Accounting 815

Taxation of Transfers and Fiduciaries

Week 9: Gifts with Strings; Life Insurance

Outline (c) 1998 Robert H. Daniels

 

Estate & Gift Software Links

1. What is a gift in the eyes of transfer tax?

Sec. 2501(1) "transfer of property by gift"

Sec. 2511(a) direct or indirect, in trust or not

whether real or personal, tangible or intangible

but not NRA's unless property in the US

Sec. 2501(A)(2), (3) : usu. not NRA intangibles

So investors in US prop eg. Canada should go through corporations

That’s one reason for FIRPTA

Sec. 2512: if property, value at date of gift

if not for full consideration, difference is gift

Regs.: 25.2511-1(a): forgiveness of debt a gift
  is this really a property transfer?

Regs. 25.2511-1(g): donative intent not essential

Distinguished from State law,

which is "voluntary transfer w/ no consideration"
  Contracts concept of "consideration"

need to give up and receive for valid contract
  can be promise for $, or promise for promise
  this is why oral gift promises not enforceable

tax looks to objective facts, not intent

tax if transfer not for full, adequate consideration
  and not ordinary business transactions

look to what giver gives up, not what donee receives

What is ordinary course of business?

"bona fide, arms length, w/o donative intent"

when can you do business with your kids?

love, marriage, release of marital rights not consideration

2. Husband-Wife transfers

Case Law background: Supreme Court

Wemyss

H transfer to W, to replace income she'd lose if she married him held taxable gift (under then-law)

Merrill v. Fahs

Prenuptial settlement for W's release of dower rights is a gift, not adequate $ consideration

Current Statutory law: H-W transfers generally not taxed

Gifts: Sec 2523(a): tho a terminable interest problem

Divorce Sec. 2516: presumption if transfers under agreement w/in 2 yrs of divorce

Estates: Sec. 2056

Income tax: Sec. 1041

3. The parent-child relation

Support obligation not a gift

EG. Calif. Civil Code Sec. 196:

F and M have equal responsibility to support, educate C in manner suitable to C's circumstances, taking their earnings into consideration

until child turns 18 (19 if FT high school), or is emancipated

Is the use of property a gift?

P pays $1500/mo to adult child
P pays rent of $1500 per month
P lets C live rent free in rental apt
P lets C live rent free in P's home

Gift loans: Clifford, Crown and Dickman

Clifford:

2 year transfer w/reversion of principal held too short: not lose dominion and control

Congress then passed 10 year bright line
  led to abuse
Since 1986 test is 5% chance of reversion

Crown

a 0 year transfer, w/ demand call
arguzbly: no gift, because 0 times 1 is 0

Dickman: Sup Ct overturned Crown loans

use of $ is a property right
indefiniteness is like tenancy at will
in the family its "subject to accomodation"

Gift of the use of funds: Sec. 7872 as response to Dickman

(f)(3) "Gift Loan defined"

effect: treat foregone i as gifted and retransferred as i

(c)(2) de minimus for $10K loan, not purchase or carry assets

(d)(1) exception for $100K:
limit deemed transfer to net investment Y.

term loan w/ 0 or low interest

 use (b)(1): NPV of loan vs face

Use of Sec. 1274 AFR's

4. Other common gift issues

Gifts of services

Specific reg on how fiduciaries waive income

constructive receipt is the issue

File waiver with probate court and mention in acctg.

P gives C shares in P’s PSC

Hypo: Tp is a famous novelist. Plenty of $$
transfers (c) to kids?
works for kids corp for nominal salary?

Gifts by agents: power of attorney:

 Est of Casey, (para. 3073)

Note that estate of Bronston in 2nd Cir goes other way, on almost identical facts

Holder of durable power (son) for an incompetent makes gifts before death: to self and other children

Held; unauthorized, thus revocable, thus include in estate
  construe POA’s narrowly
only economic transactions, unless provide otherwise

Payment of gift tax by recipient: Diedrich case

A gift of appreciated property produces taxable income for the giver

The impeccable logic:

tax is an obligation of the giver, not the recipient
when A pays B's tax liability, B has income: Old Colony Trust

So treat as tho sold for the amount of the gift tax
sale profit to extent basis is lower than tax:

note: need to solve for the amount of the gift, on which the tax is being charged

What if the donorhas no money? Sec. 6324(b): donee

Gift of encumbered property: debt relief as a "sale"

made it impossible to escape tax shelters by gift

Facts and Circumstances:

 Belli v. CIR (para. 3157)

Why do people / professionals / make gifts?

Malpractice asset sheltering
fraudulent transfer aspect

Medicaid asset sheltering

5. When is a gift: the problem of retained control

Tp wants to get asset out of estate, avoid tax on appreciation, but keep rights or controls

Issue of double inclusion: (because estate tax includes some retained controls)

Sanford estate Para 4013

a gift became complete when a power to modify a trust was renounced

the power to modify would compel inclusion under the estate tax and donees could still be changed, including power to choose a charitable/exempt donee

Smith v. Shaughnessey Para 4025,

Creation of trust with remainder interest is taxable as a gift, even though it will be in D's estate: something can be both gift and in estate tax

because of (semi-) unification: gift tx cr vs estate tx

6. Valuation of remainder interests

Regs 25.2512-5: life expectancy , w/ tables at 10%

suppose recipient is in poor/excellent health?

Again, the problem defining the "veil of ignorance"

A to B reversion to A, remainder to C:

estate tax transfer when A dies : Sec. 2037
removal of cloud on C's interest
valuation is life expectancy as of date of death

What life tables: suppose they are outdated

estimate T's life at 10, really is 15

so overstate value of remainder

what about men vs. women?: 1983 gender-neutral

is is legal to have gender-specific?

Abuse: suppose real interest rates are 12% or 8%

systematic over/undervaluation of interests
eg. real is 8%: Y to charity for 20 yrs, rem to B

Solution: Code Sec. 7520

IRSto use updated mortality tables
using 1.2x Federal Midterm rate (nearest .2%)
Publications 1457 and 1458; Notice 89-24, 1989-1 CB 660

7. Life Insurance

No income tax effect: no deduction and no inclusion
income tax advantage: tax free inside buildup of policy values]

Tax treatment in general: include in estate if

paid to or FBO the estate/executor


or if D retained any "incidents of ownership


or transferred incidents w/in 3 years of death

What is Life Insurance? What are "incidents of ownership"?

How does one handle incidents of ownership?

Avoid them from the start?

The funded, irrevocable life insurance trust

H and W set up unfunded trust, put in $20K per year.

 Crummy power to make it a present interest

H has family business take out insurance on H: payable to Company

H dies, Co gets the $, does a Sec. 303 stock redemption

Suppose its not payable to the company -- Survivor employee beneifts.

Will incidents of ownership possessed by company be attributed?

Regs. 20.2042-1(c)(6): only if D is "controlling" shareholder:

Suppose you already have a policy

Give it away (per policy terms) and wait three years: 2035

Build Date 3/24/98