2. McGraw-Hill/Irwin Copyright (c) 2003 by the McGraw-Hill Companies Inc Principles of Taxation- Advanced Strategies Chapter 14 The Transfer Tax System Slide 14-1

3. McGraw-Hill/Irwin Copyright (c) 2003 by the McGraw-Hill Companies Inc Transfer Tax Policy Issues Intent is wealth transfer to public sector Relatively few people affected by system Slide 14-2

4. McGraw-Hill/Irwin Copyright (c) 2003 by the McGraw-Hill Companies Inc Economic Growth and Tax Relief Reconciliation Act of 2001 Gradually reduces rates and raises exemptions Repeals estate but not gift tax in 2010 “Sunsets” in 2011 Slide 14-3

5. McGraw-Hill/Irwin Copyright (c) 2003 by the McGraw-Hill Companies Inc Overview of System Tax imposed on transferor Tax is cumulative in nature  Amount and rate depends on prior activity Gift and estate system integrated Rates steeply progressive  Maximum estate rate drops from 55% in 2001 to 45% in 2007  Maximum gift tax rate drops to 35% in 2011 Slide 14-4

6. McGraw-Hill/Irwin Copyright (c) 2003 by the McGraw-Hill Companies Inc Unified Credit Slide 14-5 Represents a lifetime exemption from transfer taxes Credit first used to offset gift taxes. Any remainder used to offset estate taxes For year 2002, this results in a exemption equivalent of $ 675,000  Exemption equivalent is amount of wealth that can be transferred free of transfer taxes  For estate tax unified credit continues to rise until it reaches exemption equivalent of $ 3,500,000 in 2009

7. McGraw-Hill/Irwin Copyright (c) 2003 by the McGraw-Hill Companies Inc Gift Tax Formula Fair market value of gifts during year Less: Annual exclusion and deductions Current year taxable gifts Plus: Prior year taxable gifts Cumulative taxable gifts X Transfer tax rates Tax on cumulative gifts Less: Tax computed on prior year gifts Pre-credit gift tax Less: Unified Credit Gift tax payable Slide 14-6

8. McGraw-Hill/Irwin Copyright (c) 2003 by the McGraw-Hill Companies Inc Gifts Transfers for less than adequate consideration in money or money’s worth No gift until transfer complete Slide 14-7

9. McGraw-Hill/Irwin Copyright (c) 2003 by the McGraw-Hill Companies Inc Valuation of Gifts Fair market value  Price that property would change hands with willing buyer and willing seller Difficult items to value:  Land  Interests in closely held businesses  Art work May need appraisal Slide 14-8

10. McGraw-Hill/Irwin Copyright (c) 2003 by the McGraw-Hill Companies Inc Partial Interests Example: Gift of income interest to individual 1 for life, remainder to individual 2 Regulations provide guidance on how to allocate between the two individuals Slide 14-9

11. McGraw-Hill/Irwin Copyright (c) 2003 by the McGraw-Hill Companies Inc Annual Exclusion Up to $ 11,000 of gifts to any individual may be excluded from gift tax Married couples may gift split  Election to treat any gift as made equally by each spouse Only present interests qualify for the exclusion  Exceptions:  Educational IRA’s  State prepaid tuition plans Slide 14-10

12. McGraw-Hill/Irwin Copyright (c) 2003 by the McGraw-Hill Companies Inc Gift Tax Deductions Unlimited marital deduction for gifts to spouse Deduction for gifts to charity Slide 14-11

13. McGraw-Hill/Irwin Copyright (c) 2003 by the McGraw-Hill Companies Inc Gift Tax Return Filing Requirements Return must be filed in any year gifts exceed annual exclusion Return must be filed to make gift splitting election Slide 14-12

14. McGraw-Hill/Irwin Copyright (c) 2003 by the McGraw-Hill Companies Inc Estate Tax Formula Fair market value of gross estate Less: Deductions Taxable estate Plus: Post-1976 cumulative taxable gifts Cumulative taxable transfers X Transfer tax rates Pre-credit estate tax Less: Gift taxes paid or deemed paid Less: Estate tax credits Estate tax payable Slide 14-13

15. McGraw-Hill/Irwin Copyright (c) 2003 by the McGraw-Hill Companies Inc Gross Estate Items included at fair market value at date of death May elect to value items six months after date of death if total estate decreases in value Slide 14-14

16. McGraw-Hill/Irwin Copyright (c) 2003 by the McGraw-Hill Companies Inc Items Includable in Gross Estate Property owned by decedent at date of death Life insurance owned by decedent Portion of jointly owned property Transfers with retained life estates Certain gifts made within 3 years of death Gift tax paid on gifts made within 3 years of death Survivorship annuity benefits Slide 14-15

17. McGraw-Hill/Irwin Copyright (c) 2003 by the McGraw-Hill Companies Inc Property Owned by Decedent at Date of Death Slide 14-16 Includes all probate property  Property that passes by will or through intestacy Includes all retirement accounts such as pensions and individual retirement accounts

18. McGraw-Hill/Irwin Copyright (c) 2003 by the McGraw-Hill Companies Inc Joint Ownership Ownership where two or more persons have an undivided interest in property Types:  Joint tenancy- Ownership passes to survivor or survivors  Tenancy by the entirety- same as joint tenancy but between husband and wife  Tenancy in common- no right of survivorship  Community Property- property except for gifts and inheritances acquired during marriage in a community property state Slide 14-17

19. McGraw-Hill/Irwin Copyright (c) 2003 by the McGraw-Hill Companies Inc Joint Ownership Jointly held property with rights of survivorship  General rule: Entire value of property less contribution of decedent includable in gross estate  Exception: If joint owners were married, 50% of value of property includable Slide14-18

20. McGraw-Hill/Irwin Copyright (c) 2003 by the McGraw-Hill Companies Inc Joint Ownership Tenancy in common- amount includable in gross estate determined by state law Community property- 50% owned and includable by each spouse Slide 14-19

21. McGraw-Hill/Irwin Copyright (c) 2003 by the McGraw-Hill Companies Inc Estate Tax Deductions Funeral expenses Estate administration costs Estate casualty and theft losses Certain liabilities Gifts or bequests to charity Gifts or bequests to spouse Slide 14-20

22. McGraw-Hill/Irwin Copyright (c) 2003 by the McGraw-Hill Companies Inc Estate Tax Credits State death tax credit  Subject to a maximum limitation Credit for estate tax on prior transfer  Allowed if property passed through another estate during past 10 years  Reduced by 20% for every two year increment that has passed since property was previously taxed Slide 14-21

23. McGraw-Hill/Irwin Copyright (c) 2003 by the McGraw-Hill Companies Inc Generation Skipping Transfer Tax Slide 14-22 Tax imposed on transfers that skip a generation  Example: gift to grandchild Imposed at maximum estate tax rate Exemptions:  $ 11,000 annual gift tax exclusion  Exclusion allocated to every transferor based upon exemption equivalent amount in effect during year

24. McGraw-Hill/Irwin Copyright (c) 2003 by the McGraw-Hill Companies Inc State Death Taxes Imposed by every state Types:  Inheritance tax imposed on the privilege of inheriting assets  Rate generally based upon relationship between transferor and transferee  Estate tax  Pick up tax  Tax equal to maximum deduction for state death taxes on federal return Slide 14-23

25. McGraw-Hill/Irwin Copyright (c) 2003 by the McGraw-Hill Companies Inc Charitable Contributions Allowed as an income, gift and estate tax deduction Full fair market value generally deductible for all purposes Slide 14-24

26. McGraw-Hill/Irwin Copyright (c) 2003 by the McGraw-Hill Companies Inc Tax Basis Issues Recipient taxable on any income produced by inherited or gifted property Tax basis  Property acquired from decedent  Basis equal to fair market value on date of death or alternative valuation date  Changes in 2010 when estate tax repealed Slide 14-25

27. McGraw-Hill/Irwin Copyright (c) 2003 by the McGraw-Hill Companies Inc Tax Basis Issues Slide 14-26 Property acquired by gift  Carryover basis if asset worth more than donor’s basis  Split basis if asset depreciated in value  Carryover basis for gain  Fair market value for loss

28. McGraw-Hill/Irwin Copyright (c) 2003 by the McGraw-Hill Companies Inc Tax Basis After 2009 Property acquired from decedent has modified carryover basis Aggregate step-up of $ 1,300,000 allocated to all assets by executor  Basis of property can never exceed fair market value Spousal step-up for property transferred to spouse of $ 3,000,000 Slide 14-27