Gale Encyclopedia Of American Law 3Rd Edition Volume 4 P26 pdf

representative takes the property as personal property. A life estate is alienable, and therefore, the life tenant can convey his or her estate. The grantee of the life tenant would thereby be given an estate pur autre vie. The life tenant is unable, however, to convey an estate that is greater than his or her own. Nonfreehold Estates Nonfreehold estates are interests in real proper- ty without seisin and which are not inheritable. The four main types of nonfreehold estates are an estate for years, an estate from year to year, a tenancy at will, and a tenancy at sufferance. Estate for Years The most significant feature of an estate for years is that it must be of definite duration, that is, it is required to have a definite beginning and a definite ending. The most common example of an estate for years is the arrangem ent existing between a landlord and tenant whereby property is leased or rented for a specific amount of time. In this type of estate the transferor leases the property to the transferee for a certain designated period, for example: “Transferor leases BLACKACRE to trans- feree for the period of January 1, 1998, to January 1, 2003, a period of five years.” During the five-year period, the transferee has the right to possess Blackacre and use and enjoy the fruits that stem from it. He or she is required to pay rent according to the terms of the rental agreement and is not permitted to commit waste on the premises. If the transferee dies during the term of the lease, the remainder of such term will pass to the transferee’s personal representative for distribution pursuant to a will or the laws of DESCENT AND DISTRIBUTION, since a leasehold interest is regarded as personal property or a chattel real. Estate from Year to Year The essential distin- guishing characteristic of an estate from year to year is that it is of indefinite duration. For example, a landlord might lease Blackacre to a tenant for a two-year period, from January 1, 2003, to January 1, 2005, at a rental of $600 per month, payable in advance on or before the ninth day of each month. The tenant might hold possession beyond January 1, 2005, and on or before January 9, 2005, give the landlord $600. If the landlord accepts the rent, the tenant has thereby been made a tenant from year to year. An estate of this nature continues indefinitely until one of the parties gives notice of termina- tion. The terms of the original lease are implied to carry over to the year-to-year lease, except for the term that set forth the period of the lease. Notice of termination is an important component of this type of periodic tenancy. In the preceding example, either party would be able to terminate the tenancy by providing notice at least six months preceding the end of the yearly period. Statutory provisions often abridge the length of notice required to end periodic tenancies. Such tenancies may come within requirements set forth by the STATUTE OF FRAUDS . Tenancy at Will A tenancy at will is a rental relationship between two parties that is of indefinite duration, since either may end the relationship at any time. It can be created either by agreement, or by failure to effectively create a tenancy for years. A tenancy at will is terminated by either individual without notice and ends automati- cally by the death of either party or by the commission of voluntary waste by the lessee. It is not assignable and is categorized as the lowest type of chattel interest in land. Tenancy at Sufferance A t enancy at sufferance is an estate that ordinarily arises when a tenant for years or a tenant from period to period retains possession of the premises without the landlord’s consent. This type of interest is regarded as naked and wrongful possession. In this type of estate, the tenant is essentially a trespasser except that his or her original entry onto the property was not wrongful. If the landlord consents, a tenant at sufferance may be transformed into a tenant from period to period, upon acceptance of rent. Concurrent Estates Concurrent estates are those that are either owned or possessed by two or more individuals simultaneously. The three most common types of concurrent estates are JOINT TENANCY, TENANCY BY THE ENTIRETY , and TENANCY IN COMMON. Joint Tenancy A joint tenancy is a type of concurrent ownership whereby property is acquired by two or more persons at the same time and by the same instrument. A typical conveyance of such a tenancy would be “Grantor conveys Blackacre to A, B, and C and their heirs in fee simple absolute.” The GALE ENCYCLOPEDIA OF AMERICAN LAW, 3RD E DITION ESTATE 239 main feature of a joint tenancy is the RIGHT OF SURVIVORSHIP . If any one of the joint tenants dies, the remainder goes to the survivors, and the entire estate goes to the last survivor. In a joint tenancy, there are four unities, those of interest, time, title, and possession. Unity of interest means that each joint tenant owns an undivided interest in the property as a whole. No one joint tenant can have a larger share than any of the others. Unity of time signifies that the estates of each of the joint tenan ts is vested for exactly the same period. Unity of title indicates that the joint tenants hold their property under the same title. Unity of possession requires that each of the joint tenants must take the same un- divided possession of the property as a whole and enjoy the same rights until one of the joint tenants dies. Tenancy by the Entirety A tenancy by the entirety is a form of joint tenancy arising between a husband and wife, whereby each spouse owns the undivided whole of the property, with the right of survivorship. A tenancy by the entirety can be created by will or deed but not by descent and distribution. It is distinguishable from a joint tenancy in that neither party can voluntarily dispose of his or her interest in the property. There is unity of title, possession, interest, time, and person. Tenancy in Common A tenancy in co mmon is a form of concurrent ownership that can be created by deed or will, or by operation of law, in which two or more individuals possess property simultaneously. A typical conveyance of this type of tenancy would be “Grantor, owner of Blackacre in fee simple absolute, grants to A, B, and C, and their heirs—each taking one-third interest in the property.” In the preceding illustration, A, B, and C are tenants in common. There is no right of survivorship in such a tenancy, and each grantee has the right to dispose of his or her share by deed or by will. In a tenancy in common, one of the tenants may have a larger share of the property than the others. In addition, the tenants in common may take the same property by several titles. The only unity present in a tenancy in common is unity of possession. Future Interests Future interests are interests in real or personal property, a gift or trust, or other things in which the privilege of possession or of enjoyment is in the future and not the present. They are interests that will come into being at a future point in time. There are five classes of future interests: reversions; possibilities of reverter; powers of termination, also known as rights of re-entry for condition broken; remainders, and executory interests. Incorporeal Interests Incorporeal interests in real property are those that cannot be possessed physically, since they consist of rights of a particular user, or the right to enforce an agreement concerning use. The five major types of incorporeal interests are easements; profits; covenants RUNNING WITH THE LAND ; equitable servitudes; and licenses. FURTHER READINGS Abts, Henry W. 2002. The Living Trust: The Failproof Way to Pass Along Your Estate to Your Heirs. 3d ed. New York: McGraw-Hill. Applegate, E. Timothy. 2003. “Estate Planning: Who Owns the Family Plot?” California Lawyer 23 (October). “Estate Planning FAQs.” ABA Section of Real Property/ Trust & Estate Law. American Bar Association. Available online at http://www.abanet.org/rpte/public/home. html; website home page: http://www.abanet.org (accessed September 2, 2009). Trusts & Estates Web site. Available online at http:// trustsandestates.com/ (accessed September 2, 2009). CROSS REFERENCES Equity; Servitude. ESTATE AND GIFT TAXES Estate and gift taxes are the combined federal tax on transfers by gift or death. When property interests are given away during life or at death, taxes are imposed on the transfer. These taxes, known as estate and gift taxes, apply to the total transfers that an individual may make over a lifetime. Estate and gift tax law is prim arily statutory. Although the TREASURY DEPARTMENT issues reg- ulations governing t he interpretation of the revenue laws and although state and federal courts contribute their interpretations of statu- tory la w, the foundation of the transfer taxes rests in chapters 11 and 12 of the INTERNAL REVENUE CODE . To understand the complex statutory framework requires a basic GALE ENCYCLOPEDIA OF AMERICAN LAW, 3RD E DITION 240 ESTATE AND GIFT TAXES understanding of the concepts underlying the estate and gift tax system. The TRANSFER TAX laws apply to al l gratuitous shifts in property interests. But although administered similarly, the estate tax and gift tax have somewhat different goals. The gift tax reaches the gratu- itous ABANDONMENT of ownership or control in favor of another person during life, whereas the estate tax extends to transfers that take place at death, or before death, as substitutes for dispositions at death. Both taxes are intended to limit the concentration of familial or dynastic wealth. Estate and gift taxes became a source of political debate in the late 1990s, as many members of Congress pressed for an end to these taxes. They argued that such death taxes were unfair and fo rced small businesses and family farmers to sell off their assets to pay the estate taxes. Opponents of repeal noted that even though the potential tax rate was quite high, at 55 percent, most individuals never paid any estate or gift tax. Under the tax system that had been in place since 1986, every person could transfer a combined $600,000 worth of property during life and at death without paying tax. This tax-free allowance corresponded to $192,800 worth of federal tax savings and is known as the unified credit against estate tax. This unified credit was sufficient to satisfy taxes on transfers by all but the richest 5 percent of U.S. citizens. Defenders of estate and gift taxes maintained that these taxes were guided by an important government and social policy: the prevention of large concentrations of dynastic wealth. Moreover, they pointed out that estate tax collections typically constitute less than 2 percent of total INTERNAL REVENUE SERVICE collections. The debate on this issue culminated in the Economic Growth and Tax Relief Reconcilia- tion Act of 2001. The top estate tax rate was reduced from 55 percent to 50 percent in 2002 (together with the repeal of the 5 percent surtax on estates over $10 million), 49 percent in 2003, 48 percent in 2004, 47 percent in 2005, 46 percent in 2006, and to 45 percent in years 2007 through 2009. The credit-level exemption was raised from $675,000 to $1 million in 2002, $1.5 million in 2004 , $2 millio n in 2006, and $3.5 million in 2009. Most importantly, the estate tax was to be repealed in 2010. However, the law contains a sunset provision. If Congress does not extend the law beyond 2010, the new law will end on December 31, 2010, and the previous estate law will be in effect again. The gift tax was not repealed, but it was modified. The new law increased the total gift tax exemption from $675,000 in 2001 to $1,000,000 in 2002 and thereafter . After 2009, the gift tax is retained at the top income tax rate for the applicable year, which is currently 35 percent. The retention of the gift tax is meant to discourage transfers to lower income benefici- aries to minimize capital gains taxes. With few exceptions, the individual making the transfer is responsible for any transfer tax owed (whereas the individu al receiving income is responsible for any income tax owed). Thus, the executor of an estate, as the estate’s representative, is responsible for paying any estate tax due, and the donor of a gift is responsible for paying any gift tax due. Gifts The Internal Revenue Code defines a gift as a “transfer … in trust or otherwise, whether the gift is direct or indirect, and whether the property is real or personal, tangible or intangible.” Generally, a gift is any completed transfer of an interest in property to the extent that the donor has not received something of Federal Estate and Gift Tax Receipts, 1970 to 2007 3.6 6.4 11.5 1 4 . 8 29.7 25.6 27 . 0 0 5 10 15 20 25 30 35 1970 1980 1990 1995 2000 2005 2007 Year Estate and gift taxes, in billions of dollars 0.0 0.2 0.4 0.6 0.8 1.0 1.2 1.4 1.6 1.8 2.0 Percentage of total IRS collections SOURCE: U.S. Office of Management and Budget, Historical Tables, annual, and the Internal Revenue Service, Statistics of Income (SOI) Tax Stats. Estate and gift tax amounts Amounts as percentage of total IRS collections ILLUSTRATION BY GGS CREATIVE RESOURCES. REPRODUCED BY PER- MISSION OF GALE, A PART OF CENGAGE LEARNING. GALE ENCYCLOPEDIA OF AMERICAN LAW, 3 RD E DITION ESTATE AND GIFT TAXES 241 value in return, with the exception of a transfer that results from an ordinary business transac- tion or the discharge of legal obligations, such as the obligation to support minor children. This definition of gifts does not require the intent to make a gift. An individual may make gifts of both present interests (such as life estates) and future interests (such as remainders) in pro- perty (26 U.S.C.A. § 2503[b]). From a tax standpoint, gifts have two principal advantages over transfers at death. First, gifts allow a donor to transfer property while its value is low, allowing future apprecia- tion in property value to pass to others free of additional gift or estate tax. Second, provided that the gift is of a present interest in property, a donor may transfer up to $11,000 exempt from tax to each donee every calendar year, which allows the donor to reduce the size of the estate remaining at death without any transfer tax consequences. To constitute a gift, a transfer must satisfy two basic requirements: It must lack consider- ation, in whole or in part (that is, the recipient must give up nothing in return); and the donor must relinquish all control over the transferred interest. To constitute a tax-exempt gift, a transfer also must constitute a present interest in property. (A present interest is something that a person owns at the present time, whereas a future interest is something that a person will come to own in the future, such as the procee ds of a trust.) Lack of Consideration A transfer is not a gift if the transferor receives consideration, or something of value, in return for it. For example, if A sells B a used car worth $5,000 and receives $5,000 in exchange, the transfer is not a gift because it is supported by “adequate and full consideration” (26 U.S.C.A. § 2512[b]). But if A sells B the same car for only $2,000, the transfer constitutes a gift of $3,000 because A exchanges $3,000 worth of car for nothing. Finally, if A gives B the car without receiving anything in return, the transfer constitutes a gift of $5,000. Although consideration may be whole or partial, not all transfers for partial or insufficient consid eration result in gifts. An arm’s-length sale (a sale free of any special relationship between buyer and seller) will not be considered a gift where no intent to make a gift exists, even if the consideration is not adequate. This limit on the definition of gifts excludes bad business deals and forced sales from gift tax treatment. The Completeness Requirement A transfer constitutes a gift for tax purposes only if the donor has parted with the ability to exercise “dominion and control” over the property transferred. Many transfers of property satisfy this condition. For example, if A takes B out for a birthday dinner, the act of purchasing the dinner is a gift because A cannot regain control over the food that B consumes or revoke the acts of purchasing and consuming the meal. When the donor has not relinquished absolutely the ability to control or manage the property or its use, however, the “gift” may not be complete for tax purposes. The most common example of an incomplete transfer is a transfer of property to a revocable trust, in which the donor retains the right, as trustee, to alter, amend, or rescind the trust. The gift is not completed because the donor could restore ownership in the trust property to himself or herself or change his or her mind about who will enjoy or later receive the property. This distinction between complete and incomplete transfers determines whether prop- erty will be included in an estate at death, as well as the value of that property. The value of property that was incompletely transferred during life will be included in the gross estate at death (26 U.S.C.A. §§ 2035-2038). Therefore, any appreciation in the value of incompletely transferred property will be included and taxed in the estate, whereas none of the value of completely transferred property will be included in the estate. Accordingly, if A transfers 1,000 shares of XYZ stock outright to B when it is worth $10 per share, the value of the transfer subject to tax equals zero because A can take advantage of the annual exclusion described in the following section. If A transfers the same stock to a revocable trust for B’sbenefit, however, and that stock is worth $100 per share onthedateofA’s death, the entire $100,000 is included and taxable in A’s estate. Moreover, any income distributions from the trust after the transfer of property to the revocable trust are taxable gifts to B for which A must pay tax. Sometimes people make incomplete trans- fers, rather than completed gifts, in order to retain control over the property, even though appreciation in property value is taxed as a consequence of an incomplete transfer. For various reasons, a person might not want to give GALE ENCYCLOPEDIA OF AMERICAN LAW, 3RD E DITION 242 ESTATE AND GIFT TAXES up that control. An individual might wish to control the distribution of income from a gift to a trust or even to receive the income distribu- tions from a trust. Or an individual may create a trust for non-gift reasons, such as to ensure property or investment management. Parents might not trust their children to manage gifts of stock or cash effectively and thus might retain control to ensure that transfers are not squandered. Occasionally, donors mistakenly believe that revocable trusts are effective devices to avoid paying estate taxes and simply do not realize that transfers to revocable trusts are incomplete for gift purposes. Present versus Future Interests: The Annual Exclusion Each individual may make tax- exempt gifts of up to $11,000 to each donee every year. To qualify for this so-called annual exclusion, a gift must be of a present interest in property (26 U.S.C.A. § 2503[b]). Completed transfers of future interests, such as remainder interests in real estate or the vested right to the distribution of trust principal on the donor’s death, constitute gifts for tax purposes but do not qualify for the annual exclusion. Only the unrestricted right to use, enjoy, or possess property in whole or in part constitutes a present interest. For example, if A transfers a life estate in his home to B, with a remainder to C, only the life estate to B, which is a present interest in the home, qualifies for the annual exclusion. The remainder interest to C is a completed gift but does not qualify for the annual exclusion because it is a gift of a future interest. A more subtle and common illustration of this principle involves trust property. For example, A creates an irrevocable trust giving B, the trustee, complete discretion over the distri- bution of income to C for ten years, at which time the trust will terminate, and the entire trust corpus and accumulated income will be paid to C. In this case, A has made a completed gift of the entire trust corpus, but the gift does not qualify for the annual exclusion because C has no present right to the trust income. Testamentary Transfers The gross estate is the measure of the interests an individual is considered capable of transferring at the time of death and provides the starting point for computing the estate tax (26 U.S.C.A. § 2031). The gross estate is an artificial concept, in part because it may include interests that the individual did not actually own at death (§§ 2035-2038). From the gross estate are deducted expenses of administering the estate, the decedent’slegal obligations at death, the value of property passing to a surviving spouse, and the value of bequests to charity (§§ 2053-2056). The remainder is known as the taxable estate and is the value on which the estate tax is computed. Conventional interests in property, such as ownership of real estate, stocks and bonds, cash, automobiles, art, and personal property, must be included in the gross estate and valued at their fair market value on the date of death. In addition, interests in life insurance, annuities, and certain death benefits are included to the extent that the decedent was able to confer an interest in them on another person. Finally, three somewhat artificial ownership attributes, including the power to change beneficial enjoyment and the power to revoke or change the type and time of enjoyment, are included in the gross estate to the full extent of the property to which the power applies. The value of property included in the gross estate is equal to its fair market value on the date of death. Designation of Beneficiaries Life insurance, annuities, and certain death benefits are sub- stitutes for dispositions at death and are included in the gross estate to the extent that the decedent owned or could exercise “incidents of ownership” over them until the time of death. Thus, the value of a life insurance policy payable to the decedent’s estate on death is included in the decedent’s gross estate (26 U.S.C.A. § 2042[a] [1]). In addition, life insurance is includable in the gross estate even though neither the decedent nor the decedent’s estate actually owned it, if the decedent possessed any incidents of ownership over the policy. Incidents of ownership encom- pass the rights to change the distribution of the economic benefit flowing from the insurance policy. For example, if A purchases a life insurance policy that is payable to B on A’s death, the value of that policy is includable in A’s gross estate if she retained, at the time of her death, the ability to change the policy beneficiary to C. If the decedent had no rights to direct or affect economic benefits at the time of her death, then the proceeds of the policy are not includable in the gross estate. Powers of Appointment Frequently, an indi- vidual owns the power to designate who will GALE ENCYCLOPEDIA OF AMERICAN LAW, 3RD E DITION ESTATE AND GIFT TAXES 243 enjoy an item of property. This power may be considered an attribute of ownership sufficient to be included in the gross estate. The provision 26 U.S.C.A. § 2038, discussed below under retained power, addresses these powers of appointment that individuals reserve to them- selves when creating property rights for another individual. Section 2041, in contrast, includes in the gross estate the value of property subject to a “general” POWER OF APP OINTMENT that the dece- dent acquired from another person. A general power of appointment is one that indiv iduals may exercise in their own favor or in favor of their estate, their creditors, or the creditors of their estate. If the decedent may only exercise the power in conjunction with either the creator of the power or a person having an adverse interest in the property subject to the exercise of the power, then the power is not considered a general power of appointment because the decedent cannot freely control the transfer of the property at the decedent’s death, and the property subject to the power is not included in the gross estate. For example, if A dies and leaves B the right to income in a trust, as well as the right to appo int the trust in whatever manner he wishes, then the entire value of the trust is included in B’s estate when B dies. If, by contrast, A leaves B the right to income from the trust as well as the right to appoint the trust only to C or C’s heirs, then no portion of the trust is includable in B’s estate when B dies. A power that is limited by an ascertainable standard is not a general power, even if it otherwise appears to be a general power. Ascer- tainable standards include health, education, support, and maintenance. Accordingly, if A dies and leaves B the power to appoint trust principal to herself if it is required for her health, education, support, or maintenance, B’spower is limited by an ascertainable standard, and the value of the trust is not included in the gross estate. But if B may invade the trust principal for her “comfort and happiness,” B’s power is not limited by an ascertainable standard, and the value of the trust is included in B’sestate. Artificial Aspects of the Estate Tax System Before 1976 the gross estate included the value of all gifts made in CONTEMPLATION OF DEATH. Because determining whether a gift was in contemplation of death turned out to be subjective, difficult to prove, and somewhat morbid, a 1976 amendment to the estate tax law automatically included any gift that a decedent made within three years of death (26 U.S.C.A. §2035[a]). Unfortunately, the effect of § 2035(a) was to include in the gross estate the full value of the transferred property at the date of death, including any appreciation in value since the transfer. Thus, if A transferred $3,000 worth of stock to B in 1978 and died in 1980, when the stock was worth $25,000, the stock’sfullvalue of $25,000 was included in the gross estate, defeating much of A ’s pre-death tax p lanning. In 1981 sweeping tax changes eliminated from the gross estate most transfers made within three years of death. Even so, three specific types of transfers (transfers with a retained life estate, transfers with retained powers, and transfers effective on death) are included in the gross estate because the decedent owned an interest in the property at the time of death. Moreover, the value of property once subject to certain retained interests is included in the gross estate if the release or lapse of the retained interest takes place within three years of death, because the disposition of the retained interest is considered a substitute for disposition at death. Transfers with a retained life estate Trans- fers with a retained life estate are covered in 26 U.S.C.A. § 2036. For purposes of the estate tax laws, the term life estate includes more than just an expressly retained life interest in property. For example, if A creates a trust for the benefit of B but retains the right to receive the income from the trust for the rest of her life, her retained income interest clearly is a retained life estate in the property. But the retention of the right to change the economic benefit derived from the property also constitutes a retained life estate, as when A reserves the right to change the trustee and appoint herself the trustee. It also might include retained life estates by tacit agreement, such as when A transfers her home to B, with the understanding that A and not B will live there for the rest of her life. The mere possession of a life estate in property is insufficient to bring it into the gross estate under § 2036. The life interest must be retained by the decedent and must apply to an interest in property that the decedent trans- ferred. Thus, a life income interest created by someone other than the decedent is not includable in the gross estate under § 2036. GALE ENCYCLOPEDIA OF AMERICAN LAW, 3RD E DITION 244 ESTATE AND GIFT TAXES Transfers with retained powers Transfers in which the decedent owns, at the time of death, the power to alter, amend, revoke, or terminate the enjoyment of the property are covered in 26 U.S.C.A. § 2038(a)(1). In contrast to § 2041, which allows general powers of appointment, § 2038 includes only powers associated with a property interest that the decedent gave away during his or her lifetime. The most commonly encountered retained powers are the powers applicable to a revocable trust. A revocable trust is a legal instrument through which an individual relinquishes legal ownership of the property to the trustee of a trust, either retaining to himself or herself beneficial enjoyment of the property, such as the right to income, or granting it to another individual. As its name indicates, the revocable trust is set up so that the creator, known as the grantor,thesettlor,orthetrustor, may revoke the trust entirely, may change the terms of the trust, or may change the beneficial ownership in the trust. The creation of, or an addition to, a revocable trust almost never constitutes a gift. A gift must be completed in order to be taxable; the creation of or an addition of property to a revocable trust is, by definition, incomplete because the creator may change the beneficial enjoyment at some time, effectively withdraw- ing the “gift.” Distributions from a revocable trust may, however, constitute completed gifts. For example, if A transfers $2 million to a revocable trust that pays income to B, the transfer of the $2 million is not a completed gift, but the annual payment of $100,000 in interest to B is a taxable gift when it takes place. Upon A’s death, the entire value of the property subject to the power, including both the trust corpus and undistributed income payable to B, is included in the gross estate. Moreover, because the property is valued as of the date of death, any increases or decreases in the value of the property since the transfer will appear in the gross estate. Transfers effective on death The provision 26 U.S.C.A. § 2037 includes in the gross estate the value of transfers that take effect on death. Although at a distance § 2037 seems to apply to all property transfers that occur as a result of an individual’s death, the stipulated transfers are rarely encountered. To meet the requirements of § 2037, the beneficiary must be able to acquire an interest in the property only by surviving the decedent. Furthermore, the dece- dent must have expressly retained a reversionary interest in the property that is wort h at least 5 percent of the property’s value at the time of death. Both conditions are difficult to meet. In the first place, the req uirement that the beneficiary obtain an interest in the property solely by surviving the decedent is exclusive: If the beneficiary could have obtained an interest in any other way, such as by surviving another individual, satisfying a condition, or outlasting a term of years, the property is not includable under § 2037. In the second place, the require- ment that the decedent’s retained reversionary interest exceed 5 percent of the property’svalue is difficult to satisfy because most retained reversions represent remote interests that reach fruition only if the primary, secondary, and all contingent beneficiaries die first or fail to satisfy the conditions of ownership. Release or lapse of rights The gratuitous relinquishment or lapse, within three years of death, of a retained life estate under 26 U.S.C.A. § 2036, a retained reversio n under § 2037, a retained power under § 2038, or an interest in life insurance under § 2042 will subject the value of the property, subject to the retaine d interest, to inclusion in the gross estate. This result is a remnant of the pre-1981 policy that transfers “in contemplation of death” should be included in the gross estate. Under § 2035(d)(2), the release or relinquishment of a retained interest within three years of death is conclu- sively presumed to be “in contemplation of death.” Thus, if A transfers his home to B in 2000, retaining the right to live there fo r life, but abandons that right at the end of 2006, a gift of the remainder interest in the property takes place in 2000, followed by a gift of the relinquished life estate in 2006. But if A dies before the end of 2006, both the 2000 and 2006 gift tax returns will be ignored for estate tax purposes, and the entire value of the home will be included in A’s gross estate. As with the retained life estate, the relin- quishment or release within three years of death of a power of appointment retained under § 2038 will cause inclusion of the full value of the property at its date-of-death value. For example, if A creates a revocable trust in 1990, then amends it to make it irrevocable at the end of 2002, a gift will result in 2002 when the trust becomes irrevocable. If A dies before the end of GALE ENCYCLOPEDIA OF AMERICAN LAW, 3RD E DITION ESTATE AND GIFT TAXES 245 2005, the entire value of the trust, including any appreciation in value, will be included in A’s estate, and the 2002 gift will be ignored. Finally, the release or lapse of ownership or any incidents of ownership over a life insurance policy will cause the entire value of that policy to be included in the gross estate. Deductions Once the value of the gross estate has been computed, the estate is entitled to take deduc- tions. Expenses associated with administering the estate, such as funeral expenses, executors ’ commissions, and attorneys’ fees, as well as debts the decedent owed at death, are deductible because they necessarily reduce the value of the property that the decedent actually is capable of transferring (26 U.S.C.A. § 2053[a], [b]). The two most important deductions for tax pur- poses are the marital deduction and the charitable deduction. The Marital De duction The marital deduc- tion applies to certain interests in property passing from the first spouse to die to the surviving spouse. It permits an estate to deduct the value of certain property included in the estate from the value of the gross estate, thus eliminating the estate tax with respect to that property. The rationale behind the marital deduction is simple: A husband and a wife should be considered a single unit for purposes of wealth transfer. Accordingly, as a general rule, the marital deduction will be allowed with respect to certain property passing to a surviv- ing spouse, provided that it will be included and taxed in the estate of that spouse on his or her death. To qualify for the marital deduction, property must satisfy three basic requirements. First, the surviving spouse must be a U.S. citizen. Second, the inte rest in the property must pass directly from the first spouse to die to the surviving spouse. Third, the interest generally must not be terminable (26 U.S.C.A. § 2056). The concept of a terminable interest is complex and technical, but for the most part, an interest is terminable for tax purposes if another interest in the same property passes to someone other than the surviving spouse by reason of the decedent’s death, allowing that other person to enjoy the property after the surviving spouse’ s interest terminates. For example, if A leaves to her husband, B, a life estate in her property, with a remainder to their children, her bequest to B does not qualify for the marital deduction. B’s interest terminates automatically on his death, and the children, by reason of the termination, will then enjoy the property. If no one else can enjoy the property following the termination of the surviving spouse’s interest, the property interest is not considered terminable for tax purposes, and a deduction will be allowed. For example, if A leaves to her husband, B, her interest in a patent and dies while the patent has ten years of life left, the patent interest qualifies for the marital deduction, because no one else will enjoy it after it expires. Whether an interest is terminable must be determined at the time of death. Therefore, even if an event following the first spouse’s death makes the termination of the surviving spouse’s interest impossible, the marital deduc- tion will not be allowed if it technically was terminable at the time of death. Congress in 1981 created an important exception to the general rule that a terminable interest does not qualify for the marital deduction. This exception, called the qualified terminable interest property (QTIP) exception, is a sophisticated statutory rule allowin g the estate to deduct the value of a terminable interest that passes to the surviving spouse as long as the transfer meets five requirements: 1. The surviving spouse receives all or a specific portion of the income for life from the interest. 2. The income from the QTIP … is paid at least annually. 3. The surviving spouse has the power to appoint the interest to himself or his estate. 4. The power must be exercisable in all events. 5. No other person has the power to appoint the interest to anyone other than the surviving spouse (26 U.S.C.A. § 2056[b][7 ]). In return for the marital deduction, the estate must agree that the QTIP will be included in the estate of the surviving spouse at death, to the extent that the surviving spouse has not disposed of the property dur ing his or her life (§ 2044). TheCharitableDeductionThe charitable deduction permits an estate to deduct the entire GALE ENCYCLOPEDIA OF AMERICAN LAW, 3RD E DITION 246 ESTATE AND GIFT TAXES value of bequests to any of a numb er of public purposes, including the following: n any corporation or association organized for religious, charitable, sc ientific, literary, or educational purposes n the United States n a state or its political subdivisions, and the District of Columbia n a foreign government, if the bequest is to be used for charitable purposes n selected amateur sports organizations (26 U.S.C.A. § 2055[a]) The charitable deduc tion is intended to provide wealthy individuals a tax incentive to benefit the public interest. Only bequests passing directly from the decedent’s estate to the charitable entity qualify for the deduction. Therefore, if A leaves $100, 000 to her son C, who gives $50,000 to the Red Cross immediately after A’s death, A’s estate cannot receive a charitable deduction for the sum given to the charity (§ 2518[b][4]). Computation of Tax The estate and gift taxes are progressive and unified taxes, meaning that each taxable transfer taking place after 1976 is taken into consider- ation when computing the tax on subse quent transfers. Progressivity in the estate and gift tax system ensures that individuals cannot avoid increased tax rates by making a series of small transfers. If the taxes were not progressive, then $1 million parc eled out into ten annual gifts of $100,000 would be taxed at the marginal rate of 26 percent for each gift, whereas under the PROGRESSIVE TAX system, the gifts are taxed at the marginal rate of 39 percent. Similarly, unifica- tion between the transfer tax systems ensures that individuals cannot avoid paying higher estate tax rates at death simply by giving away most of their property interests during life. Thus, in the case of A above, the marginal tax rate on A’s estate is 49 percent, computed on $2.7 million of total lifetime and death trans fers, rather than 45 percent, computed only on the value of the gross estate. FURTHER READINGS Barlett, Bruce. 2003. “Taxing Debate: The Estate Tax.” National Review (January 23). Economic Growth and Tax Relief Reconciliation Act of 2001, H.R. 1836, May 25, 2001. “The Revocable Living Trust as an Estate Planning Tool.” 1972. Real Property, Probate, and Trust Journal 11. Stephens, Richard B., et al., eds. 2002. Federal Estate and Gift Taxation. 8th ed. Valhalla, N.Y.: Warren Gorham & Lamont. ESTIMATED TAX Federal and state tax laws require a quarterly payment of estimated taxes due from corporations, trusts, estates, non-wage employees, and wage employees with income not subject to withholding. Individuals must remit at least 100 percent of their prior year tax liability or 90 percent of their current year tax liability in order to avoid an underpayment penalty. Corporations must pay at least 90 percent of their current year tax liability in order to avoid an underpayment penalty. Additional taxes due, if any, are paid on taxpayer’s annual tax return. Typically, non-wage earners pay estimated tax since their incomes are not subject to WITHHOLDING TAX to the same extent as the income of a salaried worker. Persons who receive a certain level of additional income, apart from their salaries, must also pay estimated tax. The calculation and payment of estimated tax are preliminary stages to the filing of a final income tax return. Under federal and most state laws, estimated tax is paid in quarterly install- ments. The tax paid is applied to the tax owed when the taxpayer files a final return. Any overpayment of estimated tax will be refunded after the filing of the final return. If no tax is owed, a taxpayer is still required under federal law, and many state laws, to file a final return. When tax is due upon the filing of the final return, the taxpayer must pay the outstanding amount. Depending upon the amount due and the reasons for the miscalculation, a taxpayer might be liable under federal and state law for interest imposed upon the deficiency, as well as being subject to a penalty. ESTOPPEL A legal principle that bars a party from denying or alleging a certain fact owing to that party’s previous conduct, allegation, or denial. The rationale behind estoppel is to prevent injustice owing to inconsistency or fraud. There are two general types of estoppel: equitable and legal. Equitable Estoppel Equitable estoppel, sometimes known as estoppel in pais, protects one party from being harmed by GALE ENCYCLOPEDIA OF AMERICAN LAW, 3RD E DITION ESTOPPEL 247 another party’s voluntary conduct. Voluntary conduct may be an action, silence, acquiescence, or concealment of material facts. One example of equitable estoppel due to a party’sacquiescenceis found in Lambertini v. Lambertini, 655 So. 2d 142 (Fla. 3d Dist. Ct. App. 1995). In the late 1950s, Olga, who was married to another man, and Frank Lambertini met and began living together in Argentina. Olga and Frank hired an attorney in Buenos Aires, who purported to divorce Olga from her first husband and marry her to Frank pursuant to Mexican law. The Lambertinis began what they thought was a married life together, and soon produced two children. In 1968 they moved to the United States and became Florida residents. In 1992 Olga sought a divorce from Frank. She petitioned the Florida court for sole posses- sion of the marital home and temporary alimony, which the court granted. Frank sought a rehear- ing, arguing that the Mexican marriage was not a valid legal marriage and was therefore void. Though Frank won with this argument in the trial court, the appellate court reversed, holding that Frank was equitably estopped from arguing that the Mexican marriage was invalid. According to the appellate court, Frank and Olga had held themselves out as a married couple for more than 30 years, lived together, raised two children, and owned property jointly. Both Frank and Olga apparently believed all along that the Mexican marriage was legal, and it was only when Olga filed for divorce that Frank discovered and chose to rely on its invalidity. The appellate court granted Olga her divorce, the house, and the temporary alimony. Frank’s acquiescence for three decades—holding himself out as being married to Olga—prevented him from denying the marriage’s existence. There are several specific types of equitable estoppel. PROMISSORY ESTOPPEL is a contract law doctrine. It occurs when a party reasonably relies on the promise of another party, and because of the reliance is injured or damaged. For example, suppose a restaurant agrees to pay a bakery to make 50 pies. The bakery has only two employees. It takes them two days to make the pies, and they are unable to bake or sell anything else during that time. Then, the restaurant decides not to buy the pies, leaving the bakery with many more pies than it can sell and a loss of profit from the time spent baking them. A court will likely apply the promissory estoppel doctrine and require the restaurant to fulfill its promise and pay for the pies. An estoppel certificate is a written declaration signed by a party who attests, for the benefit of another party, to the accuracy of certain facts described in the declaration. The estoppel certificate prevents the party who signs it from later challenging the validity of those facts. This type of docume nt is perhaps most common in the context of mortgages, or home loans. If one bank seeks to purchase mortgages owned by another bank, the purchasing bank may request the borrowers, or homeowners, to sign an estoppel certif icate establishing (1) that the mortgage is valid, (2) the amount of principal and interest due as of the date of the certificate, and (3) that no defenses exist that would affect the value of the mortgage. After signing this certificate, the borrower cannot dispute those facts. Estoppel by laches precludes a party from bringing an action when the party knowingly failed to claim or enforce a LEGAL RIGHT at the proper time. This doctrine is closely related to the concept of statutes of limitations, except that statutes of limitations set specific time limits for legal actions, whereas under laches, generally there is no prescribed time that courts consider “proper.” A DEFENDANT seeking the protection of laches must demonstrate that the plaintiff’s inaction, MISREPRESENTATION, or silence prejudiced the defendant or induced the defen- dant to change positions for the worse. The court applied the doctrine of laches in People v. Heirens, 648 N.E.2d 260 (Ill. 1st Dist. Ct. App. 1995). William Heirens pleaded guilty, in 1946, to three murders, for which he received three consecutive life terms in prison. Heirens sought court relief numerous times in the ensuing years. In 1989, 43 years after his conviction, Heirens filed his second postconvic- tion petition seeking, among other things, relief from his prison sentence due to ineffective counsel and the denial of due process at the time of his arrest. The court found that all the witnesses and attorneys involved in Heirens’s case had since died. Laches precluded Heirens from bringing his action because, according to the court, it would be “difficult to imagine a case where the facts are more remote and where the state might be more prejudiced by the passage of time.” GALE ENCYCLOPEDIA OF AMERICAN LAW, 3RD E DITION 248 ESTOPPEL . permits an estate to deduct the entire GALE ENCYCLOPEDIA OF AMERICAN LAW, 3RD E DITION 246 ESTATE AND GIFT TAXES value of bequests to any of a numb er of public purposes, including the following: n any. estate under § 2036. GALE ENCYCLOPEDIA OF AMERICAN LAW, 3RD E DITION 244 ESTATE AND GIFT TAXES Transfers with retained powers Transfers in which the decedent owns, at the time of death, the power. at the end of 2002, a gift will result in 2002 when the trust becomes irrevocable. If A dies before the end of GALE ENCYCLOPEDIA OF AMERICAN LAW, 3RD E DITION ESTATE AND GIFT TAXES 245 2005, the