To download more slides, ebook, solutions and test bank, visit http://downloadslide.blogspot.com CHAPTER 19 FAMILY TAX PLANNING SOLUTIONS TO PROBLEM MATERIALS Question/ Problem Learning Objective LO LO LO LO LO LO LO LO LO 10 LO 11 LO 12 LO 13 LO 14 15 LO LO Topic Relevance of ‘‘fair market value” to various situations Valuation of various assets: stock, realty, and antiques No binding note as gift intended; no taxable gift occurred as satisfaction of obligation of support not a gift Valuation of annuity and life insurance Trust: availability of annual exclusion; marital deduction as to grantor Valuation of divided interests placed in trust Various aspects of the special use valuation method Special use valuation: income tax consequences special use valuation method Assessing goodwill in the valuation of stock in a closely held corporation Various factors that are considered in valuing the stock in closely held corporations Valuation of stock in holding company where major asset has built-in gain: discount for income tax consequences Hedging valuation of family gifts with contributions to charity Reasons for and various aspects of buysell agreements Buy/sell agreements: funding with insurance Income tax basis for property acquired by gift Status: Present Edition Q/P in Prior Edition Unchanged Modified Unchanged Modified New New Modified New Modified Modified 10 Unchanged 11 Unchanged 13 Unchanged 14 New New Instructor: For difficulty, timing, and assessment information about each item, see p 19-5 19-1 © 2012 Cengage Learning All Rights Reserved May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part To download more slides, ebook, solutions and test bank, visit http://downloadslide.blogspot.com 19-2 Question/ Problem 2012 Corporations Volume/Solutions Manual Learning Objective 16 LO 17 LO 18 LO 19 LO 20 LO 21 LO 22 23 LO LO 2, 24 LO 25 LO 4, 26 LO 27 LO 28 LO 29 LO 30 LO 31 LO *32 *33 LO LO *34 LO *35 LO 36 LO 37 LO *38 LO Topic Income tax basis of property acquired from a decedent: step-up and stepdown aspects Income tax basis of property acquired from a decedent: community property situations Effect of special valuation procedures on income tax basis Gift property reacquired by death of donee: § 1014(e) Disputing estate tax value used for income tax basis purposes Planning effective gifts of S corporation stock to minor children Lifetime gifts: estate tax savings Qualifying for special use valuation by making gifts Choice of gift assets: donee liquidity considerations Transfers by gift compared to transfers by death: income tax effect of transferor Transfer by gift versus transfer by death; income tax basis considerations donee Effect of out-of-state realty and insurance policies on probate costs Marital deduction: deferral versus equalization approaches Charitable transfers: preference for lifetime over testamentary Bypass amount: definition of and use in maximizing marital deduction Proper timing of lifetime gifts to qualify under § 6166 Valuation of stock sporadically traded Valuation of life estate and remainder interest Valuation of income interest for a term certain and remainder interest Valuation of a transfer of a remainder interest where a life estate is retained Estate tax consequences of a retained life estate Availability of the special use valuation election of § 2032A Determining the value of goodwill of a closely held corporation Status: Present Edition Q/P in Prior Edition New New Unchanged 17 Unchanged 18 Unchanged 19 Unchanged 20 Modified New 21 New Unchanged 23 Unchanged 24 Unchanged 25 Modified 26 New New Unchanged 29 New New New New New Updated 35 New Instructor: For difficulty, timing, and assessment information about each item, see p 19-5 © 2012 Cengage Learning All Rights Reserved May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part To download more slides, ebook, solutions and test bank, visit http://downloadslide.blogspot.com Family Tax Planning Question/ Problem Learning Objective 39 40 *41 LO LO LO 42 LO 43 LO 44 LO 4, 5, 45 LO *46 LO *47 LO 2, 48 LO 49 LO 50 LO 51 LO 52 LO *53 LO *54 LO Topic Estate freeze Estate freeze Income tax basis of property acquired by gift Income tax basis of property acquired by gift; later sale by donee Gift property resold by donee for varying amounts Choice of property to sell to avoid stepdown in basis at death Gift property reacquired by death of donee; application of the one-year rule under § 1014(e) Gifts of partial interests in property so as to maximize gift splitting and annual exclusion Planning lifetime gifts to meet the requirements of § 2032A Installment notes receivable: tax consequences of transfer by gift or by death Determining the amount of the probate estate Charitable donation: lifetime compared to death transfers; bargain sales Effect of disclaimers on the marital and charitable deductions Bypass amount: effective utilization in spousal situations Qualifications for the § 6166 election (to pay estate taxes in installments when the estate includes an interest in a closely held business) Qualifying under § 6166 by making use of the aggregation rule 19-3 Status: Present Edition Modified Modified New Q/P in Prior Edition 39 40 New New Unchanged 42 Modified 43 Modified 44 Modified 45 Unchanged 46 Unchanged 47 New Unchanged 49 New Modified 52 Modified 53 *The solution to this problem is available on a transparency master Instructor: For difficulty, timing, and assessment information about each item, see p 19-5 © 2012 Cengage Learning All Rights Reserved May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part To download more slides, ebook, solutions and test bank, visit http://downloadslide.blogspot.com 19-4 2012 Corporations Volume/Solutions Manual Research Problem 10 Topic Timing of the sale of appreciated property: pre-death versus post-death Use or nonuse of IRS private annuity valuation tables: installment payout of LOTTO proceeds to estate of winner Valuation of claim against the estate: application of Prop Reg § 20.2053–4(b) Planning disclaimers to avoid estate taxes on death of the surviving spouse Internet activity Internet activity Internet activity Internet activity Internet activity Internet activity Status Present Edition Q/P in Prior Edition New Unchanged Unchanged Unchanged Unchanged Unchanged New Unchanged Modified New © 2012 Cengage Learning All Rights Reserved May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part To download more slides, ebook, solutions and test bank, visit http://downloadslide.blogspot.com Family Tax Planning Difficulty Est’d completion time Easy Medium 10 10 Medium 10 Medium Medium 10 10 Medium 10 Medium 10 Easy Question/ Problem 10 11 Easy Medium Medium 10 10 10 12 Medium 10 13 Easy 10 14 Easy 15 16 17 18 Easy Easy Easy Easy 5 5 19 Easy 20 Medium 15 21 Medium 15 22 Medium 10 23 Easy 24 Easy 25 Medium 10 26 Medium 10 27 Medium 10 19-5 Assessment Information AICPA* AACSB* Core Comp Core Comp FN-Measurement FN-Measurement | FNReporting FN-Measurement | FNReporting FN-Measurement FN-Measurement | FNReporting FN-Measurement | FNReporting FN-Measurement | FNReporting FN-Measurement | FNReporting FN-Measurement FN-Measurement FN-Measurement FN-Measurement | FNReporting FN-Measurement | FNReporting FN-Measurement | FNReporting FN-Measurement FN-Measurement FN-Measurement FN-Measurement | FNReporting FN-Measurement | FNReporting FN-Measurement | FNReporting FN-Measurement | FNReporting FN-Measurement | FNReporting FN-Measurement | FNReporting FN-Measurement | FNReporting FN-Measurement | FNReporting FN-Measurement | FNReporting FN-Reporting Analytic Analytic Analytic | Reflective Thinking Analytic Analytic Analytic Analytic | Reflective Thinking Analytic | Reflective Thinking Analytic Analytic Analytic | Reflective Thinking Analytic | Reflective Thinking Analytic | Reflective Thinking Analytic Analytic Analytic Analytic Analytic Analytic Communication | Analytic Communication | Analytic Analytic Analytic | Reflective Thinking Analytic | Reflective Thinking Analytic | Reflective Thinking Communication | Analytic Analytic *Instructor: See the Introduction to this supplement for a discussion of using AICPA and AACSB core competencies in assessment © 2012 Cengage Learning All Rights Reserved May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part To download more slides, ebook, solutions and test bank, visit http://downloadslide.blogspot.com 19-6 2012 Corporations Volume/Solutions Manual Difficulty Est’d completion time 28 Medium 10 29 30 31 32 33 34 35 36 Easy Easy Medium Easy Medium Medium Medium Medium 5 10 10 10 10 10 37 Medium 10 38 39 Medium Medium 10 10 40 41 42 43 44 Easy Medium Medium Medium Hard 10 10 10 20 45 46 Medium Medium 10 10 47 Medium 10 48 Medium 10 49 Hard 15 50 Medium 15 51 Medium 10 52 Medium 10 53 Medium 10 54 Medium 10 Question/ Problem Assessment Information AICPA* AACSB* Core Comp Core Comp FN-Measurement | FNReporting FN-Reporting FN-Reporting FN-Reporting FN-Measurement FN-Measurement FN-Measurement FN-Measurement FN-Measurement | FNReporting FN-Measurement | FNReporting FN-Measurement FN-Measurement | FNReporting FN-Measurement FN-Measurement FN-Measurement FN-Measurement FN-Measurement | FNReporting FN-Measurement FN-Measurement | FNReporting FN-Measurement | FNReporting FN-Measurement | FNReporting FN-Measurement | FNReporting FN-Measurement | FNReporting FN-Measurement | FNReporting FN-Measurement | FNReporting FN-Measurement | FNReporting FN-Measurement | FNReporting Analytic Analytic Analytic Analytic Analytic Analytic Analytic Analytic Analytic Analytic Analytic Analytic Analytic Analytic Analytic Analytic Communication | Analytic | Reflective Thinking Analytic Analytic Analytic Analytic Analytic Analytic Analytic | Reflective Thinking Analytic Analytic Analytic *Instructor: See the Introduction to this supplement for a discussion of using AICPA and AACSB core competencies in assessment © 2012 Cengage Learning All Rights Reserved May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part To download more slides, ebook, solutions and test bank, visit http://downloadslide.blogspot.com Family Tax Planning 19-7 CHECK FIGURES 32 33 $437 Remainder $2,104,080; life estate $3,895,920 34 Remainder $708,592; term certain $291,408 35 $2,940,750 36 $5.7 million 37 $3 million (Perry); $1,980,000 (Hopkins); $3,980,000 (Morris); $4.2 million (Allen) 38 $5,904,000 39 Gift $4.9 million 40 $1.0 million 41 $461,000 42 $859,800 gain 43.a $50,000 gain 43.b No gain or loss 43.c $20,000 loss 44.a Sell Gull stock 45.a $175,000 45.b $175,000 45.c 46 47.a 47.b 47.c 48.a 49 51.a 51.b 51.c 51.d 52.a 52.b 52.c 53.a 53.b 54 $465,000 Using the election to split the gifts, give $572,000 in each year Yes $2.3 million § 2032A election not available Gain $925,000 Probate estate is $500,000; gross estate is $2.1 million Increases bypass amount to $3.5 million Disclaimer prevents estate tax on $1 million Disclaimer reduces marital deduction but increases bypass amount Should not disclaim collection No DSUEA allowed before 2011 $10 million $9 million Yes Yes § 6166 not available Yes © 2012 Cengage Learning All Rights Reserved May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part To download more slides, ebook, solutions and test bank, visit http://downloadslide.blogspot.com 19-8 2012 Corporations Volume/Solutions Manual DISCUSSION QUESTIONS a Section 2031(b) treats the problem of stocks and securities for which there is no available sales price information (i.e., the usual case with closely-held corporations) In such situations, ‘‘the value thereof shall be determined by taking into consideration, in addition to all other factors, the value of stock or securities of corporations engaged in the same or similar line of business which are listed on an exchange.” b Reg § 20.2031-1(b) is more specific in defining fair market value as ‘‘the price at which property would change hands between a willing buyer and a willing seller, neither being under any compulsion to buy or to sell and both having reasonable knowledge of relevant facts.” c At least for tax purposes, the value of property should not be affected by what is described as ‘‘sentimental value.” Suppose, for example, Mary’s will passes her bedroom furniture to her son, Seth Because Dot, Mary’s daughter, is anxious to obtain these items as a remembrance of her mother, she pays Seth three times the price they would bring on the general market Under these circumstances, it is inappropriate to include the bedroom furniture in Mary’s gross estate at the price that Dot paid Seth, since the additional amount is attributable to the value that one person places on sentiment d If tangible personalty is sold as a result of an advertisement in the classified section of a newspaper and the property is of a type often sold in this manner, the price for which it is sold is presumed to be the retail sales price of the item at the time of such sale e A special rule applies if no sales occur on the valuation date but occur within a reasonable period before and after such date In such cases, use the weighted average of the means between the highest and lowest sales prices on the nearest dates before and after the valuation date The average is weighted inversely by the respective number of trading days between the selling and valuation dates pp 19-2, 19-3, and Examples and 2 a Although the condominiums may be comparable in size and physical appearance, recent sales prices are not a valid measure of value when location is considered The condominiums located in Kansas City cannot be compared with those in midtown Manhattan b What is described is a forced sale, which is not representative of the true value of the collection Furthermore, the retail (not wholesale) price of assets should be used pp 19-2 and 19-3 First, did Marvin make a gift when he paid for his daughter’s college education? Fulfilling one’s obligation of support is not regarded as a gift What constitutes the obligation of support is a matter determined by looking to applicable state law It is doubtful, however, that providing a daughter with a college education (even at a more costly private school) goes beyond the parameters of support Second, should the notes be included in Marvin’s gross estate? Even if they were enforceable, it is probable that Marvin never intended to collect The long period of time that has elapsed (i.e., 10 years) seems to prove a lifetime forgiveness of debt on Marvin’s part Because forgiven notes have no value, nothing is includible in Marvin’s gross estate © 2012 Cengage Learning All Rights Reserved May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part To download more slides, ebook, solutions and test bank, visit http://downloadslide.blogspot.com Family Tax Planning 19-9 pp 18-10 and 19-4 a The valuation of an annuity issued by a party not regularly engaged in the sale of annuities requires the use of special tables issued by the IRS p 19-5 b The value of a commercial policy (i.e., one issued by a company regularly engaged in selling annuities) is the cost of a comparable contract Example c The value of a single premium life insurance policy is the cost of a comparable policy Example d The value may be approximated by adding to the interpolated terminal reserve the proportionate part of the gross premium last paid before the valuation date that covers the period extending beyond that date p 19-5 a The use of the IRS tables will be necessary The valuation tables provide only for the remainder factor, and which table is appropriate depends on the mid-term interest rate in effect for the month of the transfer To obtain the factor for the income component, subtract the remainder factor from one b Freda’s life estate qualifies for the annual exclusion if the trust income has to be distributed currently (i.e., cannot be accumulated by the trustee) If the distribution is not required, the future interest limitation (see Chapter 18) precludes the annual exclusion c Unless a QTIP election is made, Freda’s life estate is a terminable interest and no marital deduction is available pp 19-5 and 19-6 a In computing the value of an income interest for a term of years, the IRS provides a special set of valuation tables The valuation factor given for the income term, however, is based on the remainder interest Thus, the income factor is the remainder factor subtracted from one b If the income has to be distributed (i.e., cannot be accumulated), an annual exclusion is available c An income interest for a specified term of years is useful to provide cash for targeted needs or a longer duration (e.g., illness, education) pp 9-5 and 9-6 a The purpose of the provision is to provide some measure of relief from the estate tax for the maintenance of the family farm upon the death of the owner Stated otherwise, by allowing special use valuation, there is less danger that the heirs will have to sell the property to pay the estate taxes generated by using best, highest, or most suitable use valuation p 19-6 b Most suitable, best, and highest use are the same and represent the general rule for valuing property Current and special use are what is allowed (up to a certain dollar limitation) under a § 2032A election p 19-6 c The executor of the estate makes the § 2032A election p 19-6 © 2012 Cengage Learning All Rights Reserved May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part To download more slides, ebook, solutions and test bank, visit http://downloadslide.blogspot.com 19-10 2012 Corporations Volume/Solutions Manual d The original amount of $750,000 has, through indexation for inflation, reached $1,020,000 for 2011 and was $1 million for 2009 and 2010 p 19-6 and Example e Qualified use property (realty or personalty) must comprise at least 50% of the adjusted value of the decedent’s gross estate A separate 25% rule requires that the qualified use property be realty For purposes of applying these percentages, use the most suitable use value p 19-7 f Material participation in the operation of the farm is necessary by the decedent (or a family member) for a five-year period prior to death as one of the conditions for qualifying for an election under § 2032A p 19-7 Mike’s fears are well founded The income tax basis of the property subject to the election will be current use value and not best or most suitable use value Thus, Mike loses the potential income tax savings that results from the step-up in basis that occurs when appreciated property is passed by death pp 19-7 and 19-16 a This would overstate the profit amount that should be considered Extraneous profits and losses should be eliminated as they have no relevance to the operating results of the business b The answer depends on the interest the shareholders charged the corporation If none or the interest charged was lower than the market rate, then profits are overstated If the interest charged exceeded the market rate, then profits are understated c Assuming a lower rate of return would tend to make the business more profitable than it should be d As a consequence, the owner’s death could have an effect on the profitability of the business pp 19-8, 19-9, and Example 11 10 a A minority interest in a closely held corporation lowers the value of the stock This would be the case particularly if the corporation has a poor dividend-paying record b Because of the control factor, a majority interest should carry a premium for valuation purposes In certain cases, however, the amount of the premium could be offset by the application of the blockage rule c The ‘‘blockage rule” lowers the value of stock It is based on the premise that selling a large block of stock at one time would depress the price d Stock in a closely held corporation rarely has a ready market For this reason, a discount for lack of marketability may be appropriate The discount accounts for costs that would be incurred (e.g., underwriting expenses) in creating a market for the stock p 19-11 11 The ExxonMobil stock has substantially appreciated in value since its original acquisition by Falcon Corporation If the estate is to obtain the stock, however, the ExxonMobil shares must be distributed by Falcon The distribution will cause a recognition of gain by Falcon, with attendant income tax consequences Thus, the Falcon stock should be valued with a discount for the built-in income tax cost p 19-9 and Footnote 21 © 2012 Cengage Learning All Rights Reserved May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part To download more slides, ebook, solutions and test bank, visit http://downloadslide.blogspot.com Family Tax Planning 19-11 12 By making both charitable and noncharitable gifts of the same stock, the donor has hedged on the valuation issue If, for example, the IRS raises the valuation of the stock to assess additional gift taxes, the donor can file amended income tax returns to increase his or her charitable contribution deduction Example 12 13 a To keep the business within the family group, some type of buy and sell agreement should be entered into among the current owners Such an agreement can either be an entity type (i.e., the business buys the withdrawing owner’s interest) or a cross-purchase type (i.e., the surviving owners buy the interest) b The entity type of buy and sell agreement often involves redeeming the withdrawing shareholder’s stock To have a stock redemption, however, the business must be a corporation Figure 19.1 14 a Each owner (i.e., shareholder or partner) takes out a policy on the life of the other owners In the case of a cross-purchase arrangement, a number of policies may be involved to achieve full coverage (e.g., six in the case of three owners, twelve in the case of four owners) b In the entity type of buy and sell agreement, the entity (i.e., corporations or partnership) insures the life of each owner (i.e., shareholder or partner) p 19-10 15 a Donor’s adjusted basis plus any gift tax attributable to the appreciation on the property but not to exceed the fair market value of the property on the date of the gift b The lower of donor’s adjusted basis or the fair market value of the property on the date of the gift p 19-14 16 Tracy’s income tax basis in the assets received usually is their fair market value on the date of Hannah’s death If the asset is worth more than Hannah’s basis, Tracy receives a “step-up” in basis If the asset is worth less than Hannah’s basis, Tracy receives a “step-down” in basis Example 19 17 The survivor’s share of the community property takes on the same basis as the deceased spouse’s share of the community Even though this property does not pass through the deceased spouse’s estate, it receives the same step-up (or step-down) in basis as the deceased spouse’s share p 19-15 18 a The value used for estate tax purposes becomes the income tax basis of the property to the heirs Consequently, a lower value secured by electing § 2032 (or § 2032A) saves on estate taxes but generates more income (or less loss) when the property is ultimately disposed of in a taxable transaction p 19-16 b The value chosen for the deceased spouse carries over to the surviving spouse’s share of the community property Thus, a double income tax penalty results Example 23 a By channeling the art collection through Della, the parties (i.e., Brent and Melody) are trying to receive a step-up in income tax basis If Della dies within the one-year period after the gift, § 1014(e) denies a change in basis under § 1014(a) Instead, Đ 1015 19 â 2012 Cengage Learning All Rights Reserved May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part To download more slides, ebook, solutions and test bank, visit http://downloadslide.blogspot.com 19-12 2012 Corporations Volume/Solutions Manual applies to give Melody a basis determined under the gift rules If, however, Della outlives the one-year rule, the step-up in basis results b The transfer to Della could generate a gift tax More significant, the inclusion of the property in Della’s probate estate can generate additional administration expenses pp 19-16 and 19-17 20 Hoffman, Raabe, Smith, and Maloney, CPAs 5191 Natorp Boulevard Mason, OH 45040 December 16, 2011 Jonathan Rand 326 Wisteria Avenue Charlotte, NC 28223 Dear Mr Rand: With regard to our discussion of a few days ago, I have researched the matter and have arrived at the conclusions stated below The income tax basis of inherited property is its fair market value on the date of death Normally, whatever value is used for death tax purposes is presumed to establish the income tax basis It is possible to overturn the presumption of value used for death tax purposes, but to so you will need to satisfy certain conditions • Present evidence of what the true date of death value was • Show that the value used was not the result of negotiated compromise between the executor of the estate and the taxing authority • Show that you did not participate in arriving at the value used Needless to say, it will be difficult, but not impossible, to deviate from the value used for death tax purposes If I can be of further assistance to you in this matter, please feel free to contact me Sincerely, Rita Smith, CPA Concept Summary 19.2 21 a Hoffman, Raabe, Smith, and Maloney, CPAs 5191 Natorp Boulevard Mason, OH 45040 December 15, 2011 © 2012 Cengage Learning All Rights Reserved May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part To download more slides, ebook, solutions and test bank, visit http://downloadslide.blogspot.com Family Tax Planning 19-13 Cynthia and Norton Enright 1486 Garden Park Elizabeth, NJ 07207 Dear Mr and Mrs Enright: In connection with our recent conversation regarding transfers by gift of stock in Ibis Company, some suggestions follow To carry out the shifting of income, the gift of stock in Ibis Company to your children must be carefully handled First, you should hold off on any gift to Jordan until he reaches age 24 Otherwise, any income from his stock will be considered unearned income and may be taxed in your tax bracket, rather than in his lower bracket Second, make sure the gifts are complete If you continue to exercise control over the stock given, the IRS may find that the transfers should not be recognized The result of such a finding will nullify the shifting of income If I can be of further assistance to you in this matter, please feel free to contact me Sincerely, John Jones, CPA Partner b December 15, 2011 TAX FILE MEMORANDUM FROM: John Jones SUBJECT: Shifting of income by the Enrights through the gift of stock of Ibis Company (an S corporation) Cynthia and Norton inquired concerning the possibility of shifting some of the income from Ibis to their children Since Ibis Company is an S corporation, the shifting could be accomplished by gifts of some of the stock In the case of Jordan (age 23), however, the kiddie tax might apply Consequently, any gifts to him should be delayed until he reaches age 24 Their daughter Addison (age 20) is not subject to the kiddie tax due to her age (she does not plan to go to college), while Tracy (age 21) is married and files a joint return Kirby meets the age cut-off of 24 I told the Enrights that any gifts to their children should be made as complete as possible They should everything possible to recognize and treat the children as real shareholders See, for example, Michael F Beirne [52 T.C 210 (1969) and 61 T.C 628 (1973)], where the gift was disregarded because the donor failed to release control p 19-23 and Example 33 © 2012 Cengage Learning All Rights Reserved May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part To download more slides, ebook, solutions and test bank, visit http://downloadslide.blogspot.com 19-14 22 2012 Corporations Volume/Solutions Manual a The amount of the annual exclusion escapes both gift and estate taxation Thus, if parents gave each of their four children $26,000 over a 10-year period, the sum of $1,040,000 ($26,000 × × 10) escapes any transfer tax b Any post-gift appreciation on the property is not subject to the estate tax upon the donor’s death (Life insurance proceeds are excepted if the 3-year rule of § 2035 comes into play.) c Contributions to § 529 plans are afforded very favorable tax treatment under the tax system One such advantage is exclusion from the gross estate of the grantor pp 19-20 to 19-22 23 a To satisfy § 2032A, make gifts of nonqualifying assets (e.g., stocks and bonds, insurance policies) b If the gifts run afoul of the three-year rule of § 2035, they will be brought back into the gross estate of the donor-decedent for testing purposes Thus, they will be treated as not having been made Examples 28 to 30 24 “Dry” assets not generate any income and this may place a burden on the donee if costs must be incurred to maintain such assets Examples of dry assets include life insurance policies that still require premium payments, and vacation homes that require upkeep and property taxes p 19-21 25 a The gift of an installment note is a taxable disposition The gift is treated as if the transferor sold the note for its fair market value on the date of the gift If the note is passed by death, the deferred gain is taxed to whomever collects on the notes (the estate or heirs) If the notes are forgiven or cancelled by the decedent’s will, the income is taxed to the estate b Upon a gift of U.S savings bonds, the donor must recognize any deferred interest income If passed by death, any deferred interest is taxed to whomever redeems the bonds (the estate or heirs) c When depreciable property is gifted, any recapture potential under § 1245 or § 1250 carries over to the donee If passed by death, however, the recapture potential disappears p 19-24 and Example 34 26 a Hoffman, Raabe, Smith, and Maloney, CPAs 5191 Natorp Boulevard Mason, OH 45040 December 15, 2011 Charles Horn 648 Scenic Drive Chattanooga, TN 37403 Dear Mr Horn: © 2012 Cengage Learning All Rights Reserved May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part To download more slides, ebook, solutions and test bank, visit http://downloadslide.blogspot.com Family Tax Planning 19-15 You have asked my advice as to whether you should give the stock in Crimson Corporation to Sharon or pass it to her under your will Making the transfer by gift is the preferred alternative for two reasons • Because of the annual exclusion, at least $13,000 of what you give does not count as a transfer The estate tax rules not include any annual exclusion • Your daughter’s income tax basis in the stock becomes $800,000 for gain purposes and $650,000 for loss purposes If, on the other hand, Sharon receives the stock under your will, her basis for both gain and loss is $650,000 Consequently, should Sharon ever sell the stock for more than $650,000, she is better off under the gift scenario • The transfer during your lifetime will result in a Federal gift tax If you live for three years or more after the gift, the amount of such tax will not be subject to the estate tax It is unfortunate that a sale of the stock would provide you with a tax loss you cannot use, as this would be the way to proceed If I can be of further assistance to you in this matter, please not hesitate to call Sincerely, Paula S Henry, CPA Partner b December 15, 2011 TAX FILE MEMORANDUM FROM: Paula Henry SUBJECT: Advice to Charles Horn regarding whether property should be transferred by gift or by death Attached is a letter sent to Mr Horn advising him that a gift of the Crimson Corporation stock to his daughter Sharon is preferable to passing it to her by death Mr Horn has a large capital loss carryover, no prospects of any capital gains, and is in poor health Otherwise, he should sell the stock, give the proceeds to Sharon, and claim the loss for tax purposes p 19-24 and Example 35 27 a The beneficiary of the insurance policies should be changed from Esther to Pamela Otherwise the proceeds will be paid to Frank’s estate, as the beneficiary designation has lapsed The title to the condo in New Mexico (when and if purchased) should be in joint tenancy with Pamela The retirement plans should designate Pamela as the beneficiary—otherwise any benefits would be paid to Frank’s estate A new will needs to be drawn up that conforms to New Mexico law and lists Pamela as sole heir Title to the Idaho property should be changed to Pamela’s name © 2012 Cengage Learning All Rights Reserved May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part To download more slides, ebook, solutions and test bank, visit http://downloadslide.blogspot.com 19-16 2012 Corporations Volume/Solutions Manual b Transfer a remainder interest in the New York property to Pamela with Frank retaining a life estate p 19-25 and Examples 36 and 37 28 a The deferral approach is preferable since it shifts assets to the lower bracket spouse b Use the deferral approach since the wife appears to be in top physical condition (this reflects potential longevity) c Use the equalization approach as the wife appears to be in poor health d Use the equalization approach since the probabilities are that the survivor will not outlive the deceased spouse for an extended period e Use the equalization approach to avoid future value (i.e., significant appreciation anticipated) being taxed at a later date pp 19-26 and 19-27 29 By making a lifetime transfer to charity, two tax benefits are achieved First, the transfer may qualify for an income tax deduction Second, since the property no longer is owned at death, it is not subject to estate tax On the other hand, such a transfer by death triggers no tax libility—the property is included in the gross estate and then backed out by means of the charitable deduction p 19-27 30 The bypass amount is the amount that can pass from the decedent free of any estate tax a To maximize the bypass amount, the surviving spouse can disclaim some of the property that passes to him or her from the deceased spouse b Nonspousal heirs that receive more than the bypass amount can disclaim the excess in favor of the surviving spouse The disclaimer would save estate taxes since the marital deduction passes free of tax pp 19-29 and 19-30 31 Janet is under a false impression as to how the tax law works Although gifts within three years of death normally are not brought back into the gross estate, such is not the case with life insurance p 18-19 and Example 35 in Chapter 18 Furthermore, § 2035(c)(2) provides a special rule when dealing with § 6166(a)(1) In testing for the 35% requirement, all gifts made within three years of death must be taken into account p 19-33 and Footnote 55 PROBLEMS 32 $437, determined as follows (5 × $400) + (8 × $460) $2,000 + $3,680 = = $437 13 days 13 Example © 2012 Cengage Learning All Rights Reserved May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part To download more slides, ebook, solutions and test bank, visit http://downloadslide.blogspot.com Family Tax Planning 33 19-17 As derived from Valuation Table S, page A-9 of the text, the value of Terry’s remainder interest is computed as follows .35068 (factor for a remainder interest with an intervening life estate based on age 52) × $6,000,000 (amount placed in trust) = $2,104,080 The value of a life estate is $3,895,920 [$6,000,000 (total gift) – $2,104,080 (value of the remainder interest)] This amount can be confirmed as follows 1.00000 – 35068 (remainder factor) = 64932 (life estate factor) × $6,000,000 (amount in trust) = $3,895,920 Example 34 As derived from Valuation Table B, page A-12 of the text, the value of Dawn’s remainder interest is determined as follows .708592 (factor for a remainder interest with an intervening income interest for an 8year term certain) × $1,000,000 (amount placed in trust) = $708,592 The value of a term certain is $291,408 [$1,000,000 (taxable gift) – $708,592 (value of remainder interest)] Example 35 a As derived from Valuation Table S, p A-9 in the text, the value of the remainder interest transferred by Dale is computed as follows .58815 (factor for a remainder interest for a person age 72) × $5,000,000 (amount placed in trust) = $2,940,750 The taxable gift also is $2,940,750 A remainder interest is a future interest and, therefore, no annual exclusion is allowed b The amount of the gift does not change However, no gift tax consequences result due to the availability of the marital deduction (a remainder interest is not a terminable interest) Example 36 a Dale’s gross estate includes $5.7 million Section 2036 causes the inclusion, as Dale retained a life estate in the trust he created b No, the answer to part a does not change since the same amount is included in the gross estate However, the effect of the inclusion is offset by the availability of the marital deduction Example 37 in Chapter 18 37 Presuming the § 2032A election is appropriate, the values allowed are set forth as: • Perry — $3,000,000 (election not appropriate) • Hopkins — $1,980,000 © 2012 Cengage Learning All Rights Reserved May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part To download more slides, ebook, solutions and test bank, visit http://downloadslide.blogspot.com 19-18 2012 Corporations Volume/Solutions Manual • Morris — $3,980,000 • Allen — $4,200,000 p 19-6 and Examples and 38 a The IRS would compute the value of Taupe Corporation as follows Average net profit for the past years 8% of $3.9 million book value Excess earnings over 8% $1,500,000 (312,000) $1,188,000 Value of goodwill (5 × $1,188,000) Book value Total value of Taupe stock $5,940,000 3,900,000 $9,840,000 The IRS will argue that the stock should be included in Inez’s gross estate at $5,904,000 (60% × $9,840,000) b Is the average net profit realistic? Perhaps it includes some extraneous gains unrelated to the business Or it might include some expenses that are understated (e.g., employees who are family owners are being underpaid) Has the IRS selected a proper rate of return for the business? If the rate should be higher, the amount of goodwill decreases accordingly because the business is less profitable Was Inez a key person in the success of the business? If so, her death can mean an impairment of any existing goodwill pp 19-8, 19-9, and Example 11 39 Kyle has made a gift of $4.9 million as the preferred stock is treated as having a zero value Example 15 40 Kyle’s gross estate must include $1.0 million for the preferred Example 16 41 Ray’s basis for gain is computed below Olivia’s basis Gift tax attributable to appreciation— $600,000 (appreciation) $987,000 (taxable gift) = 61% (rounded) × $100,000 (gift tax) Basis for gain $400,000 61,600 $461,000 As the fair market value of the real estate exceeds its basis for gain, the basis for loss is also $461,000 Examples 17 and 18 © 2012 Cengage Learning All Rights Reserved May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part To download more slides, ebook, solutions and test bank, visit http://downloadslide.blogspot.com Family Tax Planning 42 19-19 Mandy’s basis for gain is computed below Jacob’s basis Gift tax attributable to appreciation— $800,000 (appreciation) = 67% (rounded) × $60,000 (gift tax) $1,187,000 (taxable gift) Basis for gain $400,000 40,200 $440,200 Mandy’s recognized gain is $859,800 [$1,300,000 (selling price) – $440,200 (basis)] Example 17 43 As the fair market value of the stock is less than its basis, none of the $40,000 gift tax Clinton paid can be considered a $50,000 gain [$650,000 (selling price) – $600,000 (basis for gain)] b No gain or loss c $20,000 loss [$500,000 (basis for loss) – $480,000 (selling price)] Examples 17 and 18 44 a Hoffman, Raabe, Smith, and Maloney, CPAs 5191 Natorp Boulevard Mason, OH 45040 December 15, 2011 Ted and Marge Dean 290 Cedar Road Carson, CA 90747 Dear Mr and Mrs Dean: Regarding the matter recently discussed about the disposition of various assets, I suggest the following • Keep the stock in Wren Corporation because its income tax basis will increase to $500,000 (based on current values) upon the death of either of you This will mean that the survivor will have $300,000 less income to recognize when the stock is sold • Ted should make a gift of the land to Marge No gift tax results from the gift, and Marge will have a basis for gain of $650,000 Her basis for loss is $500,000—the lesser of $500,000 or $650,000 If Marge inherited the land, her basis for both gain and loss is $500,000 • The stock in Gull Corporation should be sold The resulting $100,000 capital loss can be applied against capital gains and the excess deducted against regular © 2012 Cengage Learning All Rights Reserved May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part To download more slides, ebook, solutions and test bank, visit http://downloadslide.blogspot.com 19-20 2012 Corporations Volume/Solutions Manual income up to $3,000 per year One-half of any unused loss remaining should one of you predecease the other can be used by the survivor Consequently, the transactions summarized above improve your present and future income tax positions while providing the $500,000 in cash you need to meet expenses If I can be of further assistance to you in this matter, please contact me Sincerely, Laura Sims, CPA Manager b December 15, 2011 TAX FILE MEMORANDUM FROM: Laura Sims SUBJECT: Advice to the Deans on the tax consequences of asset retention and disposition Attached is a letter sent to the Deans on the advisability of their transferring by gift, selling, and retaining various assets My recommendations were influenced by Ted’s poor health and older age (when compared to Marge’s good health and younger age) and by the preservation of income tax basis • By keeping the Wren stock, Marge receives a step-up in basis (which includes her community share) upon Ted’s prior death • By giving the land (which is Ted’s separate property) to Marge, a step-down in basis for gain is avoided on Ted’s prior death A step-down as to loss basis is not avoided, but this also will happen under § 1014 if the land is passed to Marge at Ted’s death • By selling the Gull stock, Marge avoids a step-down in basis upon Ted’s death and her share of the unused capital loss will survive Examples 22 and 35 45 a Because § 1014(e) applies, Reba’s basis will be her original basis plus any capital improvements made by the donee (Julius) Thus, Reba’s basis is $150,000 (original basis) + $25,000 (capital improvements) = $175,000 b $175,000 Section 1014(e) also applies when the property returns to a spouse of the donor c $465,000 The general rule of § 1014 now applies pp 19-15 to 19-17 and Examples 19 and 24 © 2012 Cengage Learning All Rights Reserved May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part To download more slides, ebook, solutions and test bank, visit http://downloadslide.blogspot.com Family Tax Planning 46 19-21 By making the election to split the gifts and using the available annual exclusions, Nolan and Sarah can transfer the following value in December 2010 (number of donors) × 22 (number of donees) × $13,000 (annual exclusion) = $572,000 Thus, an undivided interest in one-half of the land can be given with no taxable gift resulting In January 2011, the procedure can be repeated [It is assumed that the annual exclusion remains at $13,000 for both years.] Since the two transfers would be very close in point of time, it seems unlikely that the land should have to be appraised more than once Example 26 47 48 a Yes In testing for the 50% requirement, employ most suitable use rather than current use Thus, the farm, valued at $3.3 million, is at least 50% of $6.5 million p 19-7 b The farm must be valued at $2.3 million, because current use statutorily cannot be reduced by more than its value Example c The answers would change because the § 2032A election is no longer available Under § 2035(d), gifts made within three years of death are considered in satisfying the 50% test Consequently, $3.3 million is not equal to (or more than) $3.5 million [50% × ($6.5 million + $.5 million)] Example 30 a Henry recognizes gain of $225,000 [$300,000 (down payment) – $75,000 (basis by relative FMV)] in the year of sale In the year of the gift, he recognizes further gain of $925,000 [$1,300,000 (value of notes) – $375,000 (remaining basis)] b The notes represent income in respect of a decedent and not receive a step-up in basis at death If, for example, the executor sold the notes for $950,000, the estate recognizes income of $875,000 (see answer to part a.) Example 34 49 The table appearing below reflects the proper disposition of Monica’s assets Inclusion in Probate Estate Gross Estate Personal residence (50% × $800,000) Savings account ($40,000)* CD (100% × $100,000) Unimproved realty (50% × $400,000) Insurance (Lavender Company) Insurance (Crimson Company) Trust Total $ –0– –0– –0– 200,000 300,000 –0– –0– $500,000 $ 400,000 –0– 100,000 200,000 300,000 400,000 700,000 $2,100,000 *None of the savings account is included as the funds were provided by Rex pp 18-10, 18-21 to 18-23, 18-25, 18-26, and 19-25 © 2012 Cengage Learning All Rights Reserved May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part To download more slides, ebook, solutions and test bank, visit http://downloadslide.blogspot.com 19-22 50 2012 Corporations Volume/Solutions Manual The immediate donation provides Logan with an income tax deduction of $80,000 Upon later death, the gross estate would include only $20,000 (20% × $100,000) as to the land A bargain sale of the land also yields an income tax deduction of $80,000 [$100,000 (FMV) – $20,000 (consideration received)] but results in an income tax gain of $16,000 [$20,000 (sale price) – $4,000 (allocated basis)] The provision in the will provides no income tax deduction The full value of the land, or $100,000, is included in the gross estate and $80,000 is deducted under § 2055 as an estate tax deduction Of the three options, the first is clearly preferable It carries the same net estate tax result as the others and also provides an income tax deduction without gain recognition (the second option) It is possible, however, that Logan might run afoul of the 30% of AGI limitation on the deduction of appreciated capital gain property If so, any unused deduction can be carried forward for up to years As an alternative, an election can be made [see § 170(b)(1)(C)] to apply a 50%-of-AGI limitation and forgo any carryovers pp 19-27 and 19-28 51 a By disclaiming her interest, Nora is able to pass the property to Nick free of any gift tax Example 19 in Chapter 18 b Raymond’s disclaimer prevents $1 million from being subject to the estate tax As the $1 million now passes to George, it qualifies for the marital deduction c Brenda’s disclaimer of $500,000 passes free of any transfer tax Although it reduces the marital deduction allowed Isaac’s estate, it is sheltered by the exemption equivalent of $5 million d In no event should Leroy disclaim the collection Any such disclaimer does not affect Tricia’s estate tax position as it would merely substitute a charitable deduction for a marital deduction Leroy should accept the collection and subsequently transfer it to charity In this manner, Leroy generates an income tax deduction for himself Examples 41, 45, and 46 52 a $5 million None of her husband’s exclusion is available because he died in 2009 (before the DSUEA rules existed) b $10 million [$5 million (Ava’s basic exclusion amount) + $5 million (DSUEA)] c $9 million [$5 million (Ava’s basic exclusion amount) + $4 million (last husband’s DSUEA)] Examples 42 to 44 53 a Yes To qualify under § 6166, an interest in a closely held business must be involved In the case of a partnership, the statute requires ownership of at least a 20% capital interest or an entity with 45 or fewer partners In satisfying either of these tests, attribution from family members is allowed Consequently, Clint’s estate is deemed to own a 25% capital interest, since Phoebe’s 10% can be counted © 2012 Cengage Learning All Rights Reserved May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part To download more slides, ebook, solutions and test bank, visit http://downloadslide.blogspot.com Family Tax Planning 19-23 Section 6166 can be elected only if the interest in the closely held business exceeds 35% of the adjusted gross estate This requirement is met, as $2,600,000 is more than $2,170,000 (35% × $6,200,000) b Yes Under § 2035(d)(4), gifts within three years of death are included in the adjusted gross estate for testing purposes Thus, the adjusted gross estate becomes $7,700,000 ($6,200,000 + $1,500,000) and $2,600,000 is not more than $2,695,000 (35% × $7,700,000) pp 19-32, 19-33, and Footnote 55 54 Yes The JZ Partnership and the Silver Corporation qualify as interests in a closely held business, since the 20% ownership test is met When $700,000 and $500,000 are added to the $950,000 (sole proprietorship), the $2,150,000 total is more than $2.1 million or 35% of $6 million (adjusted gross estate) Thus, an election under § 6166 is available to June’s estate Examples 48 and 49 The answers to the Research Problems are incorporated into the Instructor’s Guide with Lecture Notes to accompany the 2012 Annual Edition of SOUTH-WESTERN FEDERAL TAXATION: CORPORATIONS, PARTNERSHIPS, ESTATES & TRUSTS © 2012 Cengage Learning All Rights Reserved May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part To download more slides, ebook, solutions and test bank, visit http://downloadslide.blogspot.com 19-24 2012 Corporations Volume/Solutions Manual NOTES © 2012 Cengage Learning All Rights Reserved May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part ... ebook, solutions and test bank, visit http://downloadslide.blogspot.com 19- 18 2012 Corporations Volume/Solutions Manual • Morris — $3,980,000 • Allen — $4,200,000 p 19- 6 and Examples and 38 a... ebook, solutions and test bank, visit http://downloadslide.blogspot.com 19- 14 22 2012 Corporations Volume/Solutions Manual a The amount of the annual exclusion escapes both gift and estate taxation. .. expenses pp 19- 16 and 19- 17 20 Hoffman, Raabe, Smith, and Maloney, CPAs 5191 Natorp Boulevard Mason, OH 45040 December 16, 2011 Jonathan Rand 326 Wisteria Avenue Charlotte, NC 28223 Dear Mr Rand: With