Taxation of Estates and Gifts
The value of the gross estate shall include the value of all property to the extent of the interest therein of the decedent at the time of his death.
Cemetary plots are only included to the extent not "designed for the interment of the decedent and the members of his family." 26 U.S.C. § 20.2033–1(b). They are consumed.
Bonds are included at their market value, not their payout amount. Just because they are exempt from income tax, does not mean that they are exempt from estate tax.
If money is only accessible after so many years, the amount must be discounted according to § 7520 Table B.
If money is only accessible after someone's death, the amount must be multiplied by the corresponding "remainder" value in § 7520 Table S.
§§ 2038 & 2033 discount; § 2036 does not.
The estate will file the return on income that comes in while the estate still owns it. If income still is being paid after such rights are distributed, the beneficiaries must pay the income tax on them.
Royalties for earnings after death are not IRD, but just income for the estate/beneficiary, so they are still included on income tax, but no longer estate tax.
It is ideal for the estate to earn as little income as possible, because high tax rates kick in very quickly for them. 26 U.S.C. § 1(e).
This applies even if it is a contractual agreement to pay a survivor, and it does not go through the estate.
Dividends, unlike rent and interest, do not accrue until they are "declared and recorded."
- Declaring a dividend means that the dividend is announced.
- The date a dividend is recorded is the date that the stock must be owned to receive the dividend.
26 U.S.C. § 2036 says that gross estates also include the value of property where the decedent transferred part of his interest but retained part of it for his life, where the portion was not sold for "adequate and full consideration."
- "For life", for a period not ascertainable without reference to his life, or for a period which does not end before he actually dies
If the right was only to the income from part of the property, only that part will be included in the gross estate.
If the right was only for an annuity, only that part of the property the income from which is necessary to maintain paying that annuity will be included. (Divide the annuity amount by the interest rate to find the corpus.)
If the child buys a remainder interest at the rates in Table S, nothing is included in the gross estate from the annuity under 26 U.S.C. § 2036. (Although the value of the consideration will be under 26 U.S.C. § 2033 if the decedent does not consume it. (And at expected interest rates, it will reach the same value as the gross estate would have included if it was not sold.))
- To find the value of a life estate or remainder, use Table S. (Although you will need an interest rate.)
If the decedent actually dies before the period ends and transfers a remaining interest, the full amount is still included by § 2036 and nothing is included by § 2033.
Unlike §§ 2033 & 2038, § 2036 does not discount. Include the entire value of the retained property at the date of the death.
Elements of § 2036
- Decedent owned property, transferred part, and kept part;
- The retained interest is a "life-like interest";
- The transferred interest was not sold "bona fide" for "adequate and full consideration;"
- The property interest retained by the decedent is either:
- possession of non-income producing property or income from income producing property, or
- the right, either alone or in conjuction with any person, to designate the persons who shall possess the property or its income; and
- The amount included in the decedent's gross estate is the value, as of the decedent's date of death, of the property transferred during life to which the retained interest relates.
The right to designate income does not include a power over the transferred property itself which "does not affect the enjoyment of the income received or earned during the decedent's life."
- If the income from principal is already being transferred to someone during the decedent's life, the right to transfer the principal to that person is not included.
This amount must be discounted to the amount of time after decedent's death that it will be until the remainder transfers by multiplying it by the corresponding "remainder" value in 26 U.S.C. § 7520 Table S or B.
A condition being immaterial means that the condition does not matter. The result is the same whether the condition is present or not.
|Condition||Immaterial under Section 2036||Immaterial under Section 2038|
|Joint Power, i.e., act of D and another person is necessary to exercise the power||✔ Treas. Reg. § 20.2036-1(b)(3) text(i)||✔ Treas. Reg. § 20.2038-1(a)|
|Capacity, i.e., D holds power as a fiduciary, like a trustee||✔ Treas. Reg. § 20.2036-1(b)(3) text(ii)||✔ Treas. Reg. § 20.2038-1(a)|
|Contingency beyond D’s control is condition precedent to D’s having the power||✔ Treas. Reg. § 20.2036-1(b)(3) text(iii)||❌ Treas. Reg. § 20.2038-1(b)|
|Contingency within D’s control is condition precedent to D’s having the power||✔ Implied from Treas. Reg. § 20.2036-1(b)(3) text(iii)||✔ Implied from Treas. Reg. § 20.2038-1(b)|
|Power relates only to time and manner of enjoyment, e.g. income and remainder beneficiary is the same person||❌ Implied from Treas. Reg. § 20.2036-1(b)(3) text(iii)||✔|
Money may be included in both §§ 2036 & 2038, so just pick the larger of the two values.
There is, in fact, significant overlap between § 2036 and § 2038. If a decedent retains the right to designate who gets the income generally, usually both with apply (and 2036 will be the one that matters). However, if the decedent only has the power to change who gets the income after he dies, it only falls under § 2038, not § 2036, and they therefore get the discounting. (Which makes sense. You only are taxed on the remainder because all you can control is the remainder.)
- This is not the case if it's the remainder after someone else dies—then it all is included under § 2036.
- Unless the other actually dies first, then I think nothing's included.
Gross estates include the fair market value of property to the extent of the interest held in, except for the portion paid for by the other party for full and accurate consideration versus how much was contributed by the decedent. 26 U.S.C. § 2040(a).
- Capital in the initial purpose and in later improvements are counted together.
- If a mortgage was used to pay for the property, it also includes any mortgage payments paid and half of any outstanding mortgage at the time of death.
- If a second mortgage is taken and partially used to pay off the first mortgage, the portion of the second mortgage used to pay off the first is includable the same way. (If $100,000 is taken out, $60k of it is used to pay off the first mortgage, the surviving partner pays off $10k, and then the other partner dies, $33k will be includable. [($60k / $100k) × ($10k + ($90k / 2)) = $33,000])
Joint interests are (mostly?) all treated the same for estate tax.
If only owned by a husband and wife, the value is is always split 50/50. 26 U.S.C. § 2040(b).
When a joint interest is gifted to a spouse, that half of the giftor's basis is transferred along with the property. 26 U.S.C. § 1041(b)(2). When the giftor then dies, a surviving joint tenant with right of survivorship will take a fair market value basis in the decedent's estate. 26 U.S.C. § 1014(a)(1).
- E.g., so if wife buys property for $10, she puts it in joint interest with husband, the value goes up to $20, and she dies, the husband's basis will be $25. $10 will be included in the gross estate.
- It does not matter if spouses paid different amounts for property if their interests are equal.
- If community property, the whole fair market value is the basis.
The basis of gifts is the basis that the giftor had. 26 U.S.C. § 1015. So if a parent buys property worth $10 and gives half to a child, both will get a basis of $5. The child's basis would also be increased by the parent's half's fair market value if the parent dies.
If two joint tenants who are not married die at the same time, the property is treated half as if the decedent survived and half as if he did not. (Usually, this will mean half is included as a joint interest under 26 U.S.C. § 2040 (Although this will be $0 if the decedent did not pay anything.) and half is included under 26 U.S.C. § 2033.)
26 U.S.C. § 2042(2) says if there is a life insurance policy on your life but the beneficiary is someone else and you have the power to exercise power over who gets the benefits of it, the amount that you can control is includable in your estate.
If bank takes out insurance on the decedent for his mortgage, that policy is includable.
- However, if it can be shown that someone other than the decedent paid premiums, that portion of the life insurance is not includable. Liebmann v. Hassett.
The actual current value of a life insurance policy is called "the interpolated terminal reserve value." (We won't have to know how to calculate it (The life insurance company would do it.), but know the term.)
There are no inclusions with irrevocable life insurance trusts (ILITs), where cash is given to the trust sufficient to generate interest equal to the premiums on the policy, which will pay to the desired persons. These are very common and optimal.
26 U.S.C. § 2035 does not apply if the property was bought for "adequate and full consideration". 26 U.S.C. § 2035(d). This usually means fair market value, but if one transfers a retained life estate, the full value of the retained and then transferred at the time of the decedent's death because it really means the amount that would have been included in the estate tax had the transfer not happened. Allen.
If less than adequate and full consideration is paid, the rest of the consideration still must be included, but the amount paid can be excluded under 26 U.S.C. § 2043 so as to avoid double-tax.
If property is transferred from a revocable trust, it is treated like the decedent transferred it directly himself.
Annuities are included in one's gross estate if the annuity is receivable by someone because he survived the decedent and if the annuity was payable to the decedent (or he had the right to receive the annuity) alone or with another for decedent's life, a period not ascertainable without reference to his death, or for a period which does not end before his death. 26 U.S.C. § 2039(a).
Annuities are taxed under 26 U.S.C. § 72, which provides for an exclusion ratio of the investment paid divided by the expected return. (So exclude that ratio of each payment.)
In a joint and survivor annuity, both people will satisfy 26 U.S.C. § 2039(a) if they die first because they both have a contractual right to the payments. The annuity to the potential survivor is deducted from that potential survivor's estate by 26 U.S.C. § 2039(b) instead, whether or not he actually survives. The second person to die is not included because of 26 U.S.C. § 2033.
To value an annuity, use the formula: annualPayment × annuityFactor = value
- Use the annuity factors from the 7520 tables to solve for whatever part you need.
- e.g., $8,000 per month at 70 years old: $96,000 × 8.4988 = value → value = $815,884.80
To value an annuity with a right of survivorship, use the formula: annuityFactor = (1 − remainderFactor) ÷ interestRate
To find the exact term (assuming a straight line) for a remainder factor, find the two closest terms in Table B and use the formula: term = termLower + (interestRateHigher − interestRateExact) ÷ ((interestRateHigher − interestRateLower) ÷ 1)
- Basic slope stuff. Would need calculus to find the exact term.
A self-cancelling installment note is a promissory note sold by a beneficiary to his benefactor which is forgiven by the benefactor upon his death.
This high-end strategy theoretically evades estate tax, but the IRS will challenge it by asking how the self-cancelling was priced into the sale.