Accounting 815

Taxation of Transfers and Fiduciaries

Week 6: Estate Deductions: Administrative and Marital

Control Panel

Fifth Week Summary

"Transfer Tax": the unification of Gift and Estate taxes through the concept of cumulative lifetime transfer tax. Why it's only semi-unification: gifts are tax-exclusive, while estates are tax-inclusive

The definition of the gross estate in Secs. 2031 and 2033: "all property and rights to property to the extent of decedent's interest." The joint tenancy rules of Sec. 2040, and the tension between joint tenancy and community property interests.

1. From Gross Estate to Taxable Estate

Overview: Take all property owned by decedent (706 Schedules A-D and F) and add the value of the "lifted cloud" on the ownership rights of others (706 Schedules E-I). Subtract administrative and funeral expenses, debts (somewhat different rule for probate vs nonprobate), casualties, and transfers to spouse and charity (706 Schedules J-O). Result is the taxable estate.

2. Administrative and Similar Expenses

Funeral, Administration, Claims, mortgages

Funeral is straightforward

Administrative expenses:

Regs. 20.2053-3(a) " actually and necessarily incurred" FBO estate

Include executors commission: paid or estimated
also Attorneys fees

Reasonable estimate when return filed

Note: Claim refund contest fees as part of refund

Note: interest may be an "administrative expense"

Causes tricky calculations if tax is adjusted in audit and interest is charged
Have to solve for Tax on
(increased estate per audit less interest on the additional tax)

Other expenses: 20.2053-3(d)(2): brokers for property sale

Is the sale a necessary part of administration?
If not, the loss is probably capital on the 1041

Interrelationship w/ income taxes

Sec. 642(g) anti-double dip rule

2053 estate deductions not allowable against income tax
unless Statement filed with return:
they weren't taken and won't be taken against estate

Does not apply to DRD items

Example of administration expense: Hibernial Bank Case Par. 25,013

Debts and Claims:

If based on a "promise or agreement

must be bona fide liability for value received
ie no deduction for disguised gifts

Is a divorce settlement "based on a promise or agreement"/

Gray case: Para. 25049: generally no, but yes in CA
because court decree ratifies, doesn't change, the spousal
property settlement
So have to investigate whether good faith and adequate consideration

3. The Unlimited Marital Deduction

History

As with income tax, the separate vs community property problem
First a 1/2 deduction
Since 1981, a complete deduction.
Applies to both gift and estate (2056 and 2523)

"Property which passes or has passed": 2056(a)

What does "passing" mean?

Schroeder case Para. 27,091
Now in Regs. 20.2056(c)-2(c)

Terminable interests

in general

no deduction if S's interest is "terminable"
and if D has transfered another interest in same property to anyone else w/o consideration
and if this interest may be enjoyed if S's interest fails

Exception for 6 month survivorship

Rationale: concern that D would get deduction for property not included in S's estate

As it has evolved: look at *hypothetical possibility* someone else may get possession or enjoyment

Spousal Allowance

Jackson case (Para. 27,127)
CA spousal allowance didn't qualify
No vested right to allowance in CA: defeatable by death or remarriage

Look to statutory language, not policy intent

Meyer case: life insurance w/ successive benes: also a terminable interest

Exception: Life estate with general power of appointment

Rationale: general power means in W's estate: 2041

And all income payable annually : Wisely case (Para. 27,211)

Exception: the QTIP Election

A postmortem executor election
made by including item on Sched M and not diselecting
irrevocable

W has qualifying income interest for life
payable at least annually
no one else may appoint to anyone but W

Consequence: Sec. 2044: include in W's estate

Difference from exception 1: D controls who ultimately gets
And ability to make partial Q-Tip election

Illustrative Case: Nicholson (Para. 27,283)

Funding the marital deduction

Problem: how to coordinate with the $600K bypass

If a specific bequest: g/loss on funding

Pecuniary vs fractional formula

fractional: 1/2, 1/3, or "smallest fraction needed to reduce estate tax to 0"

pecuniary: $100K, $200K, or the "smallest amount needed to reduce estate tax to 0"

Problem: changes in value between date of death and date of distribution

If fractional, distribution is exchange of retained asset for share in non-retained asset: gain / loss recognized

If pecuniary: Rev. Proc. 64-19 (Para. 27,463)

Concern: value at DoD. Then depreciated to spouse and appreciated to heirs

e.g. A, B AB 600 each. A FMV 900, B FMV 300. Distribute B to spouse. the gain on A will escape tax in spouse's estate

Deny deduction unless property used has FMV at least the amount of the bequest

or it fairly represents value changes since death

Result: excruciatingly opaque wording of marital deduction language in trusts and wills

Build Date 3/4/98