Estate deductions, elections and payments of tax Chapters 18-30

Funeral and Admin Expenses Funeral Expenses and expenses incurred in administering property subject to claims are reported on Schedule J Expenses related to property not subject to claims are reported on Schedule L. Funeral - actual amounts expended by executor or administrator. Must be payable out of estate. Funeral expenses must be reduced by any SS or VA death benefits Funeral expenses must be reduced by reimbursed amounts from wrongful death actions If state law requires funeral expenses to be born by the decedent’s spouse, no funeral expenses are allowed. If funeral expenses are considered part of the community estate, only 50% of the expenses are a deduction.

Administration Expenses (Limited to actual/necessary exp) These include expenses for collection of assets, payment of debts, distribution among the persons entitled to share in the estate. E.G., executors commissions, attorney’s fees, and misc. expenses Executor’s fees - best if fee set by probate court Generally actual amount paid or to be paid will be allowed. Reasonableness is key, with similar estates used as comparison. Local law may reduce the amount specified by will to the executor. Attorney’s fees - actually paid/will be paid for benefit of the estate. Unpaid amounts may be contested at final audit. Additional fees for litigation allowed at time of litigation.

Administration Expenses (Continued) Miscellaneous Expenses Includes court costs, surrogate’s fees, appraisers, clerk hire, costs for storing or maintaining estate property and other expenses necessary to the preservation and distribution of the estate. Selling expenses - allowed if sale necessary to pay decedents debts, admin expenses or taxes, to preserve the estate or to effect distribution. Interest on loans to pay estate taxes and to prevent forced sales - deductible as admin expenses. Interest on deferred Federal and State death taxes are deductible when accrued Community prop. sates - if admin expenses are considered community property - 50% ded.

Estate v. Income Tax Deduction Sec. 2053 and 2054 deductions can be claimed either on the estate return or the fiduciary income tax return. Double deduction prohibition also applies to expenses or losses that are paid/incurred by trusts or other persons, instead of the estate. Expenses subject to provisions - executors’ fees, attorney’s fees, court costs, appraisal fees, custodial fees, investment counsel, accountants, etc. Rule does not apply to deductions for taxes, interest, business expenses and other accrued expenses Waiver required to be filed if income tax treatment chosen.

Debts of Decedent Claims allowable by law deductible to extent of the value of property subject to these claims. Deductible claims - personal obligations of the decedent existing at time of death. Only claims enforceable against the estate are deductible. Amount of deduction is the value of the claim. See page 173 for examples of deductible claims. Medical expenses - from last illness are deductible Claims on Founded on promise/agreement - only deductible if contracted in good faith. Divorce decree obligations fully deductible.

Taxes Federal Estate taxes are not deductible - state inheritance/estate taxes can be deducted. Property taxes are deductible only if they accrue under state law prior to decedent’s death. Excise taxes are deductible on sales if the sales are used to pay the decedent’s debts, taxes, or expense or admin or to preserve the estate or effect distribution. Unpaid income taxes - deductible if on income prior to decedent’s death. Interest on contested gift tax liabilities and federal and state income tax deficiencies is deductible as admin expenses based on state law.

Mortgages and Liens / Net Losses / Expenses for Property Not Subject To Claims Mortgages that are charges against the estate of the decedent and date from before decedents death reduce taxable estate. If mortgage subject to all estate show on Sch. K, if subject to specific property only - show net on property schedule. Casualty and Theft losses that occur during settlement of the estate are deductible if not compensated by insurance. Depreciation of intangibles not deductible but can impact AVD / Casualty losses not deductible if claimed on I/T return Admin expenses of property not subject to claims are allowed if the expenses would have been deductible if the property was subject to claims / paid w/in 3 years after

Marital Deduction Spouse must be U.S. Citizen to qualify for deduction Property subject to deduction must be included in GE Schedule M used to report marital deduction property Amount of Deduction - unlimited unless an executed trust dated pre 1982 contains the old maximum marital deduction formula All non-terminable interest property qualifies for MD. Terminable interests may not qualify:a terminal interest in property is one that will terminate or fail on the lapse of time or on the occurrence of some event or contingency. Special rules exist for terminable interest property

Qualified Terminable Interest Property Terminable interest property generally does not qualify for the marital deduction except for QTIPs. If QTIP - entire property subject to such life interest is treated as passing to spouse and qualifying for MD. QTIP: property passing from the decedent to a spouse who is entitled to all or part of the income from the property for life payable at least annually a.k.a. - qualifying income interest - distributions from IRA can be QTIP if structured properly. No person (spouse included) can have the power to appoint any part of the QTIP to any person other than the spouse during the spouses life.

QTIP - continued If QTIP is for only a portion of the income, must be stated in fractional or percentage terms. Income interests that terminate if spouse remarries are not QTIP. Annuities qualify if SS has a qualifying income interest for life annuities not QTIP if any person other than spouse is entitled to receive, during SS’s life, any distribution from the annuity fund. QTIP election made on Schedule M by executor and is irrevocable. Generally contingent income interests are not QTIP, except if contingency is a function of electing QTIP on 706.

QTIP - continued Tax on transfer of QTIP property - if transferred during life of spouse - gift tax on the FMV of property at date of gift less any amount received by spouse if transferred at death - includible in GE on Schedule F and proper response should be answered on page 3 of form 706. Split gifts to spouse and charity are allowed and QTIP provisions are preserved Charitable deduction allowed for value of remainder interest Marital deduction allowed for value of the annuity or uni-trust interest.

Surviving Spouse / Life Estate or Other Terminable Interests Person receiving marital deduction property must qualify as Surviving Spouse on DOD of decedent. (Legal separation is OK, divorce is not) Terminable interests - life estates, annuities, patents, and copyrights. Bonds, notes or other contracts are not terminable interests - TIs determined by state law. Nondeductible Terminable interests - see requirements on page 194. Terminable interest rules are designed to prevent the allowance of a marital deduction with respect to property which, by terms of the transfer is likely to escape inclusion in the gross estate of the surviving spouse.

Widows Allowances / Dower and Courtesy Support allowance during estate settlement - deductible Marital deduction can be obtained for any portion of property obtained by operation of law or of the will. Deductibility of widow allowances after estate settlement is dependent on state statute authorizing the supp. Pymts. If vested (I.e., survives death or remarriage) qualifies for MD / If not vested, non-deductible. Nature of widow’s interest is determined as of decedents death. Dower/Courtesy follows same state rules as widows allowances based on vesting aspects.

Life Insurance and Annuities Proceeds if accompanied with GPOA may qualify for MD Proceeds must be payable in installments or held by the insurer subject to an agreement to pay interest. The SS alone must have the right to receive all or a specific poriton of the payments to be made during his/her lifetime. Distributions must be made at least annually w/ first payment not more than 13 months after decedent’s death. SS must have power to appoint the entire amount available to her. The power must be in favor of that person or that person’s estate. No other powers may exist to appoint to anyone other than the SS Power must be exercisable in all events.

Valuation of Marital Property Net interest received is considered (I.e., net of mortgages, liens, etc.) for MD Marital deduction is allowable only to the extent that property bequeathed to the SS exceeds in value the property such spouse is required to relinquish. Value of marital deduction must be reduced by death taxes that the executor is authorized by will to pay out of the marital trust even if not paid from the marital trust. If will is silent as to which assets should be used to pay estate and death taxes, state laws will determine whether marital property is used.

Other Issues Qualified disclaimer can be made by third party to increase property transferred to spouse which is avail for MD AVD election is basically the same for marital deduction property - AVD does not apply to assets that change in value simply from the passage of time, etc. Terminable interests are not included on Schedule M. No double deduction is allowed - if mortgages deducted on another schedule, net value is deducted on marital deduction schedule. Values listed on Schedule M must be reduced by the amount of federal estate tax and other taxes payable out of the assets transferred.

Charity Charitable deduction is allowed for property transferred by the decedent to or for the use of certain charities - see list on page 211 Transfers to individual members of religious order are not allowed as charitable deductions. Charitable deduction is only allowed if made by the decedent not the estate or beneficiaries Transfer can be testamentary Qualified disclaimers by third parties to benefit a charity can be used for the charitable deduction. See IRS Pub 78 to determine qualified charities. State laws also play a role in determining if a charitable transfer occurred.

Charity - continued Property passing under POA to charity qualify as charitable transfers. Transfers - not exclusively for charity - portion of payment attributable to charity that is ascertainable and severable from charitable interest is deductible. See list on page 210 for items transferred for other than exclusively charitable purposes that are deductible. A deductible charitable remainder interest must be in the form of an annuity trust (CRAT), a unitrust (CRUT) or a pooled income fund

Valuation of Charitable Bequests Estate can claim a charitable deduction for the PV of income and remainder interests in property that is bequeathed or otherwise passes to qualifying charities FMV of an annuity, life estate, term for years, remainder, reversion or unitrust interest is its PV Rules for valuing transfers not exclusively for charitable purposes - guaranteed annuity trusts, pooled income funds etc - are determined using the respective provisions of Reg., 1.642, 1.664 or 20.2301 Contingent gifts not deductible unless chance that the charity will not receive the property is negligible.

Transfers out of which death taxes must be paid. Deductions limited to amount actually received by the charity - applicable when residual estate is left to the charity and taxes and other expenses must be paid from residuary. Controversy exists as to how the marital and charitable deductions should be reduced for administration expenses. IRS Pub 904 contains examples for computing the charitable and marital deductions when these deductions are interrelated with Federal estate taxes.

Miscellaneous Issues - Charitable Deductions Deductions for charity - Schedule O. If transfer by will, copy of the will must be attached. If residuary estate transferred to charity - statement showing how deduction is computed. Alternate valuation: even if elected, any charitable transfer deductible should be valued at DOD Adjustments must be made for any difference in the value of the property six months after the decedents death or at the date of sale or exchange during the six month period. If percentage of estate given and AVD elected, used the AVD to determine.

Credit for tax on prior transfers What is the purpose of this credit? Is there a phase out to this credit? If so how does it work? Credit is computed on Schedule Q of form 706 Credit is allowed against the estate for all or part of the estate tax paid with respect to the transfer of property to the present decedent by or from a person who died within 10 years before or within two years after the decedent. Credit cannot be larger than it would have been if the present decedent had not received the property

Requirement for this Credit Transferee - current decedent Property received by transferor’s estate does not have to exist in the estate at DOD to receive credit. Property received does not have to be traced either. Key issue is whether the property was subject to taxation in the transferors estate - Do spouses often get to take advantage of this credit? Credit is allowed for property received by current decedent from former decedent to which a GPOA was held as long as the property was included in former’s Gross Estate.

Amount of the credit Credit is limited to smaller of amount of the estate tax of the transferor’s estate relative to the tranferred property Incremental difference in estate tax that occurred because the property was included in the transferee’s gross estate. Percentage reduction occurs if prior decedent died more than 2 years before current decedent. Formula - see page 253 Form 706 provides worksheets on how to calculate credit Credit is again shown on Schedule Q. When is this credit likely to occur?

Valuation of property subject to Prior Transfers Credit Value for formula - value at which included in transferors gross estate. Interest received must be able to be valued under recognized valuation principles in order to claim the credit Value is reduced by any liens or encumbrances on the property assumed by transferee amount of death taxes which the transferee might have been required to pay any marital deduction that might have been allowed. If charitable deduction allowed for the property transferred, the deduction must be reduced if the credit is allowed.

Gift Tax Credit / Foreign Death Tax Credits Credit allowed for gift tax paid on pre 1977 gifts that are included in the gross estate. Foreign death tax credit is similar to foreign tax credit. Why do such credits exist? Credit applies if a foreign country taxes property at death and the property is included in decedent’s gross estate. Credit must be claimed within 4 years after filing the return.

Miscellaneous Foreign Death Tax Issues Treaty is integral in determining both tax and amount of credit. If multiple countries, a separate computation of the credit must be made with respect to each foreign country Limitation total amount of credit allowable is limited to the amount of the estate tax attributable to such property. Situs will control whether the credit is allowed for foreign death taxes. Schedule P is used to report and compute credit.

Computation of Tax Compute decedents taxable estate Compute adjusted taxable gifts (post 1976 gifts) that are not included in gross estate. Combine taxable estate and adjusted taxable gifts to arrive at estate tax base Compute tentative tax Subtract total gift taxes paid (cash outlay) on post 76 gifts Subtract credits - unified credit, state death taxes, foreign death taxes, and any other credits. Result is tax due.

Miscellaneous rules Members of armed forces - special exemption exist for members of the armed forces that are killed in combat. Nonresident non-citizens - file form 706NA and must file if they have property in the United States Amounts included in gross estate are the same as those that would be included in U.S. estates.

Payment of the Tax Date of payment - due date of return - 9 mos after DOD Extension available but do not avoid interest Estate tax on Closely held businesses or farms Must comprise 35% of decedents gross estate Can pay over 14 years, 4 years just interest, 10 years interest & tax 2% interest rate applies to first $1 million in farm value Holding company stock can qualify/passive do not Attribution rules can be used to meet 35% test rules See list on page 296 for acceleration of unpaid taxes.