are deductible expenses. Themileage is deductible at $0.14/mile. The value of Connie’s services are not deductible. So,the total deduction for Connie’s income tax return is $242 ($200 + 300(0.14)).


9. Chris donated one of his original creation paintings to his alma mater, BackwoodsUniversity. His adjusted basis in the artwork was $400 and the fair market value was $150.Chris also contributed 100 shares of XYZ corporation that had an adjusted basis of $50 anda fair market value equal to $1,000 (held long-term). Ignoring the AGI limitations, what isthe maximum amount Chris can deduct in relation to these donations?

a. $200.

b. $1,150.

c. $1,300.

d. $1,400.

The correct answer is b.The painting has a fair market value less than its adjusted basis, and is considered ordinaryincome property. When the fair market value is less than the adjusted basis, a contributionof ordinary income property is limited to the fair market value ($150). Because Chris cre-ated the painting, we do not have to worry about the related use test. The contribution ofstock is a contribution of capital gain property and the deductible amount is equal to thefair market value of the stock ($1,000). The total of both items, and the deduction for theyear, equals $1,150.

10. Maggie contributed $10,000 to a private nonoperating foundation that has never made anydistributions. Maggie also contributed $15,000 to a private operating foundation. Maggie’sAGI for the tax year was $100,000. What is Maggie’s charitable contribution deduction forthe year?

a. $10,500.

b. $25,000.

c. $50,000.

d. $100,000.

The correct answer is b.The contribution of the $10,000 to the nonoperating foundation is subject to a 30% AGIlimitation, and the contribution to the private operating foundation is subject to a 50%AGI limitation. Neither of the limitation amounts is an issue as the total of the contribu-tions does not exceed either limit. In this case, the total charitable contribution is $25,000,the sum of both contributions.

11. Which of the following is not an issue when considering whether to deduct the adjustedbasis or the fair market value of contributed property?

a. The current market rate of interest.

b. The donor’s current and projected adjusted gross income for the 5 years afterthe contribution.

c. The fair market value of the donated property.

d. The capital gains rate in effect at the time of the transfer.


The correct answer is d.Option d is not an issue when deciding whether to deduct the adjusted basis or the fairmarket value since the transfer generally does not create a capital gain. All of the otheroptions are issues to consider.

12. Robin contributed $100 to the United Way and $300 to the Church of Good People.Which of the following statements concerning her contribution to the charitableorganizations is correct?

a. Robin must file IRS Form 8283.

b. Both the United Way and the Church of Good People are required to send aconfirmation of the contribution to Robin.

c. Only the United Way is required to send a confirmation of the contribution toRobin.

d. Only the Church of Good People is required to send a confirmation of thecontribution to Robin.

The correct answer is d.Only when a contribution totals more than $250 is the organization required to provide thedonor with a written statement of acknowledgement. So, only the Church of Good Peoplewould be required to provide this statement. Form 8283 is only filed when the total of non-cash contributions exceeds $500.

13. Which of the following contributions would require the taxpayer to obtain a statement ofvalue from the IRS?

a. The taxpayer is never required to obtain a statement of value.

b. Taxpayer donates art work valued at $150,000 to a private nonoperatingfoundation.

c. Taxpayer donates art work valued at $10,000 to a public charity.

d. Taxpayer donates art work valued at $15,000 to a public charity.

The correct answer is a.A taxpayer is never required to obtain a statement of value from the IRS. The taxpayer mayobtain a statement of value from the IRS if the art work is valued at $50,000 or more.

14. Denis sold a parcel of land to a qualified charitable organization for $10,000. The parcel ofland had a fair market value of $100,000 and an adjusted basis of $50,000. What taxablegain must Denis recognize at the time of the contribution?

a. $0.

b. $5,000.

c. $50,000.

d. $90,000.

The correct answer is b.Because Denis sold the property at 10% ($10,000/$100,000) of its fair market value, 10%of its adjusted basis offsets the sales proceeds. The capital gain is $5,000, $10,000 - $5,000= $5,000.


15. Michael transfers $100,000 of stock to a charitable organization in return for a life annuityon his life valued at $43,000. With regards to this transfer, how much is Michael’scharitable deduction?

a. $0.

b. $43,000.

c. $57,000.

d. $100,000.

The correct answer is c.When an individual transfers property in exchange for a charitable annuity, the value of theproperty less the value of the retained annuity interest is the value of the charitable deduc-tion. In this case, $100,000 - $43,000 = $57,000.

16. Which of the following statements regarding life insurance is true?

a. When an individual designates a charitable organization as the beneficiary ofhis life insurance policy, the individual can deduct the face value of the policy asa charitable contribution on his income tax return.

b. If an individual designates a charitable organization as the beneficiary of his lifeinsurance policy, but retains the right to change the beneficiary designation, thedeath proceeds of the life insurance policy will be included in his gross estate.

c. If an individual designates a charitable organization as the beneficiary of his lifeinsurance policy, and then dies without changing the beneficiary designation,the death proceeds of the life insurance policy will be included in his taxableestate.

d. Transferring ownership of a life insurance policy to a charitable organizationdoes not qualify for an income tax charitable deduction.

The correct answer is b.Option b is a correct statement. Option a is incorrect as only a transfer of the ownership ofa life insurance policy qualifies as a charitable deduction. A simple beneficiary designationwill not create a charitable deduction. Option c is incorrect as the life insurance death ben-efit will be included in the gross estate, but if the decedent dies and the charitable organiza-tion is the listed beneficiary, the estate will receive a deduction from the gross estate to arriveat the taxable estate. Option d is incorrect because a transfer of the ownership of a life insur-ance policy to a charitable organization will qualify for an income tax charitable deduction.

17. Four years ago, Walter created a charitable remainder trust with himself as the incomebeneficiary and a charity as the remainder beneficiary. In the current year, Walter would liketo make an additional contribution to the trust. Which of the following charitable trustswould allow Walter to make an additional contribution during the year?

a. CRAT.

b. CRUT.

c. CRET.

d. CRIT.


The correct answer is b.Only a CRUT allows additional contributions. A CRAT does not allow additional contri-butions. A CRET and CRIT do not exist.

18. Gillian transfers property to a revocable trust naming herself as the income beneficiary andthe United Way as the remainder beneficiary. What type of trust has Gillian created?

a. Revocable living trust.

b. CRAT.

c. CRUT.

d. Pooled income fund.

The correct answer is a.To be a CRAT, CRUT or pooled income fund, the trust would have to be irrevocable. Sinceit is a revocable trust, it must be a revocable living trust.

19. Todd irrevocably transfers property to a trust over which he retains an annuity paymenteach year equal to 6% of the initial fair market value of the property transferred to the trust.Todd designates the United Way as the remainder beneficiary. Which of the followingstatements concerning this transfer is true?

a. Todd can make an additional contribution to the trust in subsequent years.

b. Todd must inform the United Way of their right to the remainder of the trust’sassets.

c. Todd will receive an income tax charitable deduction on his income tax returnfor the year in which the trust is formed.

d. The United Way can force Todd to transfer the present value of their interest tothem immediately.

The correct answer is c.At the creation of a CRAT, Todd will receive an income tax charitable deduction on hisincome tax return for the year in which the trust is formed. Option a is incorrect because aCRAT does not allow subsequent contributions after creation. Options b and d are incor-rect as the United Way does not have to be informed of their right to receive the remainderinterest and they have do not have a right to force the payment of their interest.

20. Which of the following statements concerning a pooled income fund is correct?

a. A pooled income fund is created for each individual.

b. The pooled income fund is managed by its contributors.

c. Pooled income funds invest strictly in tax-exempt securities.

d. The income of a pooled income fund is paid to the contributors.

The correct answer is d.Option d is a correct statement. Option a is incorrect as a pooled income fund is created bythe contributions of many individuals whose funds are commingled. Option b is incorrectbecause the pooled income fund is managed by the charity for whom it will benefit. Optionc is incorrect because pooled income funds are not allowed to invest in tax-exempt securi-ties.


The Unlimited Marital Deduction

The Unlimited Marital Deduction

10

1. Explain the theory behind the unlimited marital deduction.The theory behind the unlimited marital deduction is that a married couple should betreated as a single economic unit for estate tax purposes. To the extent that either spouseconsumes property during their lifetime, it should not be subject to estate tax. Only theproperty owned by the couple that remains after the death of the surviving spouse (or, inthe eyes of the law, the termination of the economic unit) that passes to some other partyshould be subject to estate tax. Therefore, property that passes from one spouse toanother is not subject to estate tax at the death of the first spouse. To the extent that thesurviving spouse did not consume the property before the surviving spouse’s death, how-ever, the property will be subject to estate tax in the surviving spouse’s estate.

2. List three benefits of the unlimited marital deduction.• The use of the unlimited marital deduction defers the payment of estate tax.• The use of the unlimited marital deduction can fund the surviving spouse’s applicable

estate tax credit.• The use of the unlimited marital deduction helps to ensure that the surviving spouse

will have sufficient assets to maintain his lifestyle after the death of the first spouse.

3. Discuss the following statement: “The use of the unlimited marital deduction does notavoid estate tax, it merely postpones it.”If a transfer of property to a surviving spouse qualifies for the unlimited marital deduc-tion, the value of that property will be included in the surviving spouse’s gross estate tothe extent that the surviving spouse has not consumed the property before her death.Thus, the estate tax is only avoided at the death of the first-to-die spouse. At the death ofthe surviving spouse, the fair market value (at that time) of the property is included inthe surviving spouse’s gross estate.

4. List the three most common methods of leaving property to a spouse and qualifying thetransfer for the marital deduction.Outright transfers, General Power of Appointment Trusts, and QTIP Trusts.


102 CHAPTER 10: THE UNLIMITED MARITAL DEDUCTION

5. What are the three requirements for a transfer of property to qualify for the unlimited mar-ital deduction?First, the property must be included in the decedent’s gross estate. Second, the propertymust be transferred to the surviving spouse. Third, the interest must not be a nondeductibleterminable interest.

6. Define terminable interest.A terminable interest is any interest in property that will terminate at some point in thefuture.

7. List the exceptions to the terminable interest rule.• A six-month survival contingency.• A terminable interest, either outright or in trust, over which the surviving spouse has a

general power of appointment.• A Qualified Terminable Interest Property Trust.• A Charitable Remainder Trust where the spouse is the only noncharitable beneficiary.

8. Identify the requirements necessary for a General Power of Appointment (GPOA) Trust toqualify for the unlimited marital deduction.A General Power of Appointment (GPOA) Trust must meet the following requirements toqualify for the unlimited marital deduction:• The surviving spouse must be entitled to receive all of the income from the trust, at least

annually.• The general power of appointment granted to the surviving spouse must be exercisable

by the surviving spouse alone.• No other person other than the surviving spouse may appoint any part of the trust’s

property to anyone other than the surviving spouse.

9. Identify the requirements necessary for a QTIP Trust to qualify for the unlimited maritaldeduction.In order to qualify as a QTIP Trust, the following requirements must be met:• The property transferred to the QTIP trust must qualify for the marital deduction.

Consequently, the property must be in the gross estate of the first-to-die spouse andmust be transferred to the surviving spouse (in this case, in trust).

• The surviving spouse must be entitled to all income from the trust for life. The incomemust be paid at least annually. In the event the trust has income that was earned duringthe surviving spouse’s lifetime and has not been distributed as of the date of the surviv-ing spouse’s death, the trust must distribute this income to the surviving spouse’s estate(this is referred to as “stub income”).

• The surviving spouse must have the authority to compel the trustee to sell non-income-producing investments and reinvest those proceeds in income-producing investments.

• During the surviving spouse’s lifetime, no one can have the right to appoint the propertyto anyone other than the surviving spouse.

• The decedent’s executor must file an election to treat the trust as a QTIP Trust with theestate tax return.


10. Discuss the alternatives available for paying the estate taxes incurred at the death of the sur-viving spouse attributable to the QTIP Trust property. Unless otherwise directed by the surviving spouse’s will, the estate tax attributable to theQTIP Trust property is paid from the QTIP Trust. The surviving spouse’s will may directthat estate taxes related to the QTIP Trust property be paid from the residuary of the surviv-ing spouse’s gross estate.

11. Identify the requirements necessary for a Qualified Domestic Trust (QDOT) to qualify forthe unlimited marital deduction.To qualify for the unlimited marital deduction, a QDOT must meet the following require-ments:• At least one of the QDOT trustees must be a U.S. citizen or a U.S. domestic corpora-

tion.• The QDOT must prohibit a distribution of principal unless the U.S. citizen trustee has

the right to withhold estate tax on the distribution.• The trustee must keep a sufficient amount of the trust assets in the United States to

ensure the payment of federal estate taxes, or the trustee must have a minimum networth sufficient to assure the payment of estate taxes upon the death of the noncitizensurviving spouse.

• The executor of the citizen-spouse’s estate must elect to have the marital deductionapply to the trust.

12. How is a bypass trust used in estate planning?A bypass trust is used to ensure that an individual makes full use of his available applicableestate tax credit at his death. The bypass trust is created, usually in a decedent’s will, toreceive an amount equal to the decedent’s available applicable estate tax credit equivalencyamount. The remainder beneficiaries of the bypass trust are non-spouse heirs and thespouse can be an income beneficiary if the decedent chooses. Because the property will ulti-mately transfer to non-spouse heirs, the bypass trust property does not qualify for theunlimited marital deduction and the property is subject to estate tax. By funding the trustwith only the amount equal to the decedent’s available applicable estate tax credit equiva-lency amount, the estate will still not bear any estate tax and the trust property will not besubject to the estate tax at the death of the surviving spouse.

13. What is a qualified disclaimer and how is it used?A qualified disclaimer allows an individual to refuse property from the estate of a decedent.When a disclaimer is used, the disclaimed property will pass to the next person eligible toreceive it under the terms of the decedent’s will, or if no one is listed, under the state intes-tacy laws. A disclaimer is used so that the determination of the surviving spouse’s needs(after the death of the first-to-die spouse) does not have to be determined at the writing ofthe first-to-die’s will. If the first-to-die spouse leaves all of his property to his survivingspouse and includes a clause in the will directing that any disclaimed property will transferto his children, the surviving spouse is able to determine at the first-to-die spouse’s deathexactly how much property she needs to survive. Any property that she does not need canbe disclaimed and transferred to the decedent’s children. The property she ultimately takeswill be eligible for the unlimited marital deduction.


1. When a U.S. citizen dies and bequeaths property to his U.S. citizen spouse, the maritaldeductions is limited to the following amount:

a. $0.

b. $1,455,800.

c. $3,500,000.


The correct answer is d.An individual is generally permitted to leave an unlimited amount of property to his U.S.citizen spouse at death without incurring any federal estate tax. For a transfer to qualify forthe marital deduction, the property interest must meet three requirements. First, the prop-erty must be included in the decedent’s gross estate. Second, the property must be trans-ferred to the surviving spouse. Third, the interest must not be a terminable interest.

2. Jeremy and Rosa were married forty years ago after meeting on the beaches of Cozumel.Rosa moved to the U.S. with Jeremy, but she never applied for U.S. citizenship. If Jeremy isconcerned about utilizing the marital deduction for the fair market value of the property hebequeaths to Rosa, which of the following techniques could he use?

a. Qualified Terminable Interest Trust (QTIP).

b. Section 2503(b) Trust.

c. Section 2503(c) Trust.

d. Qualified Domestic Trust (QDOT).

The correct answer is d.In order to use the unlimited marital deduction for any transfers to Rosa, Jeremy wouldhave to create a Qualified Domestic Trust (QDOT). A QDOT will allow the U.S. govern-ment to subject any assets remaining at Rosa’s death to estate taxation. In order to qualifythe QDOT for the unlimited marital deduction, the following requirements must be met: 1. At least one of the QDOT trustees must be a U.S. citizen or U.S. domestic corporation.2. The QDOT must prohibit a distribution of principal unless the U.S. citizen trustee has

the right to withhold estate tax on the distribution. 3. The trustee must keep a sufficient amount of the trust assets in the U.S. to ensure the

payment of federal estate taxes, or the trustee must have a minimum net worth sufficientto assure the payment of estate taxes upon Rosa’s death.

4. Jeremy’s executor must elect to have the marital deduction apply to the trust.

3. When a U.S. citizen married to a resident alien dies, what is the maximum value of aspecific, outright bequest of property that can qualify for the unlimited marital deduction?

a. $0.

b. $1,455,800.

c. $3,500,000.




The correct answer is a.An outright specific bequest of property from a U.S. citizen to his resident alien spouse doesnot qualify for the marital deduction. As such, the unlimited marital deduction is not avail-able.

4. An executor may elect the unlimited marital deduction for which of the following transfers?

1. Decedent’s will directs the creation of a CRAT and the decedent’s nonresident alienspouse is the income beneficiary. The trustee of the CRAT is a citizen of the UnitedKingdom.

2. Bequest to U.S. citizen spouse of the right to use property for the remainder of herlife. Executor has elected QTIP on the property.

3. A payment of $650,000 to fulfill a specific bequest to decedent’s U.S. citizenspouse. Decedent’s spouse became a U.S. citizen two months before the filing of thedecedent’s estate tax return.

4. A payment of $250,000 to fulfill a specific bequest to decedent’s resident alienspouse.

a. 2 only.

b. 2 and 3.

c. 3 and 4.

d. 1, 2, and 3.

The correct answer is b.Statement 2 is eligible for the marital deduction because the executor made a QTIP electionon the property. Statement 3 is eligible for the marital deduction because at the time of thedistribution, the spouse was a U.S. citizen. Statements 1 and 4 are not eligible for the mari-tal deduction because if the spouse is a nonresident or noncitizen, a QDOT must be usedfor a transfer to qualify for the marital deduction. The CRAT in statement 1 does not qual-ify as a QDOT because the trustee is not a U.S. citizen.

5. Juan’s will creates a General Power of Appointment Trust (GPOA Trust) that distributesincome to his wife annually for life and gives his wife a general power of appointment overthe assets in the trust. Which of the following statements is true regarding a GPOA Trust?

a. The GPOA Trust only qualifies for the unlimited marital deduction if thetrustee agrees to make distributions of principal to Juan’s wife.

b. The unlimited marital deduction cannot be elected over the propertytransferred to the trust because Juan’s wife cannot appoint assets to herself, hercreditors, or to anyone on her behalf.

c. The unlimited marital deduction is not available because Juan’s wife does nothave the current right to the assets in the trust.

d. The GPOA Trust automatically qualifies for the unlimited marital deductionbecause Juan’s wife has a general power of appointment over the trust’s assets.

The correct answer is d.The GPOA Trust gives Juan’s wife a general power of appointment over the trust’s assets andthe ability to appoint the assets to herself, her creditors, or to anyone on her behalf. A


GPOA trust that gives the surviving spouse these rights will qualify for the unlimited mari-tal deduction. Option a is incorrect because the trustee of the GPOA Trust does not haveany influence on Juan’s wife’s general power of appointment over the trust’s assets. Option bis incorrect because Juan’s wife can appoint the assets of a GPOA Trust to herself, her credi-tors, or anyone on her behalf. Option c is incorrect because Juan’s wife has a current right tothe GPOA Trust’s assets through her general power of appointment.

6. If a decedent bequeaths the outright ownership of his house to his children subject to hiswife’s right to live in that house for the remainder of her life, which of the followingstatements is correct?

a. If the wife disclaims her interest in the house, the house is not included in thedecedent’s taxable estate.

b. If the children disclaim their interest in the house, the house will automaticallytransfer to the decedent’s spouse as the life estate beneficiary.

c. If the decedent’s wife is a resident alien of the U.S., a QTIP election over theproperty will allow a marital deduction equal to the fair market value of theproperty.

d. If the executor makes a QTIP election on the house, the house is not includedin the decedent’s taxable estate.

The correct answer is d.Option d is a true statement. Option a is a false statement. If the decedent’s wife disclaimsher interest in the property, the property will transfer to the children without being subjectto the wife’s life estate. In this case, the transfer would not be eligible for any deductions andwould be fully included in the decedent’s taxable estate. Option b is a false statement. If thechildren disclaim their outright ownership in the house, the outright ownership of theproperty will transfer according to the disclaimer clause in the will. If the will does notinclude a disclaimer clause, the outright ownership of the house will transfer according tothe residuary heirs of the estate. Option c is a false statement. A QTIP election will notqualify a bequest to a non-U.S. citizen spouse for the unlimited marital deduction. Only atransfer to a qualifying QDOT will qualify a bequest to a non-U.S. citizen spouse for theunlimited marital deduction.

7. Which of the following is not a benefit of the unlimited marital deduction?

a. The estate tax on property can be deferred until the death of the second-to-diespouse.

b. The unlimited marital deduction can fund the applicable estate tax credit of thesurviving spouse.

c. The use of the unlimited marital deduction can shelter the future appreciationof an asset from estate taxes at the death of the second-to-die spouse.

d. The unlimited marital deduction can ensure the surviving spouse has sufficientassets to support her lifestyle.

The correct answer is c.Property that transfers to the second-to-die spouse is eligible for the marital deduction and,to the extent it is not consumed, will be included in the second-to-die spouse’s gross estate


at the fair market value at his date of death, including any appreciation that may haveoccurred since the first-to-die spouse’s estate. If the first-to-die spouse had transferred theproperty to other beneficiaries, such as children, at the death of the second-to-die spouse,the assets would have only been subjected to estate tax in the first-to-die spouse’s estate. Allof the other statements are benefits of the unlimited marital deduction.

8. Of Pablo’s $10,000,000 federal gross estate, his will includes one specific bequest of$7,500,000 to his wife, Ariana, and directs the debts and other expenses of $1,000,000 tobe payable from the residuary of the estate. The residuary heirs are Pablo’s children. What isthe amount of the marital deduction included on Pablo’s federal estate tax return?

a. $0.

b. $6,500,000.

c. $8,500,000.

d. $7,500,000.

The correct answer is d.Since the debts and expenses are payable from the residuary of the estate, the marital deduc-tion is equal to the specific bequest to the wife. An allocation of the debts, expenses andtaxes only offsets the marital deduction when the wife is the residuary beneficiary or the willdirects the bequest to the wife to bear the debts, expenses, and taxes attributable to hershare.

9. Given only the following information, which would qualify for the estate tax unlimitedmarital deduction?

a. Property transferring to a surviving spouse as beneficiary of an irrevocable trustcreated six years ago. At the time of the trust’s creation, the gift was complete,but the decedent did not pay any gift tax as the only beneficiary of the trust wasthe decedent’s spouse.

b. A bequest of 2,000 shares of Holiday Incorporated stock to a surviving spouse.The surviving spouse is a U.S. citizen.

c. The bequest of the life estate interest in a home to the surviving spouse. Thedecedent bequeathed the remainder interest to his children.

d. A bequest of property with a fair market value of $10,000 to a surviving spouse.The surviving spouse disclaims the interest and the property transfers to thedecedent’s residual heirs, his children.

The correct answer is b.For a transfer to qualify for the estate tax unlimited marital deduction, the property interestmust meet three requirements. First, the property must be included in the decedent’s grossestate. Second, the property must be transferred to the surviving spouse. Third, the interestmust not be a terminable interest. Utilizing only the information in each of the aboveoptions, only option b describes property that would qualify for the unlimited maritaldeduction. The property is included in the decedent’s gross estate, transfers to the survivingspouse, the surviving spouse is a U.S. citizen, and the property interest transferred is out-right ownership, not a terminable interest. Option a is incorrect as a completed transfer ofproperty to an irrevocable trust is not included the decedent’s gross estate, and therefore will


not qualify for the unlimited estate tax marital deduction. Option c is incorrect as the inter-est transferred is a terminable interest. Option d is incorrect because the surviving spousedisclaims the interest and the property transfers to the decedent’s children. To qualify forthe unlimited marital deduction, the surviving spouse must inherit the property.

10. Jeff died in the current year. He had inherited the following property from his wife in 1992:

*No QTIP election.

Considering only the property listed above, what is the value of the property included inJeff ’s gross estate?

a. $250,000.

b. $704,000.

c. $750,000.

d. $1,350,000.

The correct answer is c.Property inherited by a surviving spouse is only included in his gross estate to the extent theasset has not been consumed. It is included at the fair market value at his date of death. If asurviving spouse inherits terminable interest property and the QTIP election was made onthe property, the surviving spouse must also include the fair market value of the QTIPproperty. Accordingly, Jeff ’s gross estate will include the value of the cash at his date ofdeath and the value of the IRA at his date of death. $250,000 + $500,000 = $750,000. Thelife estate in the home is a terminable interest, and the QTIP election was not made so thevalue of the property is not included in Jeff ’s gross estate, and Jeff did not own the Chevro-let at his date of death.

11. Which of the following property interests qualifies for the unlimited marital deduction?

a. John dies and leaves his vacation home to his wife as trustee of a testamentarytrust created for the sole benefit of his two children.

b. The executor of John’s estate made the QTIP election for the bequest of a lifeestate interest in his personal residence to Deborah, John’s wife.

c. John bequeaths his interest in community property to his wife subject to hiswife surviving him by more than 8 months.

d. At John’s death, his will created a trust for the benefit of his wife. The trustdocument gives his wife the authority to appoint assets to herself, her creditors,and her heirs with the approval of John’s brother, Colin.

AssetFair Market Value at Wife’s Date of Death

Fair Market Value at Jeff ’s Date of Death

Life Estate* in Home $240,000 $600,000Cash $450,000 $250,0001991 Chevrolet $14,000 Sold in 1996IRA $380,000 $500,000


The correct answer is b.Only the property interest detailed in option b would qualify for the marital deduction.Even though a life estate is a terminable interest, which is normally not eligible for the mar-ital deduction, the QTIP election on the property qualifies the transfer for the maritaldeduction. Option a does not qualify for the unlimited marital deduction because the prop-erty does not transfer to the surviving spouse. She only holds an interest as trustee for John’schildren. Option c does not qualify for the unlimited marital deduction because the survi-vorship clause cannot require the spouse to survive the decedent by more than 6 months.Option d does not qualify for the unlimited marital deduction because the surviving spousecannot act alone to exercise the general power of appointment. To qualify the survivingspouse must be able to exercise the general power of appointment alone.

12. Which of the following is not a requirement for a GPOA Trust to be eligible for theunlimited marital deduction?

a. No person, other than the surviving spouse, may appoint any part of the trustproperty to anyone other than the surviving spouse.

b. The general power of appointment granted to the surviving spouse must beexercisable by the surviving spouse alone.

c. The surviving spouse’s right to the trust property must be limited to anascertainable standard, such as health, education, maintenance, and support.

d. The surviving spouse must be entitled to receive all of the income from thetrust, at least annually.

The correct answer is c.Options a, b, and d are the requirements for a general power of appointment trust to be eli-gible for the unlimited marital deduction. Option c does not describe a requirement of ageneral power of appointment trust eligible for the marital deduction.

13. Which of the following statements is true?

a. An estate is described as overqualified when, due to a failure to make proper useof the marital deduction, too much of the property is subject to estate tax at thedeath of the first spouse.

b. An estate is described as underqualified when, due to a failure to make properuse of the marital deduction, not enough property is subject to estate tax at thedeath of the first spouse.

c. A bypass trust aids in guaranteeing the full use of an individual’s applicableestate tax credit.

d. An estate that does not take advantage of its available applicable estate tax creditis transferring assets at the lowest possible cost.

The correct answer is c.A bypass trust is generally created in a will to receive, at the decedent’s date of death, theamount of property necessary to utilize the decedent’s available applicable estate tax credit.By creating this trust in his will, the decedent is ensuring that the applicable estate tax creditwill be utilized. Options a and b are the definitions of an “underqualified” and “overquali-fied” estate. The definitions are reversed in each answer. Option d is an incorrect statement.


An estate that does not take advantage of its available applicable estate tax credit is transfer-ring assets at a higher overall estate tax cost than necessary. In other words, the assets thatare sheltered under the marital deduction could have transferred estate tax free to otherheirs.

14. Which of the following statements regarding bypass trusts is false?

a. A bypass trust can give the surviving spouse the right to distributions ofprincipal for an ascertainable standard without causing inclusion of the trust’sassets in the surviving spouse’s gross estate.

b. A surviving spouse can demand the greater of $5,000 or 5% of the trust’sprincipal each year without causing inclusion of the trust’s assets in her grossestate.

c. Distributions of trust income to the surviving spouse will not create anownership interest in the trust’s assets.

d. The right to appoint the assets of the trust to herself, her creditors, or anyoneshe desires will not create an interest which will cause inclusion of the trust’sassets in the surviving spouse’s gross estate.

The correct answer is d.Option d describes a general power of appointment over the trust’s assets. Anyone dyingwith a general power of appointment over the assets of a trust will include the fair marketvalue of the trust’s assets in his gross estate. Options a, b, and c are correct statements.

15. Jimmy and Rebecca have been married for 35 years. Jimmy had a net worth of $4,000,000when he died in 2009. Which of the following scenarios would incur the lowest overall (atJimmy’s death and Rebecca’s death) estate taxes assuming the property transfers at equalvalue at the death of both individuals and utilizing 2009 estate tax rates?

a. Jimmy’s will directs that all of his property is transferred to Rebecca.

b. In his will, Jimmy funds a trust with $3,500,000 for the benefit of his twochildren. Rebecca will receive an annual income distribution from the trust. Allother assets will transfer to Rebecca.

c. At Jimmy’s death, specific bequests totalling $275,000 are transferred per thedirection of the will to individual’s other than Rebecca. The remainder of theassets are transferred to a trust with the income payable to Rebecca for her lifeand the remainder interest payable to the children at Rebecca’s death. Jimmy’sexecutor elected to treat this as a QTIP trust.

d. Jimmy’s will directs the transfer of $345,800 to his two children and theremainder of his assets to his wife, Rebecca.


The correct answer is b.

As depicted in the table above, Scenario b provides the lowest overall federal estate taxesbecause the maximum assets are transferred utilizing the available applicable estate taxcredit at Jimmy’s death.

16. Which of the following allows an individual to refuse property from the estate of adecedent?

a. Bypass trust.

b. Exclusionary clause.

c. Disclaimer.

d. Rejection.

The correct answer is c.A qualified disclaimer allows an individual to refuse property from the estate of a decedent.A bypass trust maximizes the use of the available applicable estate tax credit at the death ofthe first-to-die spouse. The exclusion clause and rejection do not exist.

17. Within how many months must an heir file a qualified disclaimer for it to be valid?

a. 6 months.

b. 9 months.

c. 12 months.

d. 15 months.

The correct answer is b.In order for a disclaimer to be valid, the disclaimer must be in writing, must be filed within9 months of the decedent’s date of death, and the disclaimant must not have benefited fromthe disclaimed inheritance.

Answer A Answer B Answer C Answer DAssets in Jimmy’s Gross Estate $4,000,000 $4,000,000 $4,000,000 $4,000,000Unlimited Marital Deduction ($4,000,000) ($500,000) ($3,725,000) ($3,654,200)

Taxable Estate $0 $500,000 $275,000 $345,800Estate Tax $0 $780,800 $79,300 $103,372

Applicable Estate Tax Credit N/A ($780,800) ($79,300) ($103,372)Estate Tax Due $0 $0 $0 $0

Assets in Rebecca’s Gross Estate $4,000,000 $500,000 $3,725,000 $3,654,200Estate tax $1,680,800 $155,800 $1,557,050 $1,525,190

Applicable Estate Tax Credit ($1,455,800) ($155,800) ($1,455,800) ($1,455,800)Estate Tax Due $225,000 $0 $101,250 $69,390


18. Janice died in 2009. She had been married to Thomas for 17 years, and the two hadamassed a community property estate of $9,000,000. Janice’s will directs three specificbequests to her mother, brother, and father of $350,000, $225,000, and $100,000,respectively and creates a bypass trust to receive property equal to any remaining applicableestate tax credit available after her specific bequests. The bypass trust gives Thomas the rightto income for his life and the remainder of the trust to her two sons and leaves the residualof the estate to Thomas. Janice’s will directs the residual to be used to pay the estate taxes.What is the marital deduction on Janice’s federal estate tax return?

a. $675,000.

b. $1,000,000.

c. $2,825,000.

d. $3,500,000.

The correct answer is b.Since Janice and Thomas own the property as community property, each is deemed to own1/2 of the property. In this case, Janice would include $4,500,000 in her federal gross estate.The three specific bequests totalling $675,000 are directed to non-spouse beneficiaries andare taxable transfers which will utilize the applicable estate tax credit. The bypass trust willreceive $2,825,000 ($3,500,000-$675,000), an amount necessary to utilize any remainingavailable applicable estate tax credit, and will not qualify for the marital deduction. Thomaswill receive the residual, which will be eligible for the marital deduction. No estate tax willbe due because only an amount equal to the applicable estate tax credit equivalency trans-fers outside of the marital deduction. The marital deduction on Janice’s estate tax return is$1,000,000 - the gross estate of $4,500,000 reduced by the specific bequests of $675,000and the additional amount transferred to the bypass trust ($2,825,000).


Life Insurance in Estate Planning

Life Insurance in Estate Planning

11

1. List the five most common objectives of using life insurance in an estate plan.The five most common objectives of using life insurance in an estate plan are as follows:• Protecting the income stream of the client’s family.• Providing liquidity at the insured’s death.• Providing a source of retirement income.• Funding the children’s education.• Creating or sustaining family wealth.

2. When selecting the amount of life insurance needed to protect the income stream ofbeneficiaries, what should be considered?When selecting the amount of life insurance needed to protect the income stream ofbeneficiaries, the following should be considered:• The annual income needed by the family.• The family’s outstanding debt.• The need to replace the income of the decedent.• Any extra expenses that a surviving spouse may incur since the decedent’s domestic

services will no longer be available to the family.

3. What is the advantage of paying off debt at the death of the first spouse?The surviving spouse will not have the burden of servicing an outstanding debt. With-out this burden, monthly expenditure requirements are lessened, and if the survivingspouse is not skilled at managing his finances, paying off debt provides some protectionagainst future financial problems.

4. How is life insurance included in a plan for funding college education?Many parents want to help their children by providing them with the funds necessary toattend college. Usually, parents will develop a plan to contribute a certain amount,monthly or yearly, to an account or an Education IRA. The necessary contribution iscalculated based on the number of years until the child begins attending college, and


114 CHAPTER 11: LIFE INSURANCE IN ESTATE PLANNING

each contribution must be made to provide the child with the planned amount for college.If one parent dies before completing the funding, the contribution may become too muchof a financial burden, or may be overlooked by the surviving parent. Life insurance can beused to provide the funds necessary to continue funding the contribution, or it can be usedas a lump sum funding equal to the difference between the amount funded before the par-ent’s death and the remaining amount necessary.

5. Why is liquidity an issue when a decedent’s assets pass through the probate process?Because a decedent’s property may have to go through the probate process, it can take sev-eral months for the family to actually receive the property. During those months of waiting,the family will need cash to pay the mortgage, buy clothes for the children, pay privateschool tuition, and keep food on the table. The family may also need cash to pay the funeralexpenses and last medical expenses of the decedent. An insurance company pays the benefi-ciary of a life insurance policy upon presentation of the death certificate. Although this pro-cess is not instantaneous, it is usually much quicker than the probate process and willprovide the family with the necessary cash.

6. Why is liquidity an issue for a large estate?A large estate is often comprised of a few, or even one, large asset. Commonly, the asset is aninterest in a closely held business whose appraised fair market value is much greater thanany other asset, and whose large value is based upon future earnings and the value of thecompany’s fixed assets. Consequently, the federal estate tax, and any corresponding stateestate or inheritance tax, is calculated including this fair market value, even though thevalue cannot be used to pay the estate taxes due. (You cannot pay estate taxes with fixedassets or future earnings.) Within nine months of the decedent’s death, his estate will berequired to pay the estate taxes. To avoid having to quickly sell the company’s assets, whichmay create income tax consequences, a life insurance policy can be used to fund the cashnecessary to pay the estate taxes.

7. How can life insurance provide financial security for a surviving spouse in retirement?Usually throughout an individual’s life, he contributes to various savings mechanisms toprovide income for himself and his spouse during his retirement. If an individual diesbefore his goal has been fully funded, a shortfall may result for the surviving spouse. Lifeinsurance can provide a lump sum at a decedent’s death that will provide needed retirementincome for the surviving spouse.

8. How can life insurance fund retirement needs while the insured is still alive?If a cash-value policy is purchased, and the premium is paid on a regular basis, the policycash value will grow over time. At retirement, if the insured’s estate will not have liquidityneeds, or need the life insurance proceeds for other purposes (as discussed above), theinsured can take tax-free distributions of basis and take loans from the cash value of the pol-icy to supplement retirement income. All of this assumes that the insured is also the ownerof the policy, a situation that is usually avoided in estate planning because it will cause theproceeds of the policy to be included in the insured owner’s federal gross estate.


9. List the basic types of life insurance.The basic types of life insurance are term insurance, universal life insurance, whole lifeinsurance, and variable life insurance.

10. Define a term life insurance policy.A term life insurance policy is a life insurance contract that states that if the insured dieswithin the term of the contract, the insurance company will pay a stated death benefit.

11. Why is the premium on a term insurance policy lower than the premium on a permanentpolicy?The premium on a term insurance policy is lower than the premium on a permanent insur-ance policy because the term insurance policy does not have a cash accumulation account.The premium on a term insurance policy reflects the actuarial risk that the insured will dieduring the term of the contract. Other types of permanent insurance include an amountwithin the premium that is allocated to a savings account.

12. Why is the strategy of “buy term and invest the difference” not an optimal strategy for peo-ple who have a permanent need for life insurance protection?When an individual has a permanent need for life insurance protection, buying term andinvesting the difference can be a disaster. As the individual gets older, the premium of theterm policy will rise exponentially. At advanced ages, the annual cost of the insurance policymay be prohibitive, and if the premium is not paid, the insurance will lapse.

13. How is a term insurance policy used when an estate plan includes a GRAT?If the grantor dies within the estate tax inclusion period of the GRAT, the fair market valueof the assets within the GRAT will be included in the decedent’s (grantor’s) federal grossestate. The inclusion of the assets will create additional estate tax due (potentially equal to45% of the fair market value of the assets), but the assets will physically transfer to the ben-eficiaries of the trust per the trust document. The assets do not revert to the grantor’s estate.The grantor can purchase a term insurance policy with a term equal to the estate tax inclu-sion period, and a face value equal to the federal estate tax that would be created by theinclusion of the GRAT’s assets at a lower premium cost than 45% of the fair market valueof the GRAT’s assets. So, if the grantor dies within the estate tax inclusion period, the terminsurance policy will provide the cash necessary to pay the additional federal estate tax due.

14. How does a universal life insurance policy differ from a term life insurance policy?Unlike a term insurance policy, a universal life insurance policy has a cash accumulationaccount. The cash accumulation account grows tax-deferred and in any given year, theowner of the policy can decide to reduce his premium payment by the value of the cashaccumulation account.

15. What guarantee does the insurer give the insured under a whole life insurance policy?The insurer guarantees that the life insurance policy will remain in force as long as theinsured pays a stated premium each year.


16. How is the cash value of a whole life insurance policy invested?The cash value of a whole life insurance policy is invested in the bond portfolios of theinsurer.

17. In general, how does a variable universal life insurance policy differ from a universal lifeinsurance policy?A variable universal life insurance policy allows the insured to choose how the cash accountis invested. The cash account of a universal life insurance policy is invested in the bondportfolios of the insurer.

18. Identify the parties to a life insurance policy.The owner, the insured, and the beneficiary of the policy.

19. In the event that a life insurance policy does not have a named beneficiary, who receives thedeath benefit?In the event that a life insurance policy does not have a named beneficiary, the owner of thepolicy will receive the death benefit.

20. Briefly describe the transfer-for-value rule.If a life insurance policy is transferred for valuable consideration, the death benefit in excessof the transferee’s adjusted basis will be subject to income tax.

21. List the exceptions to the transfer-for-value rule.The transfer for value rule will not apply when there is a transfer of the policy to any of thefollowing individuals:• The insured,• A partner of the insured,• A partnership in which the insured is a partner,• A corporation in which the insured is a shareholder or officer, or• A transferee who takes the transferor’s basis in the contract.

22. List the settlement options available for life insurance policies.The beneficiary of a life insurance policy can choose among the following settlementoptions:• Lump sum death benefit,• Leave the life insurance proceeds on deposit with the insurer and receive interest

income, or• Annuity option.

23. Discuss the tax consequences to a beneficiary who chooses to leave the life insurance pro-ceeds on deposit at the insurer.A beneficiary who chooses to leave the life insurance proceeds on deposit with the insurerwill receive interest income that accrues on the balance of the proceeds. The interest incomewill vary depending upon the amount of the proceeds and the prevailing market interestrates. This interest income is taxable to the beneficiary, but the balance of the proceeds willremain nontaxable, provided the policy was not subject to the transfer for value rule.


24. How is the surrender value of a life insurance policy calculated?The surrender value of a life insurance policy is the amount an owner will receive if he sur-renders his life insurance policy to the insurance company. The surrender value is the cashvalue of the contract less a surrender charge.

25. If an owner elects to receive the surrender value of the life insurance policy, why might it betaxable?When the owner elects to receive the surrender value of the life insurance policy, the policybenefit is not being paid out by reason of the death of the insured, and therefore does notqualify for the income tax exclusion (under IRC Section 101(a)). If the surrender value paidto the owner is greater than his adjusted basis in the policy, the difference between theamount received and the owner’s adjusted basis is considered taxable ordinary income.

26. How do dividends from corporations differ from dividends on a life insurance policy?When a corporation distributes a cash dividend to its shareholders, the dividend representsa distribution of the earnings and profits of the corporation, which is fully subject toincome tax. A dividend on a life insurance policy is a return of the premiums paid to thepolicy owner which constitutes an overcharge by insurance company. The return of theovercharge is not taxable to the extent that the policy owner has an adjusted basis in the lifeinsurance policy.

27. List some of the advantages and disadvantages of taking a loan from a life insurance policy.Advantages:• The interest rate may be lower than commercially available lending rates.• The loan does not have to be paid back.Disadvantages:• The outstanding loan balance, plus the accumulated interest, will reduce the death ben-

efit on the policy dollar for dollar.• If the policy lapses, the gain in the policy will include the outstanding loan balance and

will be subject to income tax.

28. The designated beneficiary of a life insurance policy will receive the death benefit of thepolicy at the death of the insured. Why is the designation of the beneficiary not a com-pleted gift for federal gift tax purposes?The designation of the beneficiary of a life insurance policy is not a completed gift for fed-eral gift tax purposes because the owner may still exercise all economic rights over the pol-icy, including the ability to change the designated beneficiary again.

29. In general, how is the value of a life insurance policy in pay status determined for federalgift tax purposes?The value for federal gift tax purposes of a life insurance policy in pay status is the sum ofthe policy’s interpolated terminal reserve plus any unearned premium as of the date of thegift.

30. In general, how is the value of a paid-up life insurance policy determined for federal gift taxpurposes?The value for federal gift tax purposes of a paid-up life insurance policy is the replacementcost of the life insurance policy as of the date of the gift.


31. How can the owner of a life insurance policy receive a current income tax deduction for thevalue of the life insurance policy?Life insurance is generally considered ordinary income property. Thus, the gifting of lifeinsurance policies to a charity will follow the charitable rules for ordinary income property.The deduction for donated ordinary income property is equal to the fair market value of theproperty reduced by any ordinary income that would have resulted from its sale - usuallythe adjusted basis of the property. In the event the fair market value is less than the adjustedbasis (no ordinary income would result from this sale), the deduction is equal to the fairmarket value of the property itself. If the policy is “paid-up” (i.e., no premiums remain to bepaid), the fair market value is equal to the policy’s replacement value. If premiums remainunpaid on the policy, the fair market value is the policy’s interpolated terminal reserve value.If the donor continues to pay the premiums on any policy donated to a charity, those pre-mium payments are an additional tax deductible charitable gift.

32. If the owner of a life insurance policy gifts ownership of the policy to charity, what is theeffect of the owner continuing to pay the premiums?When the owner gifts ownership of the life insurance policy to a charity and continuesmaking the premium payments, the owner will have an itemized deduction equal to thepremium payment.

33. Define “incident of ownership” in a life insurance policy and give an example.An incident of ownership in a life insurance policy is the ability to exercise any economicright in the policy. The right to borrow from the cash value of the policy, the right to assignthe policy for a loan, and the right to change the beneficiary of the policy are all incidents ofownership in a life insurance policy.

34. With regards to the federal estate tax and life insurance, what is the three-year rule?The three-year rule states that if an individual gratuitously transfers ownership of a lifeinsurance policy on his or her life, or any incident of ownership in a policy on his or her lifewithin three years of death, the death benefit of the policy is included in the individual’sgross estate.

35. What provision allows the gift of premium payments to an ILIT to be eligible for theannual exclusion?Including a Crummey provision in the trust document of an ILIT will make the gifts ofpremium payments to the trust eligible for the annual exclusion.


1. Jack purchased a life insurance policy on his own life and never designated a beneficiary. Inthis case, the life insurance policy death benefit is:

a. Included in Jack’s federal gross estate if Jack dies within three years of the initialpremium payment.

b. Included in Jack’s federal gross estate if Jack paid the premiums until his death.

c. Never included in Jack’s federal gross estate.

d. Always included in Jack’s federal gross estate.

The correct answer is d.Because Jack did not list a beneficiary, the death benefit is payable to Jack’s estate and will bedistributed per Jack’s will or the intestacy laws of Jack’s state of residency. There is no three-year rule with regard to the initial premium payment of the life insurance policy as listed inoption a.

2. Colleen transferred ownership of a whole life insurance policy on her life to an IrrevocableLife Insurance Trust (ILIT) six years ago and retained the right to borrow against the policy.When Colleen dies, the proceeds of the life insurance policy are:

a. Included in Colleen’s federal gross estate if she has any outstanding loans againstthe life insurance policy.

b. Included in Colleen’s federal gross estate if Colleen continued paying the policypremiums after the life insurance policy was transferred to the ILIT.

c. Never included in Colleen’s federal gross estate.

d. Always included in Colleen’s federal gross estate.

The correct answer is d.The IRC (Section 2042) states that if a decedent owns a life insurance policy on her ownlife or possesses any incidents of ownership in the policy on the date of her death, the policydeath benefit will be included in her gross estate. The right to borrow against the life insur-ance policy is considered an incident of ownership which would cause inclusion in Colleen’sfederal gross estate. Because Colleen retained this right, her federal gross estate wouldinclude the death benefit of the whole life insurance policy owned by the ILIT. Option a isincorrect because as long as the decedent has the right to take a loan against the policy, it isconsidered an incident of ownership. There is no requirement that a loan be outstanding.Option b is incorrect because paying the premium on a policy transferred to an ILIT doesnot create the incidents of ownership that would cause inclusion in Colleen’s federal grossestate.



3. Carol and Joe, unrelated business partners, began operating a drug store in southernFlorida. They funded a buy/sell agreement with a cross-purchase life insurancearrangement. Carol purchased a life insurance policy with Joe as the insured, and Joepurchased a life insurance policy with Carol as the insured. If Carol dies, which of thefollowing is/are true?

1. The death benefit of the life insurance policy on Carol’s life, owned by Joe, isexcluded from Carol’s federal gross estate.

2. The death benefit of the life insurance policy on Carol’s life, owned by Joe, isincluded in Carol’s federal gross estate if Carol own’s 50% or more of the stock ofthe drug store.

3. The value of the life insurance policy on Joe’s life, owned by Carol, is included inCarol’s federal gross estate.

4. The death benefit of the life insurance policy on Carol’s life, owned by Joe, isincluded in Carol’s federal gross estate.

a. 1 only.

b. 1 and 3.

c. 1, 2, and 3.

d. 1, 2, 3, and 4.

The answer is b.Option 1 is correct because Carol’s federal gross estate will not include the death benefit ofthe life insurance policy on her life owned by Joe because Carol does not possess any inci-dents of ownership in the policy. Option 3 is correct because when an individual dies own-ing a life insurance policy on the life of another person, the value of the life insurance policywill be included in her federal gross estate. Option 2 is incorrect because Carol’s ownershipin the drug store does not change the fact that Carol does not possess any incidents of own-ership in the life insurance policy on her life, owned by Joe. The death benefit of a lifeinsurance policy on Carol’s life would only be included in Carol’s federal gross estate if shepossessed any incidents of ownership in the life insurance policy. Option 4 is incorrectbecause the death benefit of a life insurance policy is only payable at the death of theinsured. In this case, Joe has not died, and as such, the death benefit of the policy is not pay-able to Carol and would not be included in Carol’s federal gross estate.


4. Many individuals who have been diagnosed with terminal illnesses sell their life insurancepolicies to viatical settlement providers. Which of the following statements is true regardingthe transfer of a policy from an individual with a terminal illness to a viatical settlementprovider?

a. If the individual dies within three years of the transfer, the full proceeds of theinsurance policy are included in his federal gross estate.

b. The individual is subject to capital gain taxes on the difference between hisadjusted basis in the life insurance policy and the amount paid to him by theviatical settlement provider.

c. Regardless of when the individual dies, the payment from the viaticalsettlement company is excluded from income tax.

d. If the individual lives for more than one year after the transfer, the individualwill be subject to income tax on the payment from the viatical provider.

The correct answer is c.The IRC (Section 101(g)) excludes amounts received under a life insurance contract on thelife of an insured individual who is chronically or terminally ill from the individual’s grossincome. There is no requirement that the individual die within a certain period of time.Option a is incorrect because the three-year rule (Section 2035) only applies to gratuitoustransfers of life insurance. In this case, the life insurance policy was sold to the viatical settle-ment provider, and thus would not be subject to the three-year rule.

5. Last year, Jerry gave a life insurance policy with a $400,000 death benefit to his son, Brad.At the time of the gift, the value of the life insurance policy was $50,000 and Jerry had topay $5,000 in federal gift tax. Jerry unexpectedly died this year. What amount will beincluded in Jerry’s federal gross estate related to this life insurance policy?

a. $5,000.

b. $400,000.

c. $405,000.

d. $455,000.

The correct answer is c.Life insurance proceeds on policies gratuitously transferred within three years of death areincluded in the gross estate of the donor. Gift tax paid within three years of death isincluded in the federal gross estate as well under the gross-up rule.

6. Four years ago, Marvin gave a life insurance policy with a $750,000 death benefit to hisdaughter, Marsha. At the time of the gift, the value of the life insurance policy was $65,000,and Marvin paid $10,000 in federal gift tax. Marvin unexpectedly died this year. Whatamount will be included in Marvin’s federal gross estate related to this life insurance policy?

a. $0.

b. $10,000.

c. $65,000.

d. $750,000.


The correct answer is a.Because Martin died more than three years after the gratuitous transfer of the life insurancepolicy, Martin’s federal gross estate would not include any amount related to this life insur-ance policy.

7. Louie gave a $1,000,000 life insurance policy on his own life to his brother. At the date ofthe gift, the life insurance policy was valued at $200,000. Which of the followingstatements regarding the gift of this life insurance policy is correct?

a. If Louie dies two years after this gift, his federal gross estate will include$200,000.

b. If Louie dies four years after this gift, his federal gross estate will include$200,000.

c. If Louie dies two years after this gift, his federal gross estate will include$1,000,000.

d. If Louie dies four years after this gift, his federal gross estate will include$1,000,000.

The correct answer is c.The three-year rule (IRC Section 2035) states that if an individual gratuitously transfersownership of a life insurance policy on his life, or any incident of ownership in a policy onhis life within three years of death, the death benefit of the policy is included in his federalgross estate. In this case, only answer c provides the correct solution. If Louie dies two yearsafter the gift, the gratuitous transfer of the policy falls within the three-year rule and thedeath benefit is included in Louie’s federal gross estate. All of the other options are incor-rect.

8. As part of his employee benefit package, Larry’s employer provided him with a $50,000term life insurance policy. Larry named his wife, Cynthia, as the sole beneficiary of the lifeinsurance policy. Which of the following statements is true with regard to this life insurancepolicy?

a. Because the term insurance policy is part of a group term life insurance policy,the death benefit payable to Cynthia is considered taxable income.

b. At Larry’s death, the death benefit payable to Cynthia will be included in Larry’sfederal gross estate.

c. Larry cannot change the beneficiary of the life insurance policy withoutCynthia’s prior written approval.

d. If Cynthia dies before Larry, her federal gross estate will include the lifeinsurance policy death benefit.

The correct answer is b.The death benefit of the life insurance policy will be included in Larry’s federal gross estatebecause Larry was the owner of the life insurance policy and had the right to change thedesignated beneficiary of the policy. Option a is incorrect because the death benefit payablefrom a policy issued under a group term life insurance policy is treated just like the deathbenefit payable from any other life insurance policy. As long as the policy has not beentransferred for valuable consideration, the beneficiary will receive the death benefit without


any income tax ramifications. Option c is incorrect because the owner of the policy canchange the beneficiary designation without any authorization from the current beneficiary.Option d is incorrect because the beneficiary of a life insurance policy does not have anyright to the death benefit until the insured has died. In this case, Cynthia, the beneficiary,has died before the insured on the policy, Larry, so Cynthia will not include any amountrelated to the life insurance policy in her federal gross estate.

9. James owned a life insurance policy with his brother, Fred, as the insured. When Jamesdied, his will specifically bequeathed the policy to his sister, Lolita. Which of the followingstatements regarding the value of the life insurance policy to include in James’ federal grossestate is not true?

a. If the life insurance policy is a term life insurance policy, the value is the unusedpremium.

b. If a new life insurance policy is involved, the net premium paid is the value.

c. If the life insurance policy is a whole life policy in pay status, the value is equalto the unearned premium plus the interpolated terminal reserve.

d. If the life insurance policy is a paid-up or single premium life insurance policy,its value is its replacement cost.

The correct answer is b.If a new life insurance policy is involved, the value is the gross premium paid. All of theother statements are true.

10. Which of the following is not a reason for using life insurance in an estate plan?

a. The proceeds of the life insurance policy can be used to create liquidity for thedecedent’s estate.

b. The proceeds of the life insurance policy can be used to eliminate any debt forthe decedent’s surviving spouse.

c. The insured can borrow the death benefit from the life insurance policy to fundhis retirement.

d. Expected future education expenses can be funded with the death benefit of thelife insurance policy.

The correct answer is c.The insured can borrow against the cash surrender value of the life insurance policy to fundhis retirement. The insured cannot borrow the death benefit of the life insurance policy. Allother statements are reasons for using life insurance in an estate plan.


11. Which of the following statements regarding term life insurance is correct?

a. The premium on a term life insurance policy reflects the actuarial risk that theinsured will die during the term of the contract.

b. The cash accumulation account of a term life insurance policy is invested in thebond portfolios of the insurer.

c. The cash accumulation account of a term life insurance policy is invested inindividual stocks selected by the insured.

d. The premium of a term life insurance policy will decrease as the pure cost of lifeinsurance increases.

The correct answer is a.The premium on a term life insurance policy reflects the actuarial risk that the insured willdie during the term of the contract. Options b and c are incorrect because a term life insur-ance policy does not have a cash accumulation account. Option d is incorrect because thepremium of a term life insurance policy increases as the pure cost of life insurance increases.

12. Travis, 28, and his wife, 26, have recently moved into a new home. They financed$350,000 of the $500,000 purchase price and utilized all of their savings to pay the downpayment of $150,000. Travis’ wife stays at home with their 3-year old son, Alex, and isexpecting a baby in two months. Which of the following statements is not correct?

a. Travis should consider a 30 year term life insurance policy on his life whichcould fund his children’s educational needs if he should die during the term.

b. A universal life insurance policy would provide Travis with the insuranceprotection of a term life insurance policy and would also provide him with atax-deferred savings mechanism.

c. A whole life insurance policy would provide Travis with the least expensivetemporary life insurance needed to eliminate the mortgage at his death.

d. Travis should consider a whole life insurance policy on his life which could fundhis children’s educational needs or pay off the mortgage if he dies while thoseneeds exist, and which could also provide Travis with a source of funds if helives through his retirement.

The correct answer is c.A whole life insurance policy is a permanent type of insurance - eliminating a mortgage is atemporary need. Also, whole life insurance at Travis’ age would have the highest premium.All of the other statements are correct.


13. Mary selected her son as the beneficiary of a whole life insurance policy on her life. Whichof the following statements concerning this beneficiary designation is incorrect?

a. Mary could have chosen her son and her daughter as co-beneficiaries.

b. If Mary lists her nephew as the contingent beneficiary of the whole lifeinsurance policy, her nephew will collect the death benefit if her son dies beforeMary.

c. If Mary entered an irrevocable beneficiary designation, she is the completeowner of the life insurance policy and can amend the irrevocable beneficiarydesignation at anytime.

d. At Mary’s death, her son will receive the death benefit of the life insurancepolicy.

The correct answer is c.If Mary had entered an irrevocable beneficiary designation, she continues to be the owner ofthe life insurance policy, but she will need her son’s permission to amend the beneficiarydesignation. All of the other statements are true.

14. Which of the following statements regarding universal life insurance policies is true?

a. As long as the premium of a universal life insurance policy is paid, the insurerguarantees that the life insurance policy will remain in force.

b. A universal life insurance policy will be cancelled if the pure cost of insuranceprotection increases and the cash accumulation account does not have the fundsto pay the additional cost.

c. Funds within the cash accumulation account of a universal life insurance policycannot be used to pay the policy premium.

d. A universal life insurance policy allows the insured to select the cashaccumulation account investments.

The correct answer is b.A universal life insurance policy is a term life insurance policy with a cash accumulationaccount attached to it. In the initial years of the policy, the premium paid is in excess of thepure cost of the insurance, and the excess is deposited into the cash accumulation account.In the later years of the life insurance policy, the pure cost of the insurance will increase, butthe insured will continue to pay the same premium. Funds within the cash accumulationaccount will pay any difference between the pure cost of the insurance and the premiumpaid by the owner. However, if the cash accumulation account does not have the funds topay the difference, the life insurance contract will lapse. Only a whole life insurance policywill remain in force when the pure cost of the insurance is in excess of the premium paid.Option a is incorrect because the universal life insurance policy will lapse if the policy pre-mium is not paid and the cash accumulation account does not have the funds necessary topay the policy premium. Even if the policy premium is paid, the universal life insurancepolicy will also lapse if the cash accumulation account does not have the funds to pay theexcess pure insurance cost. Option c is incorrect because the cash accumulation account canbe used to pay the policy premium. Option d is incorrect because the insured does notselect the investments for the cash accumulation account.


15. Raphael is the owner of a variable life insurance policy on his life. His wife, Isabel is thedesignated beneficiary. Which of the following statements is correct?

a. If Isabel dies before Raphael, Isabel must include the value of the life insurancepolicy in her federal gross estate.

b. At Raphael’s death, the variable life insurance policy death benefit will be paidto Isabel.

c. When the beneficiary of a life insurance policy is the wife of the insured/owner,the death benefit payable to the wife is included in the insured’s probate estate.

d. As beneficiary, Isabel can borrow against the death benefit during Raphael’s life.

The correct answer is b.As listed beneficiary, Isabel will receive the death benefit of the life insurance policy atRaphael’s death. Option a is incorrect because only the owner of a life insurance policy isrequired to include the value in her federal gross estate. In this problem, Isabel is only thebeneficiary; she does not have any right to the life insurance policy until Raphael’s death.Option c is incorrect. A life insurance policy is included in the insured’s probate estate onlywhen the death benefit is payable to the insured or no designated beneficiary has beenselected. Option d is incorrect because the beneficiary of a life insurance policy cannot bor-row against the death benefit.

16. Jason is the owner of a paid-up whole life insurance policy on his own life. Which of thefollowing is not true?

a. Jason has title to the whole life insurance contract.

b. Jason can borrow against the cash value of the whole life insurance policy.

c. The death benefit of the whole life insurance policy will be included in Jason’sfederal gross estate.

d. If Jason gifts the whole life insurance policy to his son, the value for gift taxpurposes is the sum of the policy’s interpolated terminal reserve plus anyunearned premium.

The correct answer is d.Because it is a paid-up whole life insurance policy, the value for gift tax purposes is thereplacement cost of the policy. All of the other statements are true.

17. Jim purchased a yacht from Ronald for $200,000 seven years ago. The terms of the saleincluded a note of $50,000 and cash for the remaining amount. Ronald had a zero basis inthe yacht. Immediately after purchasing the yacht, Jim’s business began to fail and Jim couldno longer make the payments. In exchange for the note, Jim gave Ronald a life insurancepolicy on his life with a face value of $50,000. This year, Jim died and Ronald received thedeath benefit as the designated beneficiary of the policy. How much of this death benefit istaxable to Ronald?

a. $0.

b. $50,000.

c. $150,000.

d. $200,000.


The correct answer is b.The transfer of the life insurance policy for the note is a transfer for valuable consideration.If a life insurance policy is transferred for valuable consideration, the death benefit in excessof the transferee’s adjusted basis will be subject to income tax. Ronald did not have any basisin the boat, so correspondingly, he does not have any basis in the note and must recognizegain to the extent any value is received. As such, the $50,000 death benefit received is tax-able income to Ronald.

18. In which of the following situations would the death benefit of a life insurance policy betaxable, partially or wholly?

a. Deborah, as designated beneficiary, received the $80,000 death benefit ofLarry’s life insurance policy. Larry had purchased the policy for $35,000 fromhis employer when he retired in 1997.

b. Clean-it, LLC, received the $100,000 death benefit of David’s life insurancepolicy. In 1990, David, the owner of 50% of the stock of Clean-it, LLC sold thepolicy to Clean-it for $12,000 as part of an entity-type buy-sell agreement.

c. Weakam, Ullo, and Evans, LLP, received the $1,000,000 death benefit of a lifeinsurance policy on Randy Evans, one of the managing partners. Randy hadsold the policy to Weakam, Ullo, and Evans, LLP in 1945 when the businesswas just starting out as part of an entity-type buy-sell agreement.

d. Adam sold a $100,000 death benefit life insurance policy to Dawson for$35,000 as part of cross-purchase buy-sell agreement. Dawson and Adam werethe only two shareholders of Cupper Corporation and each owned a policy onthe other.

The correct answer is d.If a life insurance policy is transferred for valuable consideration, the death benefit in excessof the transferee’s adjusted basis will be subject to income tax. An exception exists for anytransfer of the life insurance policy for valuable consideration to the insured, a partner ofthe insured, a partnership in which the insured is a partner, a corporation in which theinsured is a shareholder or officer, or a transferee who takes the transferor’s basis in the con-tract. Option a is an example of a transfer to the insured. Option b is an example of a trans-fer to a corporation in which the insured is a shareholder. Option c is an example of atransfer to a partnership in which the insured is a partner. Option d does not fit any of theexceptions. The life insurance policy is transferred to Dawson, not Cupper Corporation.

19. Pamela’s dad, Tim, died on August 10 of this year. Six years ago, Tim had gifted ownershipof a paid-up $1,000,000 whole life insurance policy on his life with a replacement value of$150,000 and an adjusted basis of $100,000 to Pamela. If Pamela, as designated beneficiary,receives the death benefit of the life insurance policy this year, how much will be taxable toher?

a. $0.

b. $50,000.

c. $100,000.

d. $1,000,000.


The correct answer is a.A gift of a life insurance policy is not a transfer for valuable consideration and as such thedeath benefit, payable by reason of Tim’s death, is not included in Pamela’s taxable income.

20. Jerry is the owner, the insured, and the beneficiary of a whole life insurance policy. Whichof the following situations regarding this scenario is incorrect?

a. When Jerry dies, his federal gross estate will include the death benefit of the lifeinsurance policy.

b. When Jerry dies, his probate estate will include the death benefit of the lifeinsurance policy.

c. Jerry’s estate will include the death benefit in its taxable income.

d. If Jerry designates a new beneficiary before he dies, and the beneficiary is aliveat the time of Jerry’s death, the death benefit will be excluded from his probateestate.

The correct answer is c.The IRC (Section 101(a)) provides an income tax exemption for a death benefit paid froma life insurance contract by reason of the death of the insured. In this case, Jerry’s estate willreceive the death benefit, but it will still be excluded from the taxable income of the estatebecause of the exemption provided by the IRC (Section 101(a)). All of the other statementsare correct.

21. Which of the following is not a valid settlement option for the designated beneficiary of alife insurance policy?

a. A lump sum payment of the death benefit.

b. Individual Retirement Account Rollover.

c. Life Annuity.

d. Term Annuity.

The correct answer is b.A beneficiary of a life insurance policy cannot rollover the death benefit into an IRA. Thedesignated beneficiary of a life insurance policy can choose to receive the death benefit as alump sum payment, as an annuity (term or life), or the beneficiary can leave the death ben-efit on deposit with the insurer. In some situations, the owner of the life insurance policywill establish an irrevocable settlement option, thereby choosing the beneficiaries settlementoption.


22. Jackie’s father died last month and she is the listed beneficiary on his insurance policy. Jackiehas contacted the insurer and has requested a lump sum payment of the death benefit of thelife insurance policy. Which of the following statements regarding this lump sum paymentis true?

a. When Jackie receives the lump sum payment of the death benefit from theinsurer, part of the payment will be taxable.

b. Because Jackie has elected a lump sum payment of the death benefit, she willactually receive a payment less than the face value of the policy.

c. Had Jackie elected the life annuity, each payment would have been excludedfrom her gross income.

d. Jackie could have elected to leave the death benefit on deposit with the insurerand continue the tax-deferred growth of the policy.

The correct answer is a.When Jackie receives the lump sum death benefit, she will also receive fully taxable intereston the death benefit that accrued from the time of her father’s death to the date the insurerpaid Jackie. Option b is a false statement. Option c is incorrect because if Jackie had electedthe annuity option, a portion of each annuity payment would have been taxable as interestincome and the remaining portion of the payment would have excluded from Jackie’s tax-able income. Option d is incorrect because if Jackie had chosen to leave the death benefit ondeposit with the insurer, she would have to include the earnings on the death benefit in hertaxable income each year.

23. Who has the right to surrender a life insurance policy for its cash surrender value?

a. The insured of the life insurance policy.

b. The owner of the life insurance policy.

c. The beneficiary of the life insurance policy.

d. The insurer of the life insurance policy.

The correct answer is b.The owner of a life insurance policy is the only party to a life insurance policy who can sur-render a life insurance policy for its cash surrender value.

24. At age 69, John, a widower, needs more than his pension and Social Security income to payhis living and medical expenses. His children do not have the resources to help him and hehas already liquidated his individual retirement accounts. Which of the following is true ifJohn decides to surrender his whole life insurance policy to the insurer?

a. John would receive the present value (using the actuarial factors according toJohn’s life expectancy) of the life insurance policy death benefit.

b. Any amount of surrender value paid to John would reduce the death benefitpayable to the listed beneficiary of the policy dollar-for-dollar.

c. To surrender the life insurance policy, John must receive the approval of thelisted beneficiary of the life insurance policy.

d. The surrender value of the policy would be paid to John and the life insurancecontract would be cancelled.


The correct answer is d.If John surrenders the life insurance policy to the insured, the insurer will pay John the sur-render value, the contract will be cancelled, and correspondingly there will not be a deathbenefit payment at John’s death. Option a is incorrect because if John surrender the lifeinsurance policy, the surrender value is equal to the cash accumulation account less a surren-der charge from the insurer. Option b is incorrect because once the policy is surrendered thecontract is cancelled and no death benefit would be paid to the beneficiary. Option c isincorrect because John would not have to receive the approval of the listed beneficiaryunless it was stated that he had made an irrevocable beneficiary designation.

25. Gayle is the owner and insured on a $1,000,000 face value life insurance policy in paystatus. Gayle’s adjusted basis in the life insurance contract is $250,000. If Gayle gifts this lifeinsurance policy to her daughter and listed beneficiary, Celeste, which of the followingstatements is correct?

a. After the date of the gift, any dividends paid on the life insurance policy will betaxable to Gayle.

b. Celeste can amend the beneficiary designation of the life insurance policy toinclude her son, Matt, as a co-beneficiary.

c. If Celeste dies before Gayle, Celeste’s probate estate will include thereplacement value of the life insurance policy.

d. If Gayle dies within 3 years of the gift of the life insurance policy to Celeste, thedeath benefit will be included in Gayle’s probate estate.

The correct answer is b.After Gayle has gifted the life insurance policy to Celeste, Celeste can select the designatedbeneficiary of the life insurance policy. Celeste has the right to change the beneficiaryselected by Gayle and does not need Gayle’s approval to amend the designation. Option a isincorrect because any dividends issued on the life insurance policy will be paid to Celesteand the dividends are nontaxable distributions equal to return of capital. Option c is incor-rect because the value of a life insurance policy in pay status is the sum of the interpolatedterminal reserve plus any unearned premium. Option d is incorrect as the life insurance pol-icy will be included in Gayle’s federal gross estate if she dies within three years of the gift ofthe life insurance policy.

26. The owner of a life insurance policy has decided to surrender the life insurance policy to theinsurer. Since inception of the life insurance contract, the owner has paid premiums of$100,000 and received cash policy dividends equal to $20,000. If at the surrender date, theowner receives a cash payment of $140,000 from the insurer, what is his gain/loss subject toincome tax on the life insurance policy?

a. $0.

b. $20,000.

c. $40,000.

d. $60,000.


The correct answer is d.The owners adjusted basis in the property would be $80,000 - the sum of the premiumspaid on the policy less any dividends received (a dividend on a life insurance policy is areturn of the policy owner’s adjusted basis). If the insurer pays a cash surrender value of$140,000, the gain on the policy would be $60,000 ($140,000-$80,000).

27. Mr. Fahey, age 71, has been paying the premium on a whole life insurance policy for thepast 30 years. The policy has a $1,000,000 death benefit and has built up a cash value of$250,000. Mr. Fahey’s adjusted basis in the life insurance policy is $200,000. Which of thefollowing statements is not correct?

a. If the insurer pays Mr. Fahey a life insurance policy dividend of $3,000, hisadjusted basis in the whole life insurance policy will increase to $203,000.

b. If the insurer pays Mr. Fahey a life insurance policy dividend of $4,000, hisadjusted basis in the whole life insurance policy will decrease to $196,000.

c. The cash surrender value of Mr. Fahey’s whole life insurance policy would beequal to the cash value of the policy less a life insurance policy surrender charge.

d. Mr. Fahey can take a loan from the cash value of the life insurance policywithout suffering any income tax consequences.

The correct answer is a.Life insurance policy dividends are a return of the policy owner’s adjusted basis. Any policydividends received would decrease, not increase, the owner’s adjusted basis. All otheroptions are correct.

28. Which of the following statements is true?

a. Life insurance policy dividends are taxable as dividend income.

b. Life insurance policy dividends kept on deposit with the insurer will generatetax-deferred interest income.

c. If a life insurance policy lapses, any outstanding loans will be required to berepaid to the insurer immediately at the lapse.

d. If a life insurance policy owner takes a loan from the policy, the death benefit ofthe policy will be reduced by any outstanding loans plus the accumulatedinterest due on the loan at the death of the insured.

The correct answer is d.Option d is a correct statement. Option a is incorrect as policy dividends are return of thepolicy owner’s adjusted basis. Option b is incorrect as life insurance policy dividends kepton deposit with the insurer will generate taxable interest income to the life insurance policyowner. Option c is incorrect because the outstanding loan would be off set by the surrendervalue.


29. Warren purchased a single premium life insurance policy on his life 15 years ago for$65,000. The current value of the policy is $155,000. Which of the following statementsregarding Warren’s life insurance policy is true?

a. If Warren takes a loan of $140,000 against the cash surrender value of the lifeinsurance policy, he will have long-term capital gain of $65,000.

b. If Warren takes a loan of $65,000 against the cash surrender value of the lifeinsurance policy, he will not have any capital gain.

c. If Warren takes a loan of $75,000 against the cash surrender value of the lifeinsurance policy, he will recognize $10,000 of long-term capital gain.

d. If Warren takes a loan of $155,000 against the cash surrender value of the lifeinsurance policy, he will recognize $90,000 of long-term capital gain.

The correct answer is d.Because Warren’s life insurance policy was funded with a single premium payment, the pol-icy is considered a modified endowment contract (MEC). Any loan from a MEC is consid-ered capital gain to the extent there is any gain in the contract. Therefore, option d iscorrect because Warren takes a $155,000 loan from the contract and has $90,000($155,000-$65,000) of capital gain. Warren must recognize capital gain to the extent of thecapital gain inherent in the policy before receiving a return of capital. In answer a, if Warrenborrowed $140,000, he would also recognize $90,000 of capital gain. In option b, Warrenwould recognize $65,000 of capital gain if he took a loan of $65,000. If Warren borrowed$75,000 as in option c, Warren would have a $75,000 capital gain.

30. Twelve years ago, Paul purchased a single premium $1,000,000 life insurance policy on hisown life for $150,000 and named his daughter as the sole beneficiary. Paul gifted ownershipof the policy to Holly this year when the value of the life insurance policy was $200,000.Paul paid $15,000 of gift tax on the transaction. At Paul’s death, how much of the deathbenefit that Holly receives will be subject to income tax?

a. $0.

b. $785,000.

c. $800,000.

d. $1,000,000.

The correct answer is a.Even though the life insurance policy is considered a modified endowment contract, thereceipt of the death benefit remains income tax free to the extent the policy had not beentransferred for valuable consideration. In this case, the transfer to Holly was a gift, not atransfer for valuable consideration, so the death benefit is not subject to income tax.


31. The owner of a whole life insurance policy would like to exchange his life insurance policyfor an annuity on his life. Currently, the value of the life insurance policy is $150,000,excluding a $50,000 loan the owner has against the life insurance policy, and the owner’sadjusted basis in the policy is $65,000. Which of the following statements is true?

a. If the owner exchanges the life insurance policy for an annuity, the owner mustrecognize a $135,000 capital gain on the exchange.

b. The owner’s basis in the annuity after the exchange will be $115,000.

c. The exchange will be considered a transfer for valuable consideration.

d. If the annuity has a death benefit, the beneficiary will have to include the deathbenefit in her taxable income at the owner’s death.

The correct answer is b.In an exchange of a life insurance policy for an annuity, the owner of the life insurance pol-icy must recognize gain to the extent he receives boot in the exchange. Outstanding loansagainst the life insurance policy are considered boot. In this problem, the owner has poten-tial gain of $135,000 ($150,000 + $50,000 - $65,000), and must recognize gain to theextent he had a loan outstanding, or $50,000. Normally, the owner’s adjusted basis in thelife insurance policy will be carried over to the annuity, but if the owner recognizes any gainon the exchange or pays additional expenses, he will increase his adjusted basis in the annu-ity by the gain recognized or the expenses paid. Because the owner had to recognize gain onthe loan, he will increase his adjusted basis by this recognized gain of $50,000. After theexchange, the owner’s adjusted basis in the annuity is $115,000, the adjusted basis in thelife insurance policy increased by the amount of gain recognized on the transaction($65,000 + $50,000). Option c is incorrect as an exchange is not considered a transfer forvaluable consideration. Option d is incorrect because the death benefit would not be sub-ject to income tax as long as the death benefit is payable by reason of the death of the owner.

32. Sally was recently diagnosed with stage four lung cancer. Her doctors have given her 9months to live. She has many medical expenses and needs money. If Sally sells a whole lifeinsurance policy, with a $1,000,000 face value and a $250,000 adjusted basis to a viaticalsettlement provider for $350,000, how much capital gain will Sally have to recognize forincome tax purposes on the sale?

a. $0.

b. $250,000.

c. $350,000.

d. $1,000,000.

The correct answer is a.The IRC (Section 101(g)) states that amounts received under a life insurance contract onthe life of an insured individual who is chronically or terminally ill may be excluded fromgross income. Because her doctors expect her to die within 9 months, Sally is consideredterminally ill. A terminally ill individual is a person who has been certified by a licensedhealth care provider as having a condition or illness that can reasonably be expected to resultin death within 24 months.


33. In an attempt to exclude the death benefit of a paid up $500,000 face value whole lifeinsurance policy from his gross estate, Jerry gifted the policy to his daughter. Six monthsprior to the gift, Jerry had been diagnosed with a terminal illness and given a 12 month lifeexpectancy by his doctor. What is the gift tax value of the gift of this policy?

a. The replacement cost of the life insurance policy.

b. The life insurance policy’s interpolated terminal reserve plus any unearnedpremium.

c. $500,000 discounted for Jerry’s six month life expectancy.

d. The cash surrender value of the life insurance policy.

The correct answer is c.If a physician has determined that the insured has a physical condition that is terminal, thevalue of a life insurance policy for gift tax purposes will be the death benefit, discounted forthe predicted life expectancy of the insured.

34. In an attempt to exclude the death benefit of a paid up $500,000 face value whole lifeinsurance policy from his gross estate, Jerry gifted the policy to his daughter. Six monthsprior to the gift, Jerry had been diagnosed with a terminal illness and given a 12 month lifeexpectancy by his doctor. Jerry died 4 years after the gift of the life insurance policy. Whatamount is included in his federal gross estate related to this whole life insurance policy?

a. $0.

b. $250,000.

c. $500,000.

d. $500,000 discounted for Jerry’s six month life expectancy.

The correct answer is a.Jerry’s federal gross estate would not include any value related to this life insurance policybecause he is not the owner or beneficiary of the life insurance policy at his death, and thegift was made more than three years prior to his death. An individual’s federal gross estateonly includes the death benefit of a life insurance policy on the insured, if the individual isthe owner, the beneficiary, or if there was a gratuitous transfer of the life insurance withinthree years of the individual’s death.

35. Which of the following is not considered an incident of ownership?

a. The right to change the beneficiary of a life insurance policy.

b. The insured making cash gifts to the owners of the life insurance policy of thepremium amount.

c. The right to take loans against the cash value of the life insurance policy.

d. A provision in an ILIT that directs the trust to pay the federal estate taxes of theinsured.

The correct answer is b.If the insured makes cash gifts to the owners of the life insurance policy equal to the pre-mium amount it is not considered an incident of ownership. All of the other options wouldbe considered an incident of ownership.

Special Elections & Post Mortem

Planning

Special Elections & Post Mortem

Planning


12

1. Why is it important for an estate to have cash?An estate must cover the taxes, administrative expenses, last medical costs, and funeralcosts. All of these expenses must be paid for with cash, and if the estate does not have thecash necessary to make these payments, assets will have to be liquidated and possiblysold at a price lower than the asset’s fair market value to generate the necessary cash.

2. How can an individual potentially reduce the medical expenses to be paid by his estate?An individual’s estate is required to pay the medical expenses not otherwise paid byhealth insurance. If an individual keeps his medical insurance up to date until his death,the amount his estate will have to pay should be less than if he did not have health insur-ance.

3. How can an individual reduce the funeral expenses that his estate will have to pay?If an individual pre-arranges and pre-funds his funeral before his death, his estate will berelieved of the burden of paying for the services.

4. List three common administration costs of an estate.• Executor’s fees.• Attorney’s fees.• Fees for the preparation of the estate and inheritance tax returns.• Fees for appraisals of assets.

5. Why should selling an estate’s assets to generate the liquidity necessary for the estatetaxes generally be the last option?When the estate’s assets are sold to generate the liquidity necessary for the estate, theassets are often sold in a fire-sale fashion for an amount less than the true fair marketvalue of the assets. The executor usually has to spend a substantial amount of time sell-ing the assets which may increase his executor’s fee. Also, the estate must pay capital


136 CHAPTER 12: SPECIAL ELECTIONS & POST MORTEM PLANNING

gains tax on the amount of the sales price above the adjusted basis at the decedent’s date ofdeath. All of these result in a loss for the heirs of the estate.

6. List three methods that an executor can use to reduce the liquidity requirements of anestate.• The executor can make in-kind distributions to beneficiaries.• If planned properly, the executor could sell assets to an ILIT.• The executor could use the assets of a qualified plan payable to the decedent’s estate.• If there is an interest in a closely held business, the executor can redeem some of the

stock under Section 303.• The executor could take a loan for the amount necessary to meet the cash needs of the

estate.

7. How can an ILIT be used to generate liquidity for an estate without requiring the value ofthe ILIT to be included in the decedent’s gross estate?To avoid inclusion of the ILIT assets in the decedent’s gross estate, the trust should notmake the death benefits available to the executor or give the executor of the estate the rightto demand a withdrawal from the ILIT. To use the assets of the ILIT and still prevent theinclusion of the ILIT’s assets, the trust can allow the executor to make a loan, with interest,from the ILIT or the executor can sell the decedent’s assets to the ILIT at the fair marketvalue. In the latter scenario, the estate will be subject to capital gains tax on the sales priceabove the estate’s adjusted basis, but the estate will not be required to sell the assets at a fire-sale price.

8. Even if qualified plans are payable to the decedent’s estate, why should the executor seekalternative means of meeting the cash requirements of the estate before taking distributionsfrom the qualified plans?Distributions from qualified plans are taxed as ordinary income for the heir or party takingthe distribution. If the estate takes the distribution from the qualified plan to generate thecash necessary to meet the estate’s cash requirements, the estate will be required to payincome tax on the distribution. Also, if the estate takes a distribution, it eliminates anyopportunity of future tax-deferred growth of the assets in the qualified plan.

9. Explain the tax benefit allowed by a Section 303 stock redemption.With a stock redemption to a closely held corporation, the redemption is considered a divi-dend if it is not for a complete redemption of the stock. Section 303 allows the estate toredeem enough shares to pay its estate taxes and receive capital gain treatment on the sale,even if it is only a partial redemption. Section 303 is only allowed at a decedent’s death.

10. What requirements must an estate meet to benefit from Section 303 stock redemption?To qualify for a Section 303 redemption, more than 35 percent of the decedent’s adjustedgross estate must consist of the closely held business interest. In the event that the decedentowned interests in several closely held businesses, all of the business interests can be aggre-gated to meet the 35 percent test provided the decedent owned at least 20 percent of eachcompany’s outstanding stock. In addition, the shareholder redeemed must be responsiblefor the payment of the estate taxes, administration expenses, and funeral expenses. Also,


only the stock redeemed to generate the necessary cash to cover the taxes, administrationexpenses, and funeral expenses receives the Section 303 capital gains treatment.

11. List two reasons why borrowing cash is an attractive option for the executor of an illiquidestate.• Borrowing may prevent the fire-sale of assets.• The interest incurred on the note is deductible.

12. In the year of a decedent’s death, what are his surviving spouse’s filing status options?The surviving spouse may file married filing jointly or married filing separately in the yearof a decedent’s death.

13. What requirements must be met for a surviving spouse to file as a qualifying widow/wid-ower?The surviving spouse can file as a qualified widower for two years following the decedent’sdeath if the surviving spouse has not remarried and the surviving spouse is maintaining ahome for one or more dependent children.

14. Unpaid medical expenses of a decedent are deducted on which form, the estate tax return orthe final income tax return?The executor of the estate may elect to deduct the decedent’s unpaid medical expenseseither on the estate tax return or on the decedent’s final income tax return, but the sameexpenses may not be deducted in both places.

15. When is the tax year-end of an estate for income tax purposes?The executor can elect to have the estate’s tax year end on the last day of any month duringthe year.

16. When would an executor choose to deduct an estate’s administrative fees on the fiduciaryincome tax return?An executor would choose to deduct an estate’s administrative fees on the fiduciary’s incometax return when the decedent did not have a taxable estate (an estate under the applicableestate tax credit equivalency), and the estate received income during the year.

17. Why might an executor choose to waive his executor’s fee?The executor’s fee is subject to ordinary income tax and potentially self-employment tax ifhe is a professional executor or administrator. So, if the executor is also a beneficiary of theestate and the estate is in a lower marginal estate tax bracket than the executor’s income taxbracket, the executor may choose to waive his fee and receive a distribution, as an inherit-ance, from the estate. The inheritance is not subject to income tax or self-employment tax.Of course, this may only work when the executor is the only heir.

18. Why do small estates generally overvalue the fair market value of assets in the gross estate?Small estates are estates with a fair market value less than the applicable estate tax creditequivalency amount. These estates do not owe any estate tax, so they are not concernedwith reducing the value of the gross estate. Instead, these estates will try to include all of theassets of the estate at the highest fair market value possible without creating an estate tax


due. In such a case, the heirs of the estate will receive the property with the highest adjustedbasis possible, and will pay the lowest capital gains on a subsequent sale, or receive the high-est capital loss on a subsequent sale.

19. What are the two requirements for electing the alternate valuation date?• The total value of the assets included in the gross estate six months after the decedent’s

date of death must be lower than the value of the assets on the decedent’s date of death.• There must be a reduction in the estate tax due as a result of the election.

20. List the three requirements necessary for an estate to elect Section 6166.• The value of the business interest must be more than 35% of the value of the decedent’s

adjusted gross estate.• The business interest must be a closely held business.• The entity must have been actively engaged in the conduct of a trade or a business at the

date of the decedent’s death.

21. Explain why the government would allow an estate to utilize the special use valuation as aproperty’s fair market value in the gross estate.Generally, fair market value implies the value of a property in its highest and best use. Overthe years, the highest and best use of a particular piece of property may change. For exam-ple, 50 years ago the use of property outside of a city for farming purposes may have beenthe highest and best use of the land, but as the city expands, the highest and best use of theproperty may shift from farming activities to a residential subdivision or office complex. Forestate tax purposes, the fair market value (i.e., the highest and best use value) of the prop-erty must be included in the gross estate; the value of the land in its current use does notmatter. If an individual is using a piece of real property as a farm or in another trade or busi-ness that is not employing the property at its highest and best use, the value of the propertymay be higher than the value of the property in its current use. This may create an estate taxthat could be much larger than an estate tax based on the value of the property utilizing itscurrent use value. As a result, the farming operation or business enterprise may not be ableto continue, since the real estate it is using must be sold to pay the estate taxes it has gener-ated.

22. Why is the special use valuation rarely used?Special use valuation is rarely used because of the ongoing requirements that must be met inorder to benefit from its use.


1. Which of the following is not a typical reason an estate will have liquidity concerns?

a. To meet specific bequests.

b. To pay taxes.

c. To pay life insurance premiums on the decedent’s life.

d. To pay funeral and administrative expenses and the executor’s fee.

The correct answer is c.Generally, an estate does not need cash to pay the premiums on a life insurance policy forthe decedent since the decedent is dead. All of the other options are reasons an estate willhave liquidity concerns.

2. Which of the following estates will most likely have the greatest liquidity problem?

a. An estate with $4,000,000 of marketable securities.

b. An estate comprised of rental real estate and marketable securities totalling$2,000,000.

c. An estate consisting of a closely held business interest valued at $3,000,000,several pieces of art work valued at $400,000, and $500,000 of cash.

d. An estate comprised of a closely held business interest valued at $4,000,000,and cash of $100,000.

The correct answer is d.The estate in answer d will most likely have the greatest liquidity problem because of thelack of cash that will be necessary to pay the estate tax, and the fact that the closely heldbusiness interest will generally not be very liquid. Answer a is completely comprised of mar-ketable securities which can easily be converted to cash. Answer b is an estate below theapplicable estate tax credit equivalency amount and will not owe any estate tax, thus reduc-ing its liquidity needs. The estate in answer c will, after the applicable estate tax creditequivalency, only be a $400,000 taxable estate. With the amount of cash it has on hand,liquidity should not be a problem.

3. The executor of an estate liquidated assets to generate the cash necessary to pay the estatetaxes. Of the following assets, which is the least likely to generate income tax consequencesupon its sale?

a. Real estate sold within three months of the decedent’s date of death.

b. Publicly traded securities sold two weeks after the decedent’s date of death.

c. The redemption of the stock of a closely held business. The redemptionqualified for Section 303 treatment.

d. Publicly traded securities sold eight months after the decedent’s date of death.

The correct answer is a.The real estate sold within three months of the decedent’s date of death would not generallycreate any income tax consequences because the fair market value on the estate tax return ofthat piece of real estate would be that sales price. So, when the estate sold the real estate it



would not have any gain or loss on the transaction because its adjusted basis (the fair marketvalue on the estate tax return) would be equal to the proceeds of the sale. Answers b and dwould create income tax consequences as the adjusted basis of the securities to the estatewould be the fair market value of the securities at the decedent’s date of death. Since theseare publicly traded securities, their value changes daily, and the estate would most likelyhave some gain or loss on the sales. The stock redemption in answer c would create tax con-sequences. Section 303 redemption takes an otherwise dividend distribution subject toordinary income tax and subjects any gain to capital gains tax.

4. Which of the following statements regarding selling an estate’s assets to generate cash is notcorrect?

a. The estate may have income tax consequences.

b. The assets may not be sold at full, realizable fair market value.

c. Any losses on the sale of the assets are deductible as losses on the estate taxreturn.

d. Any selling expenses are deductible on the estate tax return.

The correct answer is c.Any losses on the sale of the assets are income tax losses and are deductible on the estate’sincome tax return, not on the estate tax return. All of the other answers are true statements.

5. In 2005, Amy funded an Irrevocable Life Insurance Trust (ILIT) naming her children as thebeneficiaries. Amy contributed cash each year to the trust to pay the life insurance policypremiums. In 2009, Amy died in a car accident, and the policy death benefit of $1,000,000was paid to the ILIT. Which of the following statements regarding this ILIT and Amy’sestate is false?

a. The ILIT will be included in Amy’s gross estate because Amy had made acontribution to the trust within three years of her death.

b. If Amy’s executor can demand a distribution from the ILIT to pay Amy’s estatetaxes, the value of the ILIT will be included in Amy’s gross estate.

c. Amy’s executor can sell the assets from Amy’s estate to the ILIT without causingthe value of the ILIT to be included in Amy’s gross estate.

d. If Amy had released her right to revoke the ILIT in 2007, the value of the ILITwould be included in Amy’s gross estate.

The correct answer is a.Answer a is false statement. Since Amy was only making cash contributions to the trust, thevalue of the ILIT will not be included in Amy’s gross estate. If Amy had to pay any gift taxon the contributions to the ILIT, the gift tax paid on the contributions would be includedin her gross estate. All of the other options are true statements. Answer d is a true statement,because to the extent the grantor of an ILIT releases a right to revoke the trust within threeyears of death, the value of the ILIT is included in their gross estate.


6. Josh was a majority owner in a closely held business. He had an adjusted basis in his interestof $400,000, and at his death this year, the fair market value reported on his estate taxreturn was $6,000,000. Like most majority owner’s in closely held businesses, Josh did nothave much liquidity in his estate and his executor was forced to redeem some of his interestin the business. If Josh’s executor redeemed 30% of Josh’s interest for $2,500,000 to pay theestate tax and administration fees, how much is subject to capital gains tax?

a. $0.

b. $700,000.

c. $2,100,000.

d. $2,500,000.

The correct answer is b.Josh’s estate would have an adjusted basis in the 30% interest equal to 30% of the fair mar-ket value at Josh’s date of death, or $1,800,000. If the executor of Josh’s estate sold the inter-est for $2,500,000, the gain of $700,000 ($2,500,000-$1,800,000) would be subject tocapital gains tax under Section 303 (only available at the death of the owner). Ordinarily,unless a redemption is a complete redemption, the redemption is treated as a dividend.

7. Which of the following statements concerning an illiquid estate is true?

a. If the executor of an illiquid estate takes a loan to pay estate taxes, and pledgesthe estate’s assets as security for the loan, the interest on the loan is deductible.

b. When an executor sells an estate’s assets eight months after the decedent’s dateof death, any gain or loss is included in the fair market value of the asset in thedecedent’s gross estate.

c. An heir who agrees to take an in-kind distribution, instead of a cashdistribution, from the estate, will take the property with an adjusted basis equalto the decedent’s adjusted basis immediately before his death.

d. Real property valued under the Special Use Valuation rules can be sold afterfour years for an unrelated use without suffering recapture.

The correct answer is a.The interest on a loan used to pay estate taxes is deductible by the estate. Answer b is a falsestatement as the property is reported on the estate tax return at the fair market value at thedecedent’s date of death, or the alternate valuation date. Answer c is incorrect as the heirwould receive the property with an adjusted basis equal to the fair market value at the dece-dent’s date of death. Answer d is incorrect as the recapture occurs if property valued underthe special use valuation rules is sold within ten years of the decedent’s date of death.

8. Which of the following is not a benefit of taking a loan to pay estate taxes andadministration fees?

a. The interest on the loan is deductible for income tax purposes.

b. The executor of the estate will have more time to sell the estate’s assets.

c. The estate’s assets will not be sold in a fire-sale fashion.

d. The principal of the loan is a debt on the estate tax return.


The correct answer is d.The principal of the loan is not a debt on the estate tax return. The estate tax return wouldonly include those debts that existed at the date of his death. This debt would have beenacquired by the executor after the decedent’s date of death. All of the other answers are truebenefits.

9. Mary Jane’s husband died in October of 2009. Which filing status will Mary Jane use onher 2009 income tax return?

a. Single.

b. Head of household.

c. Married filing jointly.

d. Qualifying widow.

The correct answer is c.In the year of death, the surviving spouse can file either married filing separate or marriedfiling jointly.

10. Mary Jane’s husband died in October of 2009. Mary Jane has a one year old dependentchild and has not remarried. Which filing status will Mary Jane use on her 2012 income taxreturn?

a. Single.

b. Head of household.

c. Married filing jointly.

d. Qualifying widow.

The correct answer is b.Mary Jane will file as head of household in 2012. Since Mary Jane’s husband died in 2009,she will file married filing jointly for the year of her husband’s death. In the two years afterher husband’s death (2010 and 2011), Mary Jane will file as qualifying widow. For the 2012tax year, Mary Jane will file head of household, and this will continue until she remarries ordoes not provide a home for her child.

11. The executor of an estate makes many elections before he files an estate tax return. Whichof the following is not an available election for the executor?

a. Utilizing the annual exclusion against the testamentary transfers.

b. Selection of the tax year-end.

c. Electing QTIP on certain property passing to the surviving spouse.

d. Deducting the expenses of administering the decedent’s estate on the estate’sincome tax return.

The correct answer is a.The annual exclusion cannot be used against testamentary transfers. All of the other optionsare available elections for the executor.


12. Before his death in 2009, Melvin incurred $65,000 in medical bills. Melvin’s taxable estateat his death was $675,000 and his adjusted gross income for 2009 was $100,000. Howmuch of Melvin’s medical expenses will be deducted on his estate tax return?

a. $0.

b. $57,500.

c. $65,000.

d. $100,000.

The correct answer is a.In this situation, Melvin’s executor would not elect to deduct any of the final expenses onMelvin’s estate tax return because the medical expenses will not change the estate tax due onMelvin’s estate tax return - Melvin’s taxable estate is less than the applicable estate tax creditequivalency. Melvin’s executor will deduct the expenses, to the extent they exceed 7.5% ofMelvin’s AGI, on Melvin’s final income tax return.

13. In which of the following cases will Robert, the executor of his father’s estate, not waive hisexecutor’s fee?

a. Robert is a 35% taxpayer and his father’s estate is a 20% taxpayer.

b. Robert is the only heir of his father’s estate.

c. Robert and his mother are the only heirs to his father’s estate. Neither Robert’sfather or his mother are very wealthy and his mother has very expensiveprescription costs. Robert is a financial planner in the 35% marginal taxbracket.

d. Robert is also one of three beneficiaries of his father’s estate. The beneficiarieswill share the residual of the estate equally.

The correct answer is d.Based on the scenario, Robert will not waive his executor’s fee in answer d. If he waived thefee he would have to share the residual with two other beneficiaries, and he would be leftwith less than if he would have taken the executor’s fee. Robert would waive his fee in thescenarios under answers a and b as the overall tax burden would be lower. Robert would alsowaive his fee in answer c because he would want to help his mother.

14. Which of the following is not a requirement of using the special use valuation of property?

a. The property must be used in a farming operation or a trade or business thatwas actively managed by the decedent or the decedent’s family for 5 out of the 8years immediately preceding the decedent’s death.

b. The value of the real and personal property used in a qualifying manner mustequal or exceed 50 percent of the decedent’s gross estate as adjusted.

c. The value of the real property used in a qualifying manner must equal or exceed75 percent of the value of the decedent’s gross estate as adjusted.

d. The qualifying property must pass to qualifying heirs who must activelyparticipate in the farming activity or trade or business.


The correct answer is c.Answer c simply reads the percentage incorrectly. The value of the real property used in aqualifying manner must equal or exceed 25 percent of the value of the gross estate asadjusted.

15. Joseph died this year. His will specifically bequeaths $1,000,000 to his son, Kevin andbequeaths the residual of his estate to his wife, Martha. At the time Joseph had written hiswill, his net worth was in excess of $4,000,000, but at his death his net worth hadplummeted to $1,050,000. Because Kevin’s mother would only receive $50,000($1,050,000-$1,000,000) of his father’s assets, Kevin fully disclaimed his bequest threemonths after his father’s death. How much will Kevin have to report as a taxable giftbecause of this disclaimer?

a. $0.

b. $38,000.

c. $50,000.

d. $1,000,000.

The correct answer is a.A qualified disclaimer is a disclaimer that is made in writing, filed within nine months ofthe decedent’s date of death, does not allow the disclaiming party to specify to whom theproperty will pass, and does not allow the disclaiming party to benefit from the propertybefore disclaiming his interest. If a disclaimer is qualified the property will pass to the resid-ual heirs of the estate, or as directed by a disclaimer clause, with no effect to the disclaimingparty. In this case, Kevin has no taxable gift related to this disclaimer.

Generation-Skipping Transfers

Generation-Skipping Transfers


13

1. Define skip person.A natural person two or more generations younger than the transferor is a skip person. Atrust is a skip person if all interests in the trust are held by skip persons, or no personholds an interest in the trust and at no time after the transfer may a distribution be madeto a non-skip person.

2. To which type of transfers does the GSTT apply?The GSTT applies to direct skips, taxable distributions, and taxable terminations.

3. Who is liable for the GSTT on a direct skip?The transferor is liable for the GSTT on a direct skip from an individual. The trustee isliable for the GSTT on a direct skip from a trust.

4. Define taxable distribution.A taxable distribution is defined as any distribution from a trust to a skip person otherthan a taxable termination or a direct skip. Distributions of income or principal from atrust to a skip person that are not taxable terminations or direct skips are taxable distri-butions.

5. Who is liable for the GSTT on a taxable distribution?The transferee is liable for the GSTT on a taxable distribution. As a result, if any GSTTis paid by the trust, another taxable distribution occurs.

6. List the characteristics of a termination of an interest in property held in trust that doesnot create a taxable termination.• When at the termination, the transfer is subject to federal estate or gift tax.• When at the termination, a non-skip person has an interest in the property.• When at the termination, it can be determined that no distribution may be made at

any time to a skip person.


146 CHAPTER 13: GENERATION-SKIPPING TRANSFERS

7. Who is liable for the GSTT on a taxable termination?The trustee of the terminating trust is liable for the GSTT on a taxable termination.

8. What is the GSTT rate?The GSTT is a flat tax equal to the maximum estate tax rate in effect at the time of theGST. For 2009, the rate is 45%.

9. How much can an individual transfer to a skip person during his lifetime, or at his death,without incurring any GSTT?An individual can transfer $13,000 for 2009 per year, per transferee without incurring anyGSTT. In addition to the annual exclusion, an individual can transfer $3,500,000 for 2009to a skip person without incurring any GSTT.

10. When must the allocation of the GST exemption take place?An individual may allocate his GST exemption at any time from the date of the transferthrough the date for filing the individual’s federal estate tax return. If no estate tax return isrequired to be filed, the GST exemption may be allocated at any time through the date afederal estate tax return would be due if a return were required to be filed.

11. Explain the predeceased ancestor exception.If a child of the transferor is deceased at the time of the transfer, that child’s descendents aremoved up one generation for purposes of determining whether the transfer constitutes aGST. As a result, a grandchild would be considered a child for GST purposes.

12. What is a qualified transfer and what are its GSTT implications?A qualified transfer is the payment of tuition to a qualified educational organization or thepayment of qualified medical expenses to a medical care provider on behalf of a skip person.Qualified transfers are not subject to the GSTT and do not deplete the annual exclusion orGST exemption.

13. What is the estate tax inclusion period?The estate tax inclusion period is the period during which, should the transferor or thetransferor’s spouse die, the value of the transferred property would be included in the grossestate of the transferor or the transferor’s spouse.

14. How are lifetime direct skips reported to the IRS?Lifetime direct skips are reported on Form 709, the gift tax return.

15. What are the benefits of using a generation-skipping trust?Use of a generation-skipping trust allows the planner to split the legal ownership of assetsfrom the use of assets. If the beneficiaries do not have legal title to the trust assets when theydie, the beneficiary cannot transfer anything in the trust at his death, and therefore no partof the trust may be included in the beneficiary’s gross estate.


16. What is the Uniform Statutory Rule Against Perpetuities?The USRAP states that an interest in trust will be valid if it will vest or terminate withinlives in being plus 21 years, or the interest actually vests within 90 years of the creation ofthe trust. The USRAP is a uniform set of rules adopted by many states to follow the RuleAgainst Perpetuities.

17. Who pays the income tax on the income generated within a dynasty trust?To the extent the income of a dynasty trust is not distributed, the trust pays the income tax.On the income distributed, the beneficiary pays the income tax on the income.

18. Why should a dynasty trust give some beneficiaries a limited power of appointment?Certain beneficiaries may be given a limited power of appointment to change some of thetrust provisions because laws may change or the need for the trust may be completely elim-inated.


1. To which of the following transfers does the GSTT not apply?

a. A taxable termination.

b. A taxable distribution.

c. A direct skip.

d. A skip-over.

The correct answer is d.A skip-over does not exist. GSTT applies to the three other listed options.

2. Robin transfers$13,000 to her son, Gerry; $40,000 to her niece, Bernadette; and paysHollowpoint Medical Hospital $50,000 for her granddaughter, Jill’s, medical expenses.Which of these transfers is subject to GSTT?

a. None of the listed transfers will be subject to GSTT.

b. The transfer to Jill.

c. The transfers to Bernadette and Jill.

d. The transfers to Bernadette, Gerry, and Jill.

The correct answer is a.None of the transfers will be subject to GSTT. The transfers to Gerry and Bernadette arenot subject to GSTT because Gerry and Bernadette are non-skip persons. The payment toHollowpoint Medical Hospital is not subject to GSTT because it is a qualified transfer paiddirectly to the medical institution.

3. Amy, a 46-year-old divorced mother of 3, has owned her own automotive repair center for15 years. She would like to provide income to her assistant, JoAnn, and her other friends.Amy established a trust naming JoAnn, age 67, as the initial income beneficiary for her life.At JoAnn’s death, Walt, a 59-year-old mechanic who has worked for Amy, will receive theincome for the remainder of his lifetime. At Walt’s death, the remainder interest will bedivided equally between Amy’s sons, Paul, John, and Donald. When will this trust besubjected to GSTT?

a. At the date of creation of the trust.

b. At JoAnn’s death.

c. At Walt’s death.

d. Never.

The correct answer is d.The trust will not be subjected to the GSTT because the stranger beneficiaries are olderthan the trust settlor, and the remainder beneficiaries are the first generation below the sett-lor. Thus, no beneficiary is a skip person.



4. Mel has never made any gifts subject to GSTT. He is single and would like to transfer asmuch as he possibly can during the year to his grandchild without triggering any GSTT.How much can Mel transfer to his grandchild this year and meet his goal?

a. $0.

b. $13,000.

c. $1,013,000.

d. $3,513,000.

The correct answer is d.Mel can transfer an amount up to the GST exemption, $3,500,000 and the annual exclu-sion for the year, $13,000. Utilizing both exclusions, Mel can transfer $3,513,000 for 2009without being subject to the GSTT.

5. David, age 78, retired from his 40-year career at BBB Corporation last year. As part of anoverall estate plan, David has begun establishing many different trusts. Of the following listof beneficiaries listed in David’s trusts, who would be a skip person for purposes of theGSTT?

a. Jenna, age 31, David’s wife.

b. Tiffany, age 22, David’s girlfriend.

c. Peter, age 25, David’s grandson, whose mother is living, but whose father,(David’s son) is deceased.

d. Bill, David’s 81-year-old lifelong neighbor.

The correct answer is b.Because Tiffany is technically a stranger and is more than 37.5 years younger than David,she is a skip person. Jenna is not a skip person because a spouse is always deemed to be inthe transferor’s generation. Peter is not a skip person because of the predeceased ancestorrule. Bill is not a skip person because he is older than David.

6. Which of the following statements concerning the GSTT is not correct?

a. Each individual can exclude up to $3,500,000 of transfers from GSTT.

b. The GSTT is applied to a gift after the application of the annual exclusion.

c. Gifts that are subject to GSTT can be split.

d. The GSTT only applies to transfers in trust.

The correct answer is d.The GSTT applies to the transfer of any property to a skip person or an interest in trust forthe benefit of a skip person. All of the other statements are true.


7. Many grandparents name their grandchildren as the beneficiaries of their life insurancepolicies. How should the life insurance policies for the benefit of grandchildren be held?

a. A revocable life insurance trust should be established and funded with a transferof the life insurance policy.

b. The grandparent should be the owner with the grandchild as the listedbeneficiary.

c. An irrevocable life insurance trust should be created for the benefit of thegrandchild.

d. The ownership of the policy should be transferred to the grandchild.

The correct answer is c.The policy should be transferred to an ILIT with the grandchild listed as the beneficiary.Ideally, the ILIT would be funded with cash contributions less than the annual exclusionand would pay the premiums of the life insurance policy on the grandparent’s life. Answer ais incorrect because a revocable trust would still cause inclusion in the grandparent’s grossestate and possible GSTT consequences. Answer b is incorrect because if the grandparentowns the policy, the death benefit will be included in the grandparent’s gross estate and stillsubject to GSTT. Answer d is incorrect because the grandchild should not own the lifeinsurance policy outright since it would not place any limitations on the grandchild’s abilityto spend the funds.

8. Byron, age 65, gave $30,000 each to his son, his daughter, his six-year-old niece, his 21-year-old female neighbor, and his wife. Which of the transfers would be subject to GSTT?

a. The transfer to his wife.

b. The transfer to his neighbor.

c. The transfer to his niece and the neighbor.

d. The transfer to his niece, his neighbor, and his daughter.

The correct answer is b.Only the transfer to his neighbor would be subject to GSTT. If the transferee is a strangerwho is more than 37.5 years younger than the transferor, the transfer is subject to GSTT.All of the other transfers are transfers to relatives within one generation. A niece is only onegeneration below.

9. Justin transfers $200,000 in 2009 to an irrevocable trust providing that income is to beaccumulated for 22 years. At the end of 22 years, the accumulated income is to bedistributed to Justin’s child, Chip, and the trust principal is to be paid to Justin’s grandchild,Beau. Justin allocates $80,000 of his GST exemption to the trust on a timely filed gift taxreturn. What is the GSTT rate applicable to the trust?

a. 19.40%.

b. 27.00%.

c. 40.00%.

d. 60.00%.

The correct answer is b.


The applicable fraction of the trust is 0.40 ($80,000 / $200,000) and the inclusion ratio is1 - 40% = 60%. If the maximum federal transfer tax rate is 45% (in 2009), the GSTT rateapplicable to the trust is 27% (0.45 x 0.60).

10. Upon what form is a lifetime GST reported?

a. Form 1040.

b. Form 709.

c. Form 706.

d. Form 1041.

The correct answer is b.Any lifetime GST is reported on Form 709, the United States Gift and Generation-Skip-ping Transfer Tax Return.

11. Upon what form is a testamentary transfer subject to GSTT reported?

a. Form 1040.

b. Form 706.

c. Form 1041.

d. Form 709.

The correct answer is b.Testamentary transfers subject to GSTT are reported on the Form 706, the United StatesEstate and Generation-Skipping Transfer Tax Return.

12. Which of the following statements regarding dynasty trusts is not true?

a. A dynasty trust will not vest its ownership in each generation of beneficiaries.

b. Alaska has laws that favor the creation of dynasty trusts.

c. The income of a dynasty trust is always taxed at the trust level since ownershipdoes not vest in the beneficiaries.

d. A dynasty trust can give a beneficiary a limited power of appointment withoutcausing inclusion of the trust’s assets in the beneficiary’s gross estate.

The correct answer is c.The income of a dynasty trust is taxed at the trust level to the extent the income is not dis-tributed to the beneficiary. The income that is distributed to the beneficiary is taxed to thebeneficiary. All of the other statements are true.