2. McGraw-Hill/Irwin Copyright (c) 2002 by the McGraw-Hill Companies Inc Principles of Taxation: Advanced Strategies Chapter 14 Chapter 14 The Transfer Tax System The Transfer Tax System Slide 14-1

3. McGraw-Hill/Irwin Copyright (c) 2002 by the McGraw-Hill Companies Inc Overview of System Tax imposed on transferor Tax imposed on transferor Tax is cumulative in nature Tax is cumulative in nature  Amount and rate depends on prior activity Integrated gift and estate system integrated Integrated gift and estate system integrated Rates steeply progressive Rates steeply progressive Slide 14-2

4. McGraw-Hill/Irwin Copyright (c) 2002 by the McGraw-Hill Companies Inc Unified Credit Slide 14-3 Represents a lifetime exemption from transfer taxes Represents a lifetime exemption from transfer taxes Credit first used to offset gift taxes. Any remainder used to offset estate taxes Credit first used to offset gift taxes. Any remainder used to offset estate taxes For year 2001, this results in a exemption equivalent of $ 675,000 For year 2001, this results in a exemption equivalent of $ 675,000  Exemption equivalent is amount of wealth that can be transferred free of transfer taxes

5. McGraw-Hill/Irwin Copyright (c) 2002 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 14-4

6. McGraw-Hill/Irwin Copyright (c) 2002 by the McGraw-Hill Companies Inc Gifts Transfers for less than adequate consideration in money or money’s worth Transfers for less than adequate consideration in money or money’s worth No gift until transfer complete No gift until transfer complete Slide 14-5

7. McGraw-Hill/Irwin Copyright (c) 2002 by the McGraw-Hill Companies Inc Valuation of Gifts Fair market value Fair market value  Price that property would change hands with willing buyer and willing seller Difficult items to value: Difficult items to value:  Land  Interests in closely held businesses  Art work May need appraisal May need appraisal Slide 14-6

8. McGraw-Hill/Irwin Copyright (c) 2002 by the McGraw-Hill Companies Inc Partial Interests Example: Gift of income interest to individual 1 for life, remainder to individual 2 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 Regulations provide guidance on how to allocate between the two individuals Slide 14-7

9. McGraw-Hill/Irwin Copyright (c) 2002 by the McGraw-Hill Companies Inc Annual Exclusion Up to $ 10,000 of gifts to any individual may be excluded from gift tax Up to $ 10,000 of gifts to any individual may be excluded from gift tax Married couples may gift split Married couples may gift split  Election to treat any gift as made equally by each spouse Only present interests qualify for the exclusion Only present interests qualify for the exclusion Slide 14-8

10. McGraw-Hill/Irwin Copyright (c) 2002 by the McGraw-Hill Companies Inc Gift Tax Deductions Unlimited marital deduction for gifts to spouse Unlimited marital deduction for gifts to spouse Deduction for gifts to charity Deduction for gifts to charity Slide 14-9

11. McGraw-Hill/Irwin Copyright (c) 2002 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 14-10

12. McGraw-Hill/Irwin Copyright (c) 2002 by the McGraw-Hill Companies Inc Gross Estate Items included at fair market value at date of death 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 May elect to value items six months after date of death if total estate decreases in value Slide 14-11

13. McGraw-Hill/Irwin Copyright (c) 2002 by the McGraw-Hill Companies Inc Items Includable in Gross Estate Property owned by decedent at date of death Property owned by decedent at date of death Life insurance owned by decedent Life insurance owned by decedent Portion of jointly owned property Portion of jointly owned property Transfers with retained life estates Transfers with retained life estates Certain gifts made within 3 years of death Certain gifts made within 3 years of death Gift tax paid on gifts made within 3 years of death Gift tax paid on gifts made within 3 years of death Survivorship annuity benefits Survivorship annuity benefits Slide 14-14

14. McGraw-Hill/Irwin Copyright (c) 2002 by the McGraw-Hill Companies Inc Property Owned by Decedent at Date of Death Slide 14-13 Includes all probate property Includes all probate property  Property that passes by will or through intestacy Includes all retirement accounts such as pensions and individual retirement accounts Includes all retirement accounts such as pensions and individual retirement accounts

15. McGraw-Hill/Irwin Copyright (c) 2002 by the McGraw-Hill Companies Inc Joint Ownership Ownership where two or more persons have an undivided interest in property Ownership where two or more persons have an undivided interest in property Types: Types:  Joint tenancy- Ownership passes to survivors 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 14-14

16. McGraw-Hill/Irwin Copyright (c) 2002 by the McGraw-Hill Companies Inc Joint Ownership Jointly held property with rights of survivorship 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 Slide14-15

17. McGraw-Hill/Irwin Copyright (c) 2002 by the McGraw-Hill Companies Inc Joint Ownership Tenancy in common – amount includable in gross estate determined by state law Tenancy in common – amount includable in gross estate determined by state law Community property – 50% owned and includable by each spouse Community property – 50% owned and includable by each spouse Slide 14-16

18. McGraw-Hill/Irwin Copyright (c) 2002 by the McGraw-Hill Companies Inc Estate Tax Deductions Funeral expenses Funeral expenses Estate administration costs Estate administration costs Estate casualty and theft losses Estate casualty and theft losses Certain liabilities Certain liabilities Gifts or bequests to charity Gifts or bequests to charity Gifts or bequests to spouse Gifts or bequests to spouse Slide 14-17

19. McGraw-Hill/Irwin Copyright (c) 2002 by the McGraw-Hill Companies Inc Estate Tax Credits State death tax credit State death tax credit  Subject to a maximum limitation Credit for estate tax on prior transfer 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 14-18

20. McGraw-Hill/Irwin Copyright (c) 2002 by the McGraw-Hill Companies Inc Generation Skipping Transfer Tax Slide 14-19 Tax imposed on transfers that skip a generation Tax imposed on transfers that skip a generation  Example: gift to grandchild Imposed at 55% rate Imposed at 55% rate Exemptions: Exemptions:  $ 10,000 annual gift tax exclusion  $ 1,060,000 exclusion allocated to every transferor

21. McGraw-Hill/Irwin Copyright (c) 2002 by the McGraw-Hill Companies Inc State Death Taxes Imposed by every state Imposed by every state Types: 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 14-20

22. McGraw-Hill/Irwin Copyright (c) 2002 by the McGraw-Hill Companies Inc Charitable Contributions Allowed as an income, gift and estate tax deduction Allowed as an income, gift and estate tax deduction Full fair market value generally deductible for all purposes Full fair market value generally deductible for all purposes Slide 14-21

23. McGraw-Hill/Irwin Copyright (c) 2002 by the McGraw-Hill Companies Inc Tax Basis Issues Recipient taxable on any income produced by inherited or gifted property Recipient taxable on any income produced by inherited or gifted property Tax basis Tax basis  Property acquired from decedent  Basis equal to fair market value on date of death or alternative valuation date Slide 14-22

24. McGraw-Hill/Irwin Copyright (c) 2002 by the McGraw-Hill Companies Inc Tax Basis Issues Slide 14-23 Property acquired by gift 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