mcgraw-hill's taxation of business entities, 2016 edition

8/20/2019 McGraw-Hill's Taxation of Business Entities, 2016 Edition

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Taxation of Individuals, by Spilker

estate. 2ence, unless 0red has made significant taxable gifts during his life, he is unlikel to have an

estate that is sufficientl large to be sub'ected to the federal estate tax.

. [LO 1] $efine fair market %alue for transfer tax purposes.

$ccording to the regulations, fair market value is the price at which such propert would change hand

between a willing buer and a willing seller, neither being under an compulsion to bu or to sell, and

both have reasonable knowledge of the relevant facts.

. [LO 2] $escribe the re3uirements for a complete gift* and contrast a gift of a present interest !ith a g

a future interest.

$ gift is onl complete with deliver !of control of the gift" and acceptance b the donee. $ present

interest is one that the donee can en'o immediatel such as an unrestricted use of propert or income

contrast, a future interest is one that cannot be en'oed immediatel 3 the en'oment is postponed unti

sometime in the future.

4. [LO 2] $escribe a property transfer or payment that is not* by definition* a transfer for inade3uate

consideration.

$ gift is defined as a transfer for inade#uate consideration. The gift tax is not imposed on paments

associated with sales of goods or services because these transfers occur in a business context where

consideration !mone" is exchanged for the goods or services. That is, there is ade#uate consideratio

4either is the satisfaction of an obligation considered a gift. 0or example, tuition paments for a chil

education would satisf a support obligation and would not be considered a gift.

5. [LO 2] $escribe a situation in !hich a transfer of cash to a trust might be considered an incomplete g

In some instances, a donor ma relin#uish some control over transferred propert, but retain other po

to influence the en'oment or disposition of the propert. If the retained powers are important, then th

transfer will not be a complete gift. 0or example, a transfer of propert to a trust where the grantor

retains the power to revoke the trust will not be a complete gift. In instances where the grantor retains

important powers, the gift will generall be complete once the powers are released or the propert is n

longer sub'ect to the donors control. 0or example, a distribution of propert from a revocable trust w

be a completed gift because the grantor would no longer have the abilit to revoke the distribution.

6. [LO 2] Identify t!o types of transfers for inade3uate consideration that are specifically excluded from

imposition of the gift tax.

5olitical contributions are specificall excluded from the gift tax as are the pament of medical or

educational expenses on behalf of an unrelated individual. To avoid confusing a division of propert w

a gift, a transfer of propert in con'unction with a divorce is treated as nongratuitious !e.g., a transfer

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consideration" if the propert is transferred within three ears of the divorce under a written propert

settlement.

10. [LO 2] 7nder !hat circumstances !ill a deposit of cash to a bank account held in 8oint tenancy be

considered a completed gift9

$ deposit to a 'oint account is viewed as an incomplete gift until the donee withdraws cash from the

account because the donor !depositor" can withdraw the deposit at an time.

11. [LO 2] xplain ho! a purchase of realty could result in a taxable gift.

$ completed gift results when realt is purchased in the name of a donee as sole owner of the propert

tenants in common, or as 'oint tenants with the right of survivorship if the donee does not provide

ade#uate consideration for their ownership interest.

12. [LO 2] $escribe the conditions for using the annual exclusion to offset an other!ise taxable transfer.The annual exclusion can onl offset a gift of present interest. $ gift of a future interest is not eligible f

an annual exclusion. The onl exception is a transfer in trust for a minor !under age -1" where the

propert can be used to support the minor and an remaining propert is distributed once the child

reaches age -1.

1#. [LO 2] List the conditions for making an election to split gifts.

In order to utilie gift splitting, each spouse must be a citien or resident of the nited 8tates, be marr

at the time of the gift and not remarr during the remainder of the calendar ear. In addition, both

spouses must consent to the election b filing a timel gift tax return.

1&. [LO 2] $escribe the limitations on the deduction of transfers to charity.

$s long as a #ualifing charit receives the donors entire interest in the propert, the amount of the

charitable deduction is onl limited to the value of the gift after the annual exclusion.

1. [LO 2] xplain the purpose of adding prior taxable gifts to current taxable gifts and sho! !hether the

prior gifts could be taxed multiple times o%er the years.

&ith a progressive tax rate schedule, adding to the tax base increases the likelihood that a higher

marginal tax rate will appl to the latest increment !transfer". To prevent double taxation of prior gift

the gift tax on prior taxable gifts is subtracted from the total gift tax.

1. [LO #] xplain !hy the gross estate includes the %alue of certain property transferred by the deceden

death* such as property held in 8oint tenancy !ith the right of sur%i%orship* e%en though this property i

not sub8ect to probate.

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The gross estate includes testamentar transfers even though this propert is transferred outside of the

probate court !automaticall through operation of law". &hile he didnt own: the propert at death,

decedent had control of the ultimate disposition of the propert.

14. [LO #] Identify the factors that determine the proportion of the %alue of property held in 8oint tenancy

!ith the right of sur%i%orship that !ill be included in a decedent:s gross estate.

The amount includible for propert held as 'oint tenanc with the right of survivorship depends upon t

marital status of the owners. 0or propert 'ointl owned b a husband and wife with the right of

survivorship, half of the value of the propert is automaticall included in the estate of the first spouse

die. 0or other propert held in 'oint tenanc with the right of survivorship b unmarried co;owners, t

proportion of the value included in the decedents gross estate is the proportion of the consideration th

the decedent provided to ac#uire the propert. In the extreme cases, the entire value of propert is

included in the gross estate !where the decedent provided the entire purchase price of the propert" or

none of the value !where the decedent didnt provide an of the consideration for the purchase".

15. [LO #] (arold o!ns a condo in (a!aii that he plans on using for the rest of his life.

(o!e%er* to ensure his sister -aude !ill o!n the property after his death* (arold deeded the remainde

the property to her. (e signed the deed transferring the remainder in ;uly 2006 !hen the condo !as !

)20*000 and his life estate !as !orth )4*000. In ;anuary 2011 (arold died* at !hich time the condo

!as !orth )#00*000.


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referred to as the 8ection 7*- rate and is published monthl b the Treasur. The value of the income

interest is merel the difference between the value of the remainder and the total value of the propert

21. [LO #] xplain !hy the fair market %alue of a life estate is more difficult to estimate than an income

interest.

The calculation of a value of a life estate is a bit more complicated that an income interest because the

time dela for the future pament of the remainder is unknown. To estimate this dela, the calculation

based upon the number of ears the life tenant is expected to live. To facilitate the calculation, the

regulations provide a table where the discount rate is calculated b including the life tenants age and

expectanc.

22. [LO #] $escribe a reason !hy transfers of terminable interests should not 3ualify for the marital

deduction.

If terminable interests #ualified for the marital deduction, then propert would pass from the first spou

!upon death or gift" to the second spouse without transfer tax !because of the marital deduction". The

interest would then terminate and the propert would pass from the second spouse to the eventual own

without transfer tax because upon termination the second spouse had no propert to transfer. 2ence,

terminable interests #ualified for the marital deduction, no transfer tax would be imposed on the transf

of this propert.

2#. [LO #] ,rue or 'alse> Including taxable gifts !hen calculating the estate tax sub8ects these transfers t

double taxation. xplain.

0alse. The ob'ective of adding previousl taxed transfers to the taxable estate is to allow the estate ta

base to reflect all transfers, both intervivos and testamentar. nder a progressive tax rate schedule san ad'ustment is designed to increase the marginal tax rate on the estate. $d'usted taxable gifts are n

however, sub'ect to tax in the estate formula. To prevent double taxation of prior taxable gifts, the

tentative estate tax is reduced b a credit for the taxes that would have been paable on the ad'usted

taxable gifts under the current tax rate schedule.

2&. [LO #] =eople sometimes confuse the unified credit !ith the exemption e3ui%alent. $escribe ho! th

terms differ.

The unified credit is the tax calculated on an amount of transfers that /ongress intended to pass witho

imposition of either transfer tax !gift or estate". The amount of cumulative taxable transfers that can b

made without exceeding the unified credit is called the applicable exemption amount !previousl the

exemption e#uivalent".

2. [LO &] $escribe a reason !hy a generation/skipping tax !as necessary to augment the estate and gift

taxes.

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Bonors discovered that transfers across multiple generations avoided the imposition of an gift or est

taxes until the termination of the remainder interest. 0or example, a gift of a terminable interest to a

with the remainder to a grandchild spans two generations. &hen this childs interest terminates, no gestate tax is imposed even though the child had the full use of the propert perhaps throughout his !or

lifetime. The strateg here could be expanded to multiple generations with remainder interest transfer

far into the future. Indeed, some states now allow perpetual trusts that in the absence of a generation

skipping tax would allow grantors to avoid all transfer taxes save the initial transfer to the trust.

2. [LO &] xplain !hy an effecti%e !ealth transfer plan necessitates cooperation bet!een la!yers*

accountants* and in%estment ad%isors.

$n integrated team is essential to a successful wealth transfer plan because transfer and income taxes

onl represent one piece of the pule. Cawers are critical to constructing propert rights to achieve

and nontax ob'ectives while investment advisors provide the economic input necessar for long;term

plans. Dbviousl accountants provide much of the necessar tax expertise.

24. [LO &] $escribe ho! to initiate the construction of a comprehensi%e and effecti%e !ealth plan.

&ealth planning tpicall begins with understanding the individuals goals and ob'ectives. These

ob'ectives include immediate goals, such as assuring a stead source of income, and longer;term goal

such as providing for a specific division of assets or providing educational support for dependents. E

wealth plans will likel have significant tax and nontax conse#uences. &hen considering tax factors,

however, an effective wealth transfer plan should also anticipate the economic and legal ramifications

that will accompan an transfer of wealth.

25. [LO &] List t!o 3uestions you might pose to a client to find out !hether a program of serial gifts !ou

be an ad%antageous !ealth transfer plan.

The most obvious #uestion would be whether the client could afford to make gifts given the level of inc

expected to be necessar to support the client in the future. $nother important #uestion involves the

health(age of the client and the past and expected rate of appreciation for the proposed gift propert.

8erial giving is less beneficial for clients who might be expected to die soon and for propert that has

substantiall appreciated in the past.

26. [LO &] ? client in good health !ants to support the college education of her teenage grandchild. ,he

client holds %arious properties but proposes to make a gift of cash in the amount of the annual exclusio

xplain to the client !hy a direct gift of cash may not be ad%isable and !hat property might ser%e as a

reasonable substitute.

Transfers to support the education of a teenager should probabl be made in trust because the donee w

be able to spend an amounts given directl. =ather than cash, the gift could consist of propert that i

expected to appreciate rapidl in value thereb allowing the appreciation to escape the transfer tax.

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#0. [LO &] ?n elderly client has a life insurance policy !orth )&0*000 that upon her death pays )20*000

her sole grandchild @or his estateA. ,he client retains o!nership of the policy. Outline for her the cost

and benefits of transferring o!nership of the policy to a life insurance trust.

The benefit of the transfer is that the value of the polic !)-*," would not be sub'ect to the estate t

upon the clients death if the client lives for at least three ears after the transfer. The cost is that the

transfer of the polic would constitute a taxable gift !to the extent that the value exceeds the annual

exclusion" and might be sub'ect to the generation skipping tax. In addition, in order to complete the

transfer the client would need to give up !among other rights" the right to change the beneficiar of th

polic.

#1. [LO &] $escribe the conditions in !hich a married couple !ould benefit from the use of a bypass

pro%ision or a bypass trust.

The couple must expect to have an estate whose tax will exceed the unified credit upon the death of thelast spouse. In addition, the couple must have sufficient assets to provide for the support of the surviv

spouse after transferring assets through the bpass of the first spouse to die.

#2. [LO &] 7nder !hat conditions can an executor or trustee elect to claim a marital deduction for a trans

of a terminable interest to a spouse9

The FTI5 option provides an exception to the general prohibition against claiming a marital deductio

for a transfer of a terminable interest. The conditions are that the !surviving" spouse is entitled to all

the income from the propert paable at least annuall and no person has the power to appoint an pa

of the propert to anone other than the !surviving" spouse until the death of the surviving spouse. 0o

intervivos transfer, the spouse must include the value of the propert in her taxable gifts and for a

testamentar transfer the executor must include the value of the propert in the estate of the surviving

spouse.

##. [LO &] xplain ho! a transfer of property as a gift may ha%e income tax implications to the donee.

$lthough a gift is not taxable income to the donee, there is no step;up in the tax basis of the transferre

propert. 2ence, if the donee sells the propert, an appreciation !including appreciation up to the da

the gift" will be taxed to the donee.

PROBLEMS

#&. [LO 2] Ba3uel transferred )100*000 of stock to a trust* !ith income to be paid to her nephe! for 15 y

and the remainder to her nephe!:s children @or their estatesA. Ba3uel named a bank as independent tru



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but retained the po!er to determine ho! much income* if any* !ill be paid in any particular year. Is th

transfer a complete gift9 xplain.

=a#uel has retained sufficient control that the transfer of the income interest to her nephew is incompl

3 the gift to the nephew will be completed as income is actuall distributed to him. 2owever, the porti

of the transfer representing the remainder interest is a complete gift because =a#uel can no longer con

this portion of the propert.

#. [LO 2] ,his year erry:s friend* $e!ey* !as disabled. erry paid )1*000 to $e!ey:s doctor for me

expenses and paid )12*00 to State 7ni%ersity for college tuition for $e!ey:s son. (as erry made

taxable gifts* and if so* in !hat amounts9

Goth paments were complete gifts, but both are exempt from the gift tax as long as the paments were

made directl to the college or doctor.

#. [LO 2] ,his year $an and -ike purchased realty for )150*000 and took title as e3ual tenants in comm

(o!e%er* -ike !as able to pro%ide only )&0*000 of the purchase price and $an paid the remaining

)1&0*000. (as $an made a complete gift to -ike* and if so* in !hat amount9

Ban has made a complete gift to Eike of )*, !)9,H)1,J*KL ; )+," and the gift is

eligible for an annual exclusion of )1+,.

#4. [LO 2] Last year Cate opened a sa%ings account !ith a deposit of )1*000. ,he account !as in the n

of Cate and $errick* 8oint tenancy !ith the right of sur%i%orship. $errick did not contribute to the

account* but this year he !ithdre! )*000. (as Cate made a complete gift* and if so* !hat is the amou

of the taxable gift and !hen !as the gift made9

4o gift was made at the time of the deposit, but a complete gift of )*, was made once Berrick mad

the withdrawal.

#5. [LO 2] Darry transfers )1*000*000 to an irre%ocable trust !ith income to Bobin for her life and the

remainder to -aurice @or his estateA. "alculate the %alue of the life estate and remainder if Bobin:s ag

and the pre%ailing interest rate result in a ,able S discount factor for the remainder of 0.24.

The remainder is valued at )-7, !)1 million J.-7". $ccordingl, the value of the life estate is

)7, !)1,, less )-7,".

#6. [LO 2] ,his year ;im created an irre%ocable trust to pro%ide for ,ed* his #2/year/old nephe!* and ,ed

family. ;im transferred )40*000 to the trust and named a bank as the trustee. ,he trust !as directed to

income to ,ed until he reaches age #* and at that time the trust is to be terminated and the corpus is to

distributed to ,ed:s t!o children @or their estatesA. $etermine the amount* if any* of the current gift an

the taxable gift. If necessary* you may assume the rele%ant interest rate is percent and ;im is unmarr



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The )7, transfer to the trust is a current gift but onl the income interest #ualifies for an annual

exclusion. The remainder interest is valued as follows?

=emainder interest @ )7, ( !1 A .6" @ )7, ( !1.191" @ )*,77+

The income interest is )7, ; )*,77+ @)11,--6. Gecause the annual exclusion exceeds the income

interest, the income interest of )11,--6 is completel offset b the annual exclusion. The total taxable

is the amount of the remainder, )*,77+.

&0. [LO 2] ,his year "olleen transferred )100*000 to an irre%ocable trust that pays e3ual shares of incom

annually to three cousins @or their estatesA for the next eight years. ?t that time* the trust is terminated

the corpus of the trust re%erts to "olleen. $etermine the amount* if any* of the current gifts and the tax

gifts. If necessary* you may assume the rele%ant interest rate is percent and "olleen is unmarried. <

is your ans!er if "olleen is married and she elects to gift/split !ith her spouse9

The )1, transfer to the trust is a current gift onl to the extent of the income interest !the corpus

returns to /olleen". In other words, /olleen has not transferred the reversion interest because it will

return to her. The reversion interest is valued as follows?

=eversion interest @ )1, ( !1A.6" @ )1, ( !1.*9+" @ )6-,7+ !rounded"

The income interest is )1, ; )6-,7+ @)7,-6 !rounded". Gecause the income interest is paid

currentl and to three donees, the gift will #ualif for three )1+, annual exclusions. In other words

/olleen made three gifts of )1-,+- each. 2ence, /olleen did not make an taxable gifts with this

transfer because the annual exclusions completel offset each gift. If /olleen is married and elects to

split, then the gifts would be evenl split between the spouses.

&1. [LO 2] Sly is a !ido!er and !ants to make annual gifts of cash to each of his four children and six

grandchildren. (o! much can Sly transfer to his children this year if he makes the maximum gifts

eligible for the annual exclusion9


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F420 rate !as .& percent.


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4atalie. $fter appling the annual exclusion, neither Eart nor his spouse made a taxable gift to %mi

but each of them made a taxable gift of )6, to 4atalie.

&. [LO 2] ,his year ;eff earned )50*000 and used it to purchase land in 8oint tenancy !ith a right of

sur%i%orship !ith -ary. (as ;eff made a taxable gift to -ary and* if so* in !hat amount9


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/urrent taxable gifts ) -,+6, 5rior taxable gifts A1,,

/umulative taxable gifts ) 1-,+6,Tax on cumulative taxable gifts ) +,9+,-

Cess? /urrent tax on prior taxable gifts !)1 million" ; ,9+*,Tax on current taxable gifts ) 99+,+nified credit on current taxable gifts !)-.6+ million" ; 99+,+

Nift tax due )

4ote that /ase is in the top marginal gift tax rate and that the gift of )-,+6, times +K e#uthe gift tax on current gifts of )99+,+. $t the end of -1*, /ase would still have an unusedexemption e#uivalent of )1.9++ million !*.+ million less )1 million used in -1 less -.+6 milused in -1*".

2elen will owe no transfer taxes on her gift. 2er gift will not result in an tax because in -1* shas a )*.+ exemption e#uivalent available. $fter application of the -1* exemption e#uivalent 2elen will have )-,9++, of exemption e#uivalent remaining !)*.+ million ; )-.+6 million".

0. [LO #] ,om (ruise !as an entertainment executi%e !ho had a fatal accident on a film set.

,om:s !ill directed his executor to distribute his cash and stock to his !ife* Gaffie* the real estate to h

church* ,he 'irst "hurch of -ethodology* and the remainder of his assets !ere to be placed in trust fo

three children. ,om:s estate consisted of the follo!ing>

?ssets>=ersonal assets ) 500*000"ash and stock 2&*000*000

Intangible assets @film rightsA 41*00*000Beal estate 1*000*000

) 111*#00*000Liabilities>

-ortgage ) #*200*000Other liabilities &*100*000

) 4*#00*000

a. ,om made a taxable gift of )5 million in 2011. "ompute the estate tax for ,om:s estate.

4ote that the applicable exemption amount in -11 was )* million, so Tom would have paid

)1,-, of gift tax on the -11 gift. Toms estate will owe estate tax of )-*,-, calculate

follows?

Nross %state ) 111,,

Earital Beduction ; -+,,

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/haritable Beduction ; 1*,,

Bebts ; 7,,

Taxable %state ) 6*,, 5rior taxable gifts A ,,

/umulative taxable transfers ) 7,,

Tentative tax ) -9,1+*,

/urrent tax on ad'usted taxable gifts ; 1,-,

Nross estate tax ) -7,9+*,

nified /redit -,117,

%state Tax Bue ) -6,,

Toms estate is taxed at the highest estate tax rate. 2ence, the estate tax due + percent of the

cumulative transfers in excess of the exemption e#uivalent and the previousl taxed gift. !)7

million ; )*.+ million 3 million @ )6+.*7 million" )6+.*7 million x + ; )-*.- million.

'ill out lines 1 through 12 in part 2 of 'orm 40 for ,om:s estate.

1 Total gross estate less exclusion (from Part 5—Recapitulation, item 12) . . . . . . . . . .1

2 Tentative total allowable euctions (from Part 5—Recapitulation, item 22) . . . . . . . . .2

3a Tentative taxable estate (before state eat! tax euction) (subtract line 2 from line 1) . . . . .

3a b "tate eat! tax euction . . . . . . . . . . . . . . . . . . . . . .

. 3b c Taxable estate (subtract line #b from line #a) . . . . . . . . . . . . . . . .

. . 3c

4 $%uste taxable gifts (total taxable gifts (wit!in t!e meaning of section 25) mae b' t!eeceent

after ecember #1, 1*+, ot!er t!an gifts t!at are incluible in eceents gross estate (section 2&&1(b)))

4

5 $ lines #c an - . . . . . . . . . . . . . . . . . . . . . . . . .5

6 Tentative tax on t!e amount on line 5 from Table $ in t!e instructions . . . . . . . . . .6

7 Total gift tax pai or pa'able wit! respect to gifts mae b' t!e eceent after ecember #1, 1*+. nclue gift

taxes b' t!e eceents spouse for suc! spouses s!are of split gifts (section 251#) onl' if t!e eceent was

t!e onor of

t!ese gifts an t!e' are incluible in t!e eceent,s gross estate (see instructions) . . . . . . . . .7

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P a r t 2 — T a x C o m p u t a t i o n


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8 /ross estate tax (subtract line * from line +) . . . . . . . . . . . . . . . . . .8

9 0aximum unifie creit (applicable creit amount) against

estate tax

111,300,00

46,300,0

65,000,0

65,000,0

8,000,00

73,000,0

29,145,8

1,028,0

28,117,80

(see instructions) . . . . . . . . . . . . . . . .

9

10 $%ustment to unifie creit (applicable creit amount). (T!is a%ustment

ma' not excee +,&&&. "ee instructions.) . . . . . . . .10

2,117,800

11 $llowable unifie creit (applicable creit amount) (subtract line 1& from line ) . . . . . . .11

12 "ubtract line 11 from line (but o not enter less t!an 3ero) . . . . . . . . . . . . .12

2,117,80

26,000,0



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Taxation of Individuals, by Spilker et al.

1. [LO #] (al and


17/28


The value of the trust assets would be included in Terrs estate because she retains control

over the income !the abilit to force the trustee to distribute income" and has a contingent

right of reversion.

. [LO #] Last year Bobert transferred a life insurance policy !orth )&*000 to an

irre%ocable trust !ith directions to distribute the corpus of the trust to his grandson* $anny*upon his graduation from college* or to $anny:s estate upon his death. Bobert paid

)1*000 of gift tax on the transfer of the policy. arly this year* Bobert died and the

insurance company paid )&00*000 to the trust.


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a. The exemption e#uivalent for gifts in -* was )1 million so =oland paid no gift taxwith the -* transfer. =olands executor would calculate the estate tax as follows?

$d'usted taxable gifts ) 1,,Taxable estate A *,*,

/umulative taxable transfers ) 6,*,

Tax on cumulative taxable transfers ) -,*+*,Nift tax paid or paable on prior gifts ; Tax on taxable estate ) -,*+*,nified credit ; -,117

%stimated estate tax due ) +-,

4ote that the top estate tax rate is + percent of the cumulative transfers in excess ofthe exemption e#uivalent !)6.* million ; )*.+ million @ )1.7 million and )1.7million x +K @ )+-,".

b. 4ote that because the exemption e#uivalent in -* was onl )1 million, =oland paid gift tax on the -* transfer. =olands executor would calculate the credit for prior taxable gifts at the current rate and calculate the unified credit for the -*exemption e#uivalent at the current tax rate. The credit for prior taxable gifts!)-," would be calculated as follows?

/urrent tax on prior taxable transfers !)1.* million" ) *+*,nified credit under current rate

!)1 million -* exemption e#uivalent" ; +*,/redit for prior taxable gifts ) -,

The estate tax would be calculated as follows?

$d'usted taxable gifts ) 1,*,Taxable estate A *,*,/umulative taxable transfers ) 7,,

Tax on cumulative transfers ) -,7+*,/redit for prior gifts at current rate ; -,

Tax on taxable estate ) -,*+*,nified credit ; -,117,

%stimated estate tax due ) +-,

4ote that this solution is e#uivalent to the prior problem. 2ere the estate tax paable is + percent of the cumulative transfers in excess of the exemptione#uivalent and the previousl taxed gift !)7 million ; )*.+ million ; )*, @)1.7 million".

c. If =oland died within ears of the )1 million gift, the estate would be grossed up bthe amount of an gift tax paid on the gift because the gift was made within three ears of the decedents death. 2owever, if the gift did not exceed =olands unusedexemption e#uivalent, then no gift tax would be due.



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6. [LO #] Drad and ?ngelina are a !ealthy couple !ho ha%e three children* 'red*

Dridget* and Lisa. ,!o of the three children* 'red and Dridget* are from Drad:s pre%ious

marriages. On "hristmas this year Drad ga%e each of the three children a cash gift of

)10*000 and ?ngelina ga%e Lisa an additional cash gift of )&0*000. Drad also ga%e stock!orth )&0*000 @ad8usted basis of )10*000A to the ?ctor:s uild @an H? charityA.

a. Drad and ?ngelina ha%e chosen to split gifts. "alculate Drad:s gift tax. ?ssume that?ngelina has no pre%ious taxable gifts* but Drad reported pre%ious taxable gifts of )2million in 2006 !hen he used )#&*500 of unified credit and paid )*000 of gifttaxes.

a. Gefore gift splitting Grad has made personal gifts totaling )7, !)1, to threechildren and )+, to charit". &ith gift splitting Grads personal gifts arereduced to )*, but he must include half of $ngelinas gift and this increases his gifts to )**,. Grad is allowed to claim annual exclusions for the gifts to his three

children !limited to the amount of the gift for 0red and Gridget" and an additionalannual exclusion for the charitable gift. The remainder of the charitable gift#ualifies for a charitable deduction.



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Donees Brad Angelina

0red ) *, ) *,

Gridget ) *, ) *,

Cisa from Grad ) *, ) *,

Cisa from $ngelina ) -, ) -,

$ctors Nuild ) -, ) -,

Total Nifts ) **, ) **,

$nnual %xclusions !)*A)*A)1+A)1+" ; , ; ,

/haritable Beduction ; 6, ; 6,

Total Taxable Nifts ) 11, ) 11,

Grad would then calculate his gift tax as follows? 5revious taxable gifts !-9" ) -,,

/urrent taxable gift 11,

/umulative taxable transfers ) -,11,

/urrent tax on cumulative transfers ) 7*,-

/urrent tax on prior taxable gifts ; 7+*.

/urrent tax on current taxable gifts ) +,+

nified credit used this ear ; +,+Nift tax due

4ote that Grads gift is taxed at the highest gift tax rate !)11, x +K @ )+,+",and he will have an unused exemption e#uivalent of ),+19, available for futureuse !)*.+ million less )- million less )11 thousand".

b. 'ill out parts 1 and & of 'orm 406 for Drad.



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Part 1—Git! "ub#ect $n%& to Git Tax' /ifts less political organi3ation, meical, an eucational exclusions. (see instructions)

( temnumber

)

4 onees name an aress4 Relations!ip to onor (if an')4 escription of gift4 f t!e gift was of securities, give 6"P no.4 f closel' !el entit', give 78

C *

onors a%ustebasis of gift

+

ateof gift

9alue at

ate of gift

G

:or splitgifts, enter

1;2 of column :

-

8et transfer (subtract

col. / fromcol. :)

1 .+* / chi% 10,000 1225 10,000 5,000 5,000

).*G+T / chi% 10,000 1225 10,000 5,000 5,000

"( / chi% 10,000 1225 10,000 5,000 5,000

(CT$." G* 10,000 1225 40,000 20,000 20,000

/ifts mae b' spouse —complete only if you are splitting gifts with your spouse and he/she also made gifts."( / chi% 40,000 1225 40,000 20,000 20,000

Tota% o Part 1' $ amounts from Part 1, column < . . . . . . . . . . . . . . . . . . . . . . a 55,000

:orm *& Page 3

Part 4—Taxab%e Git .econci%iation

1 Total value of gifts of onor. $ totals from column < of Parts 1, 2, an # . . . . . . . . . .

2 Total annual exclusions for gifts liste on line 1 (see instructions) . . . . . . . . . . . . .

3 Total inclue amount of gifts. "ubtract line 2 from line 1 . . . . . . . . . . . . . . .

*euction! (see instructions)

4 /ifts of interests to spouse for w!ic! a marital euction will be claime, base

1 55,000

2 38,000

3 17,000

6,000

on item numbers of "c!eule $ . .

5 7xclusions attributable to gifts on line - . . . . . . . . . . . .

6 0arital euction. "ubtract line 5 from line - . . . . . . . . . . .

7 !aritable euction, base on item nos. 4 less exclusions .

4

5

6

7 6,000

8 Total euctions. $ lines + an * . . . . . . . . . . . . . . . . . . . . .

9 "ubtract line from line # . . . . . . . . . . . . . . . . . . . . . . . .

10 /eneration=s>ipping transfer taxes pa'able wit! t!is :orm *& (from "c!eule , Part #, col.


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0. [LO &] ;ones is seriously ill and has ) million of property that he !ants to

lea%e to his four children. (e is considering making a current gift of the property @rather

than lea%ing the property to pass through his !illA. ?ssuming any taxable transfer !ill be

sub8ect to the highest transfer tax rate* determine ho! much gift tax ;ones !ill o!e if he

makes the transfers no!. (o! much estate tax !ill ;ones sa%e if he dies after three years*

during !hich time the property appreciates to ).5 million9

There are two critical assumptions here. 0irst because the top transfer tax rate applies to

all transfers !currentl and for future transfers", it would appear that Mones has alread

used his exemption e#uivalent. 8econd, Mones survives at least three ears !otherwise, the

gift tax on an current transfer would be included in his estate". nder these assumptions

a current gift of )6 million will result in a taxable gift of )*,9++, !after four annual

exclusions" and a gift tax of )-,77,6. In contrast, the same propert transferred via the

estate will trigger )-,7-, in estate taxes. The difference in the amount transferred

!)+-,+" represents the )--,+ savings from the annual exclusions !)*6, x +K"

and the )-, of estate tax on the ), of appreciation. Gelow is the calculationof the tax savings and the net amount transferred to the children under both scenarios.

Current Gift Transfer at death

/urrent value of propert ) 6,, ) 6,, Cess gift tax on transfer !+K" ; -,77,6Oalue transferred via gift ) ,6--,+ $ppreciation during interim A , A ,Oalue transferred via estate ) 6,, %state tax at +K ; -,7-,

$fter tax value transferred ) +,+--,+ ) +,,

Tax savings and extra valuetransferred ) +-,+

1 [LO &] ?ngelina ga%e a parcel of realty to ;ulie %alued at )210*000 @?ngelina purchased

the property fi%e years ago for )55*000A. "ompute the amount of the taxable gift on the

transfer* if any. Suppose se%eral years later ;ulie sold the property for )21*000.


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Boug made a current gift of )-, and a taxable gift of )6, !after the annual

exclusion. Tina will not recognie an income upon receipt of the stock, and she takes a

carrover basis of )-1, and long;term holding period for income tax purposes. 0or

purposes of calculating a loss, Tinas basis in the stock is limited to the lesser of carrover

basis !)-1," or fair market value on the date of the gift !)-,". 2ence, upon the

sale Tina recognies a loss of )*.

#. [LO &] Boberta is considering making annual gifts of )1&*000 of stock each to each of her

four children. She expects to li%e another fi%e years and to lea%e a taxable estate !orth

approximately )5*000*000. She re3uests you 8ustify the gifts by estimating her estate tax

sa%ings from making the gifts.

If the estimate of =obertas taxable estate is accurate and if the estate tax rates and annual

exclusions do not change, =oberta would be able to use her annual exclusion of )1+, to

gift awa )*6, !)1+, J +" of propert each ear without incurring an tax. 2ence,

she would transfer a total of )-, !)*6, J * ears" that would save )11-, in

transfer taxes !at +K". In addition, each transfer would eliminate the appreciation on the propert between the time of the gift and =obertas death. 0or example, if the propert

appreciates at a * percent compound rate of return, the first gift of )*6, would

eliminate an additional )1*,+7- of appreciation


24/28


b. ince lea%es )10 million to -illie and the remainder to charity.

c. ince lea%es )10 million to -illie and the remainder to his son* =aul.

d. ince lea%es )10 million to -illie and the remainder to a trust !hose trustee isre3uired to pay income to -illie for her life and the remainder to =aul.

a. If all the propert in Oinces estate #ualifies for the marital deduction, then therewould be no taxable estate and there would be no estate tax due upon Oinces death. If Eillie dies with a taxable estate of )1* million, her estate would owe an estate taxof ).- million

b. Dnce again, if the propert left to Eillie #ualifies for the marital deduction and if the propert be#ueathed to charit #ualifies for the charitable deduction, then therewould be no taxable estate and there would be no estate tax due upon Oinces death.

c. $ssuming that the propert left to Eillie #ualifies for the marital deduction, thetransfer to 5aul would be less than the exemption e#uivalent, so no estate tax wouldbe due.

d. The solution is identical to !c" above because the amount left in trust is a terminableinterest that would not #ualif for a marital deduction.

. (ank is a single indi%idual !ho possesses a life insurance policy !orth )#00*000 that !ill

pay his t!o children a total of )500*000 upon his death. ,his year (ank transferred the

policy and all incidents of o!nership to an irre%ocable trust that pays income annually tohis t!o children for 1 years and then distributes the corpus to the children in e3ual shares.

a. "alculate the amount of gift tax due @if anyA on the gift. ?ssume that (ank has madeonly one prior taxable gift of ) million in 2011.

b. "alculate the amount of cumulati%e taxable transfers for estate tax purposes if (ankdies this year but after the date of the gift. ?t the time of his death* (ank:s probateestate is )10 million di%ided in e3ual shares bet!een his t!o children.

a. 2ank will owe no gift taxes calculated as follows?

Nift of life insurance polic ) ,

annual exclusions !two children" ; -,/urrent taxable gifts ) -7-,

5rior taxable gifts A *,,/umulative gifts ) *,-7-,

Tax on cumulative taxable transfers ) -,*+,6less /urrent tax on prior taxable gifts !)* million" ; 1,9+*,Tax on current taxable gifts ) 1,

+ ,he -cra!/(ill "ompanies* Inc.* 2010 2/2&


25/28


nified credit !)*.+ million" ) -,117,less used unified credit !)* million" ; 1,9+*,

nused unified credit ; 17-,Nift tax due )

b. Gecause 2ank made the transfer of the life insurance within three ears of his death,

his estate will include the life insurance proceeds !)," as well as an gifttaxes paid on that transfer. 2ence, 2anks cumulative taxable transfers will becalculated as follows?

5robate estate ) 1,, Cife insurance proceeds A ,Nift taxes on transfer within ears of death A

Nross estate ) 1,, 5rior taxable transfers A *,-7-,/umulative taxable transfers ) 16,7-,

4ote that 2anks estate will be allowed a credit for the transfer tax on the ),

value of the insurance polic. To do otherwise would sub'ect the transfer of theinsurance polic to double tax 3 once under the gift tax and again under the estatetax.

4. ;ack is single and he made his first taxable gift of )1*000*000 in 2005. ;ack made no

further gifts until 2006* at !hich time he ga%e )1*40*000 to each of his three children and

an additional )1*000*000 to State 7ni%ersity @a charityA. ,he annual exclusion in 2006 !as

)1#*000. Becently ;ack has been in poor health and !ould like you to estimate his estate

tax should he die this year. ;ack estimates his taxable estate @after deductionsA !ill be

!orth ).& million at his death.

The solution begins with the estimation of Macks cumulative taxable transfers as follows?

Nross estate ) *,+,

5rior taxable transfers !-" 1,,

5rior taxable transfers !!)1,7*, ; )1," x " A *,-11,

/umulative taxable transfers ) 11,611,

4ext, it is necessar to calculate the amount of credit for prior taxable transfers. The -

transfer was offset b Macks unified credit !)1 million exemption e#uivalent" but none of

the taxable transfer in -9 was offset b the exemption e#uivalent because Mack used the

exemption e#uivalent in -. 2ence, Mack made a )*.-11 million taxable transfer in

-9. The credit for prior taxable transfers is calculated using the current rate schedule

as follows?

Tax on taxable transfers !)6.-11 million" ) -,+,-

less unified credit !)1 million" ; +*,

/redit for current tax on prior taxable gifts ) -,+,+

The calculation of the estate tax proceeds as follows?



26/28


Tax on cumulative taxable transfers of )11,611, ) +,*9,-

less credit for current tax on prior taxable gifts ; -,+,+

Tax on taxable estate ) -,**,

less nified credit !)*.+ million" ; -,117,

%state tax due ) ,

4ote that Macks estate would be in the top marginal tax rate but that onl a portion of the

gross estate of )*.+ million would be sub'ect to transfer tax because Mack could use the

remaining )+.+ million of exemption e#uivalent to offset the tax !he onl used )1 million

of exemption e#uivalent in - and none in -9". 2ence, onl )97, of the estate is

sub'ect to tax !)*.+ million ; )+.+ million". $t the highest tax rate, this generates

), of tax !)97, times +K".

5. -ontgomery has decided to engage in !ealth planning and has listed the %alue of his

assets belo!. ,he life insurance has a cash surrender %alue of )120*000 and the proceeds

are payable to -ontgomery:s estate. ,he trust is an irre%ocable trust created by

-ontgomery:s brother 10 years ago and contains assets currently %alued at )500*000. ,heincome from the trust is payable to -ontgomery:s faithful butler*


27/28


remainder interest in the trust at his death. 2ence, onl the value of the remainder isincluded in his estate. The remainder is valued b identifing the discount factor given the P7*- interest rate !*.+K" and the age of the life tenant !7 ears". Thevalue !)1-,6" is obtained b multipling the discount factor !.1*+* from %xhibit-*;+" times the value of the trust assets !),". 2ence, the value of

Eontgomers estate is calculated as follows? $uto )-,

5ersonal effects 7*,

/hecking and savings accounts -*,

Investments -,*,

=esidence 1,+,

Cife insurance proceeds 1,,

=eal estate investments *,1-*,

Trust !), x .1*+*" 1-,6

Oalue of estate at date of death )1,+9,6

a. Eontgomers estate tax is calculated as follows?

$d'usted taxable gifts ) Taxable estate A 1,+9,6/umulative taxable transfers ) 1,+9,6Tax on cumulative transfers ) +,1+,-+Nift taxes paid or paable on prior transfers ;

Tax on taxable estate ) +,1+,-+nified credit ; -,117,

%stimated estate tax due ) -,-*,++

b. Eontgomers estate tax is calculated as follows?

$d'usted taxable gifts ) 1,,Taxable estate A 1,+9,6/umulative taxable transfers ) 11,+9,6Tax on cumulative transfers ) +,*+,-+Nift taxes paid or paable on prior transfers ;

Tax on taxable estate ) +,*+,-+nified credit ; -,117,

%stimated estate tax due ) -,+-*,++



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c. Eontgomers estate tax is calculated as follows?

Nross estate ) 1,+9,6/haritable deduction ; -,*,

Taxable estate ) 7,99,6

$d'usted taxable gifts A 1,,/umulative taxable transfers ) ,99,6Tax on cumulative transfers ) ,*+,-+Nift taxes paid or paable on prior transfers ;

Tax on taxable estate ) ,*+,-+nified credit ; -,117,

%stimated estate tax due ) 1,+-*,++

mcgraw-hill's taxation of business entities, 2016 edition

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