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I. Def. Gross income includes any economic benefit or any clearly realized accession to
your wealth. [Unless excluded]
II. Four Basic principles.
a. Realization. When dealing with any asset that can increase or decrease in value,
the increased or decreased value of an asset is not taken into account for tax
purposes until it is realized through the sale or other disposition of the asset.
b. Non-cash receipts. Gross income includes FMV of any property received and FMV
of any serves received
i. Ex. Pair of colts tickets to summer associate. Must report FMV in gross
income.
c. Claim of right rule. Property or funds received under a claim of right (that is,
received without restriction as to use or disposition) must be reported (in year 1) for
tax purpose even though taxpayer may later be required to return the property,
funds or their equivalent.
i. Ex. P wins lawsuit, with royalties ordered to be paid in year 1, even though D
plans to appeal.
1. If reversed in year 2, P takes deduction in year 2, not file an amended
tax return in yr1.
ii. Ex. Winner of American Idol got 500K when signed K in yr1. Required to repay
half if leaves program within 6 months of yr2. Must report entire salary as
gross income in yr1. No indication of restraint on use or disposition.
1. If leaves in march of yr2. Will not amend return in year 1; will take
deduction in yr2.
iii. Compare. Stolen, embezzled, or other illegally acquired funds ARE
considered taxable income.
d. Tax Benefit Rule. (i) If taxpayer takes deduction in one year and (ii) recovers
the property that gave rise to the deduction in a later tax year, (iii) the taxpayer
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has tax benefit income, to the extent that the earlier deduction provided a tax
savings or a tax benefit.
i. Ex. P donates 150K property to charity in Yr1, properly taking 150K charitable
contributions deduction on yr1. tax return. In Yr2. the charity returns it,
unable to use it, when it is worth 200K. Assuming P got a tax benefit from the
deduction in year 1, P has tax benefit income in Yr2 from the return of the
property in the amount of 150K, the amount of the prior deduction, NOT the
200K.
ii. Ex. Taxes. Employer over withheld on your state and local income taxes in
yr1. You properly take an itemized deduction on your yr1. fed. income tax
return for all state local taxes withheld. Refund check is taxable income,
assuming when was deduction it in fact gave you a tax benefit.
1. BUT if receive refund of over withheld federal income tax, no tax
benefit income issue here b/c no deduction in the picture (cannot
deduct your federal income tax).
III. Specific Rules
a. Alimony Rule. Unless otherwise provided in the written agreement, the alimony is
taxable to the receiving spouse and deductible to the paying spouse.
i. Element for alimony
1. Writingmust be pursuant to a written divorce or separation
agreement (Tip: no oral)
2. Living together disallowedcannot be members of same
household.
3. Cease at or before deathwritten agreement must provide that
liability to make payments must cease at or before death.
4. Cashpayments must be cash (or its equivalent).
ii. Ex. T and W agree that T will pay W 1Mil. yearly in cash pursuant to written
divorce decree. Payments are to cease when W dies. W has 1Mil in taxable
income. T has 1 Mil. in deduction.
b. Child Support Rule. Child support is NOT taxable to receiving spouse and NOT
deductible to paying spouse.
i. Look for Child Support In Disguise Rule. If payment is reduced upon a
contingency relating to a child, the amount of the reduction is considered
child support.
ii. Ex. T and W agreement provided T would pay W 1mil per year until youngest
child is 21. Then would be reduced to 700K. 700K considered alimony, 300K
considered child support.
1. Effect. T can now only deduct 700K instead of 1mil.
2. Tip: Watch for alimony with triggering reduction.
iii. Rule. Where total payments fall short for alimony and child support, the
payments are deemed to meet the child support (the nondeductible portion)
obligation.
c. Prizes and Awards. Gross income includes value of cash, property, or services
received as a prize, award, or wind fall.
i. Examples. Raffle prizes, gambling or lottery winnings, and treasure trove.
ii. Ex. Win on game show $1Mil. and trip to Hawaii worth 6K. Included in gross
income.
iii. Ex. Barry Bonds homerun ball valued at $3Mil. Must include value in your
gross income. (Note: this is not a matter of realization, not an asset already
own that increased in value)
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1. What if sold for $3million later? Already reported in yr1. To make
sure not taxed again, have basis in the ball, that can subtract from
any proceeds. (think like a credit) .
2. What if bought the ball for $1? If did not report it, it will be taxed
when sell. This is a bargain purchase (not taxable in yr.1) giving $1
basis and NOW principle of realization applies.
d. Cancellation of Indebtedness. Borrower has no gross income upon initial receipt
of borrowed funds. However, a taxpayer whose debt is cancelled or discharged at
less than full amount, has discharge of indebtedness income to the extent of the
difference b/t the full amount of the obligation and amount paid in satisfaction of
the debt.
i. Ex. Borrow 20K from bank. No grow income at this point, when borrowed the
funds. Bank agrees to receive 15K. Now have 5K in discharge of
indebtedness income to report in GI.
ii. Exceptions (Tip: RIGed)
1. Reduction in purchase priceif apparent discharge is really reduction
in purchase price in connection with sale of goods, discharge of
indebtedness rules will not apply.
a. Ex. 20K promisory note to dealer. Discover defects, return to
dealer who agrees to accept 15K in satisfaction of full 20K note.
Tiponly see in purchase situation and when discussion over
price.
2. Insolvencyif the discharge occurs when taxpayer is insolvent or
bankrupt, there is no immediate discharge of indebtedness income.
a. Ex. If you were insolvent at time bank agreed to accept 15K in
full satisfaction.
b. Example of an exclusion.
3. Giftif the lender intends to discharge as a gift, the discharge of
indebtedness rules will not apply.
a. Ex. Loan came from parents and they agree to accept 15K in
full satisfaction.
IV. Exclusions from GI
a. Life Insurance Proceeds. Gross income does NOT included proceeds paid by
reason of death of the insured. BUT when proceeds are paid in installments, any
interest paid will be taxable.
i. Ex. I died, naming B as beneficiary. Policy pays 13K in three installments, plus
3K in interest.
b. Inheritance. Gross income does NOT included amounts received by bequest,
devise, or inheritance.
i. Ex. J inherits home worth 100K and bank account of 300K. What are the tax
consequences? None.
1. Note: just talking about property itself, income off property different
story.
2. Note: if you had to work for that inheritance, for fed. tax purposes
may be characterized as belated compensation for work even if
legitimate bequest under state law.
c. Gifts. Gross income does NOT included amounts receive by gift.
i. Gifta transfer made out of detached and disinterested generosity.
ii. Transfers from Employer to employee. Irrebuttable presumption that
transfer taxable (NO gift).
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d. Tort Awards.
i. Rule1. Gross income does NOT included damages received on account of
PHYSICAL PERSONAL INJURIES or sickness.
1. Includes workers compensation.
2. Does not matter if received in lump sum, over time, etc.
3. Does not matter if out of court settlement, court ordered, etc.
ii. Rule2. BY THEMSELVES, damages for EMOTIONAL DISTRESS are NOT
considered damages received on account of physical personal injury.
iii. Cf. Rule3. PUNITIVE damages received in connection with personal injuries
are taxable.
iv. Ex. S punch M in nose causing physical injuries. Then in front of crowd S
made personal and offensive comments about M. In civil suit M recovers 25K.
Tax consequences?
1. Excluded.
2. Recovery of 100K for defamation? Taxable.
3. Recovery of 50K punitive damages? Always taxable.
v. Ex. C injured crossing street. Collects 8k to cover medical expenses, 1.2K in
lost wages, 100K for emotion distress.
1. Medical expensespersonal physical injury so excluded, not taxable.
2. Lost wages*would think would be taxed, but if underlying tort is for
physical personal injury, excludable.
3. Emotional distressif underlying tort is for physical personal injury,
excludable.
vi. Ex. LC injured in front of mother C while crossing street. Receives 100K for
emotional distress.
1. Now taxable, claim is not physical personal injury.
e. Reimbursement for Property Damage. Amounts received to compensate for
damage or loss of property are excludable from gross income to extent of basis or
investment in the property.
i. Note: Damages to busiess for lost profits ARE taxable.
f. Qualified Scholarships. Qualified scholarships for tuition or related expenses (not
monies paid for housing, food, etc.) are excluded from GI. To be qualified must (i)
not be payment for past or future services and (ii) must be primarily for benefit for
the individual.
g. Employee-Related Exclusions
i. Receipts from Heath and Accident Insurance. Value of employer
provided health or accident insurance coverage, i.e., the premiums paid by
the employer, are excluded from GI.
1. Health insurance reimbursements for medical expenses actually
incurred also are excluded from gross income.
ii. Life Insurance Provided By or Through an Employer. Taxpayers may
exclude the value of the first 50K of employer provided group term life
insurance.
1. GI includes the value of any excess life insurance coverage provided by
the employer.
iii. Meals and Lodging. Excluded if (i) provided for the convenience of the
employer; (ii) in kind; (iii) on the employers premises.
iv. Other tax-free fringe benefits to employees
1. De minimus (donuts, paper, pencil)
2. No additional costs to the employer
3. Qualified employee discounts (ex. 20% off at Macys)
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4. Contribution to qualified pension plans
5. Employee safety or length of service award. Cannot be more than
$400 in value, not cash, part of meaningful ceremony.
There are two sets of deductions: (1) Above-the-line; (2) Choice of Itemized or Standard
Deduction
For individuals, there are two levels of deductionsthose deducted from GI to arrive at adjusted
gross income, and those deducted from adjusted gross income to arrive at taxable income.
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c. State and Local Taxes. Taxes paid to state and local governments are deductible,
but not sales tax.
d. Unreimbursed Casualty Losses. Deductible if (i) loss is greater than $100; (ii) is
sudden or unexpected (fact and circumstances inquiry); and (iii) to the extent that
losses (in the aggregate) exceed 10% of AGI (would have to be pretty
extraordinary).
e. Unreimbursed Medical Expenses. Deductible to extent (again only portion that
exceeds) they (in aggregate) exceed 7.5% of AGI.
i. Medical Expensesincludes insurance premiums paid, deductions, co-pays,
travel for care, making changes to home.
f. Charitable Contributions. May deduct FMV of property and the amount of cash
(not time) contributed to qualified charities.
i. Ex. Donate 1K, given dinner worth 250. Can take deduction for your
contribution of 750.
ii. Limits.
1. Must subtract value of premium/consideration you receive. See
example.
2. If some quid pro quo attached, may not qualify.
3. Max. 50% of AGI, also other percentage limits depending on type of gift
and type of charity.
g. Miscellaneous Itemized Deductions
i. Taxpayers may deduct eligible miscellaneous deductions to the extent that
(in the aggregate) they exceed 2% of AGI.
1. Examples: Unreimbursed employee business expenses, certain
educational expenses, e.g. those necessary to maintain and improve
skills needed in the taxpayers current trade or business.
h. Personal v. Business Expenses. Rule. Personal expenses are not deductible.
Expenses incurred in a business or investment setter are deductible.
i. Whether expense is personal or business turns on origin of the expense.
ii. Legal fees.
1. Generally, legal fees incurred in a personal setting are not deductible.
Legal fees incurred in a business or investment setting are deductible.
2. Divorce setting, legal fees incurred in a divorce or separation matter
are generally considered personal. Consequently, not deductible. BUT:
a. Portion of legal fee to either party in divorce or separation case
attributable to tax advice will be deductible.
b. Recipient spouse may exclude legal fees necessary in
generating taxable alimony.
i. Investment fees/expenses. Taxpayer may deduct fees/expenses necessary to
generate taxable income.
i. Ex. Broker fees; settlement expenses in successful lottery dispute.
III. Choice of Standardized Deductions to reach Taxable Income.
a. For 2012 tax returns, the standard deduction is $5,950 for single person, 11, 900 for
married couple filing a joint return. Standard deduction is 8,700 for head of
household return.
IV. Exemptions. Taxpayer entitled to one exemption for themselves and one for each
dependent (qualifying child or qualifying relative).
a. After divorce, unless other parent signs a written release, the general rule after a
divorce is that the custodial parent gets the exemption for children of the marriage.
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Federal Income Tax Allocation of Income To
whom is it income?
I. Assignment of Income Rule1. Income must be taxed to he or she who earns it.
a. Ex. Associate asks firm to transfer colt tickets to dad. She has taxable income, she
earned it.
i. Tax consequence to Dad? Assuming gift, detached and disinterest.
b. Ex. J entitled to ten year payments in exchange for covenant not to compete. Asked
that payments be made to son. Same result.
II. Rule2. Income from property (investment income) is taxed to he or she who owns
the property.
a. Ex. L owns apartment. Asks T to send rent check directly to daughter. L will be
taxed when D receives.
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Federal Income Tax [Back-tracking] Gain and Loses on
Disposition of Property
I. Intro notes
a. Terminology
i. Realizationrefers to sale, disposition, or exchange of an asset.
ii. Recognitionreporting gain or lose on the tax return.
b. General rule. Unless specific statutory or CL exception applies, whenever a gain is
realized, it must also be recognized for tax purposes.
c. An involuntary sale is taxable under same principles as voluntary sale. Ex.
Foreclosure.
d. Installment Sale. Any realized gain from an installment sale can be reported as
payments are received.
i. Interest. If seller fails to charge interest on installment sale, interest
imputed at the applicable federal rate. Seller will treated as receiving
interest and the buyer treated as paying interest.
II. Basic Formula. AMOUNT REALIZED (AR) less ADJUSTED BASIS (AB) = GAIN (or loss)
a. Amount realized includes money received, plus FMV of property or services
received, plus mortgages or liabilities to which the property sold is subject or
which the buyer assumes.
b. Ex. M owns property with cost basis of 700K. In order to cover legal bills, puts
property on the market. Buyer pays 600K in cash and assumes mortgage of 500K.
How much gain will M realize and recognize on the sale of property.
i. Amount Realized: $1.1Mil (Note: includes not just cash, but mortgage
(someone taking over this debt obligation which has value))
ii. Adjusted Basis: 700K
iii. Taxable Gain: 400K (Both realized and recognized gaini.e. taxable)
c. Cost Basis Rule. A taxpayers basis in property acquired by purchase is
generally the cost of the property, including money paid AND mortgages or
borrowing incurred in connection with the purchase.
i. Ex. J purchases new home making 500K down payment and taking out
2.5mil. mortgage. His basis in the residence is $3million.
ii. Adjusted basismeans when you put in additional costs, could increase
the basis.
iii. Tax Cost Basis [variation]. If the taxpayer receives property in taxable
transaction, basis in property received is the FMV of the property that was
reported for tax purposes.
1. Ex. M received bonus of 100 shares of her employers stock worth
$500 in a transaction that did not qualify for tax-free treatment. Ms
basis in the stock is $500, the value as she reported.
III. Variations on the transaction
a. If taxpayer sells only a portion of his property, only that portions allocable
basis is subtracted in computing gain/loss.
i. Ex. M sells half of her shares for $300. What is her taxable gain? Amount
Realized (300) minus Adjusted Basis (250) = Taxable Gain (50).
b. Sale at a discount. A bargain sale of property may be treated as part sale/part
gift.
i. Ex. Mom sells property worth 100K to daughter for 75K. Sale for 75K and gift
of 25K.
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c. Divorce Property Settlements. Transfer of property b/t spouses or ex-spouses
that is incident to divorce is NOT a taxable event to either party.
i. Substituted Basis Rule. Spouse receiving the property has same basis
that donor spouse had.
ii. Ex. B agrees in divorce agreement to transfer to J property purchased years
ago for 500K, valued at 3Mil. at time of transfer.
1. B does NOT have to recognize any income upon transfer of the
property.
2. J does not have any taxable income upon receipt of the property.
a. Her basis is 500K.
b. But note: If she sells (effect is to shift the tax burden)
c. Amount Realized: $3 Mil. minus Adjusted Basis: 500K = Taxable
Gain: $2.5. Mil.
d. Basis in Gift Property. Recall gift itself is not taxable here but still need to
determine basis.
i. Substituted Basis Rule/The Gain Rule. The recipient of a gift takes the
donors basis.
ii. Ex. F purchased stock for 10K that now has FMV of 100K. Gives to daughter
who sells for 100K. Ds taxable gain on sale of stock is 90K.
1. Amount Realized: 100K minus Adjusted Basis: 10K = Taxable Gain: 90K
iii. Loss Exception. When property has lost value wile in donors hands,
recipient of gift takes FMV as her basis for determining loss.
1. Note: This loss exception does NOT apply to transfers b/t spouses. The
receiving spouse always takes the donor. Only applies in non-spousal
transfers, such as parent to child.
e. Basis in Inherited Property. Recipients basis in inherited property is the FMV of
the property at the date of the decedents death.
i. Ex. F instead died leaving the stock he had paid 10K for, now FMV of 100K, in
his will for D. Amount realized: 100K minus Adjusted Basis: 100K = Taxable
income of zero! *Note big difference way receive it can make.
ii. Called a stepped-up basis.
f. Property Held by Husband and Wife as Joint Property. When spouses hold
joint title to property,
i. Surviving spouse will get FMV basis only on half property received via
inheritance or intestacy.
ii. The half originally owned by surviving spouse will retain its basis.
iii. Ex. H and W purchased residence for 200K, taking as joint tenants. W dies,
leaving entire estate to H. At time of death, home worth 300K. Hs basis in
home after Ws death is 250K.
1. Basis in Inheritance Portion: 150K plus Basis in Hs Original Interest:
100K = Total Basis
2. Sort of a partial stepped-up basis.
g. Like-Kind Exchanges. NO GAIN OR LOSS is recognized when taxpayer exchanges
property held for productive use in business or for investment for like-kind
property also held for like-kind property also held for productive use in business or
for investment.
i. Ex. G owns apartment in Seattle, which he holds of investment purposes
only, with a basis of 100K and FMV of 250K. He exchanges for farm worth
250K.
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1. His realized gain upon exchange is 150K, BUT need not recognize any
gain if he qualifies.
2. Takes the same basis of 100K, a substituted basis of sort.
h. Involuntary Conversion. NO GAIN OR LOSS is recognized if property
involuntarily converted due to theft, fire, seizure, requisition or condemnation is
converted into property that is similar or related in service or use.
i. If property lost or damages is converted into money (more common), GAIN
OR LOSS IS NOT recognized if the taxpayer (i) purchases replacement
property that is similar or related in service or use (ii) within two years form
date of involuntary conversion. BUT gain or loss will be recognized to
extent that money received exceeds cost of replacement property.
i. Sale of Principal Residence. Up to 250K (500K for joint returns) of gain from
sale of a principal residence can be excluded if (i) the property has been used and
owned as the taxpayers principal residence (ii) for periods aggregating two
years during the five-year period ending on the date of the sale.
i. Exclusion generally not available if taxpayer has used it within two years.
ii. Ex. K acquired property in year 1 for 6Mil. Used as principal residence, except
for one summer during which he rented it out. K sells ranch in year 3 for
10Mil.
1. Ks realized gain is Amount Realized: 10Mil minus Adjusted Basis: 6Mil
= 4Mil.
2. K must recognized 3.75Mil (he could exclude 250K).
iii. Note: K could not sell, leave in estate to heirs in order to get the stepped up
basis. Gain is then never gets taxed by anyone.
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a. Note the FMV of stock is 18K; thus the 8K of gain not presently
recognized will be recognized when the SH sells the stock.
IV. Corporation Distributions.
a. Dividends. SHs are taxable o the dividends they receive.
i. A corporate distribution made out of the corporations earnings and
profits.
1. Rates. Most dividends paid by domestic corporations are now eligible
for preferential gains rates (at least through the end of this year)
ii. IF Distribution not made out of corporations earnings and profits, will
be treated as tax free recovery of the SHs basis in her stock.
1. To extent distribution not made out of corporations earnings and
profits exceeds the SHs basis in her stock, it is treated as gain
from sale of capital asset. (as a capital gain as if sale of stock).
iii. Ex.Yr.1 Corporation has earnings and profits of 30K and distributes 2.5K to
each B and H.
1. Treated as a taxable dividend. When receive dividend, do not adjust
basis.
2. If had no earnings or profits, then treated as tax-free recovery of SHs
capital. Here, do adjust basis.
b. Distributions of Property
i. Corp. is taxable upon distributions of appreciated property to its SHs. Corp.
will recognized gain, but not loss, by reason of making distribution.
ii. SH receiving the property will treat as dividend in accordance with above
rules and will have FMV basis in property received.
iii. Ex. Corp. distributes $250 worth of property to each of two SHs. Property has
basis of $50. Distribution causes Corp. to recognize $400 of gain. Both SHs
must report a dividend of $250, and each will have basis of $250.
c. Liquidation and Redemption
i. Rule. When corp. distributes property to SHs in complete liquidation of the
corp. or in complete termination of an individual SHs interest, the SH is
treated as having sold her stock to the corp.
ii. Ex. Jack and Jill each own 50% of corp. and each of them has basis of 10K in
their stock. Corporation liquidates, distributing 30K worth of assets (total 60K)
to each SH in exchange for their stock, which is cancelled. What are the tax
consequences for SHs.
1. Treated as sale. Amount realized (30K) minus basis = 20K for each.
2. If Jill decides to retire and corporation redeems Jills stock, paying her
30K. Her tax consequence is 20K upo leaving the Corp.
iii. Constructive Ownership. For purposes of corporate redemption and
liquidation rules, stock owned by one SH may be viewed as constructively
owner, i.e., deemed to be owned, by a related SH.
1. Relatedspouse, parents, and children are considered related under
these rules.
2. Ex. above. If J and J were husband and wife, 30K to Jill upon retiring not
viewed as a sale or exchange, but as a dividend.
V. Sale of Corporate Business
a. Purchase of corporate business can be structured as either a stock acquisition or
as an asset sale.
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i. Asset sale. Results in two levels of tax: (1) corporate level tax on the
asset sale itself; (2) SH level tax upon the subsequent distribution of
proceeds. These taxes are generally immediate.
ii. Stock Acquisition. Results in only one immediate tax: Tax to SHs on
sale of their stock.
1. Effect. Often preferred.
I. Basic Principle. Trusts and estates are taxable entities, which are liable to pay
federal income tax.
II. Income Taxation of Trusts and Their Beneficiaries.
a. Beneficiaries, as a general rule, are subject to federal income taxation on amounts
distributed to them from the trust.
b. The Trust, is subject to federal income taxation, but entitled to deduct distributions
made to beneficiaries so the practical effect is no tax to the trust on distributed
income.
i. BUT will be taxed on accumulated income.
c. Ex. R place property into trust with directions to trustee to annually distribute
trust income to each of twins. Trust corpus generates 30K a year. Trustee distributes
15K to each child. Tax consequences?
i. Each childmust report their receipts as income.
ii. Trust30K profits taxable but 30K distributed deductible so no tax.
III. Grantor Trusts.
a. Rule. If grantor transfers property to trust, retaining certain interests, grantor
will still be regarded as owner of property for income purposes. Thus, any income
generated by property will be taxed to grantor, and not to the trust.
b. Ex. Revocable trust, trust with life estate retained by grantor, trust with
reversionary interest of more than 5%.
c. Ex. W and H purchased real estate in NY, promptly transferring to a revocable trust
with instruction for trustee to manage the rental of the property. H and W liable for
the tax on the rental income generated.
IV. Income Taxation of Estates
a. The estate, is subject to federal income taxation on any income generated by
property held during administration of the estate.
b. Income in Respect of a Decedent (IRD)
i. Rule. Payments that were owed to a cash basis (accounting method)
decedent, but not yet paid at time of death, are taxable to the estate,
assuming the estate is entitled to receive payment.
ii. Ex. S was a cash basis taxpayer. Had K with studio, died before receiving
payment. Ss estate received 100K pursuant to K. If executor files Ss federal
income tax return and his federal estate tax return, the latter should report
the 100K. Had he received the check and died before cashing, goes on
income return.
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Federal Estate and Gift Taxation
Basic Principles
I. Indiana Note
a. IN does NOT impose separate state-level gift tax. IN residents only liable for federal
gift tax.
II. A gift tax is imposed on any completed or irrevocable transfer by gift.
a. GiftFor gift tax rules, is a transfer for less than full and adequate consideration.
i. Note: Different definition of gift than used for purposes of federal income tax
rules.
ii. Examples include:
1. A bargain sale of property to family member.
a. Ex. could be part sale, part gift
b. Ex. M purchases real estate, taking joint title with right of
survivorship with son. Gift tax consequences to M is gift of half
the property.
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2. An interest free loan to family member.
a. Ex. Will apply the applicable federal rate of interest to
determin gift amount.
b. Are certain exceptions (up to 100K)
3. Ex. J establishes joint bank account with B, making initial deposit of
500K. Both have access without others consent. To extent takes any
money out, is considered a gift.
4. Divorce property settlements generally not considered to be gifts.
b. Powers of Appointment. Exercise or release of a general power of appointment
may be subject to gift tax. Timely disclaimer or renunciation of POA different.
i. General power of appointmentone that may be exercised in favor of the
holder.
ii. Exceptions. Transfer of a POA will NOT be subject to gift tax if: (1) it is
limited to conditions related to health, education, support, or maintenance;
(2) can only be exercised with consent of grantor; OR (3) can only be
exercised with consent of another with an adverse interest.
iii. Ex. K appoints Son as trustee over a substantial trust with remainder interest
to grandchildren. Under the terms of the trust, S may distribute trust funds
to his children and also free to take trust fund for himself. Other words, he
has a general power of appoinitment. S releases his power of appointment.
There are gift tax consequences to S. The release is a gift, could have taken
for himself, chose not to.
1. If S only free to take trust funds for self in event doctor found him
terminally ill, not a general power of appointment, no gift tax.
III. Annual Exclusion
a. Rule. Each taxpayer may exclude first 13K in gift transfers per year per donee.
i. Ex. During year D transfers cash gifts of 13K to each of three children. No gift
tax consequences.
1. If made 14K cash gifts to each child, 3K in potentially taxable gift. Still
other exclusions.
b. Annual Exclusion Restrictions.
i. Generally, the annual exclusion cannot be used for gift of a future
interest.
1. Ex. D transfers 13K each into three separate trusts, keeping life
interest in each trust for himself and assigning remainder to three
children. Gift tax consequences potentially 39K
2. Ex. D transfers funds in trust, instructing trustee to accumulate
income, paying out to principal and income to each child when reaches
21. Gift of future interest, all potentially taxable gifts.
ii. Exceptions to Future Interest Restriction. Transferor can still use annual
exclusion for gift of future interest in property IF:
1. Transfer for the Benefit of a Minor.
a. (i) the property and income from the property may be used for
the benefit of the donee before the age of 21;
b. (ii) any property and income not used for minors benefit passes
to minor at age or 21; AND
c. (iii) in event of death of minor, property and income payable to
minors estate.
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2. Crummey Trust. The trust instrument gives beneficiary the
power to demand immediate withdrawal of amounts contributed
to the trust.
a. Ex. Authorizing guardian on behalf of child to demand
withdrawal. Doesnt matter if actually does.
iii. Gift-Splitting by Spouses. Spouses can effectively double annual
exclusion by electing to treat the gift as a split gift.
1. Requirements: both citizens or residents of US; married at time of
gift; and consent.
2. Results in two 13K annual exclusion being available.
3. Ex. F gives 26K to each of two children. Potentially taxed for 13K. BUT
if F and M decide to treate gifts as split gifts no potentially taxable
gift.
IV. Exclusion for Tuition and Medical Expenses
a. Rule. Amounts paid for tuition or medical expense on behalf of another excludable
from taxable gifts.
V. Charitable Contributions Deduction
a. Rule. Gifts to qualified charities are deductible for gift tax purposes. A gift of
services to charaity is not considered a taxable gift.
VI. Marital Deductions.
a. Rule. A gift transfer from one spouse to another is eligible for a 100% marital
deduction.
b. Terminable Interest Exception. Unless taxpayer makes an irrevocable
terminable interest election (Q-Tip), no marital deduction is allowed for transfers to
a spouse if the transferors property or interest may ultimately be received by
someone other than the spouse.
i. Note: Same exception to marital deduction applies to estate as well as gift
transfers.
c. Ex. W trasnfers 100K in trust for her husband, for life, with remainder to Son. Will
have gift tax consequences.
i. Must file QTIP (Qualified Terminable Interest Property).
VII. Exemptions. In addition, taxpayers are entitled to a $5 Million exemption for
lifetime gifts.
a. Extent taxpayer has used any of the lifetime gift exemption, will reduce available
estate tax exemption.
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conjunction, the power to revoke or terminate the transfer, alter
amend beneficiaries or time interests are available.
a. Ex. Under terms of trust reserved right to alter percentage of
interest of two children. Does not matter that not reserving
anything affecting self.
b. Exception if right to alter realtes to specific condition RE health,
injury, etc.
vi. Life Insurance. Policies Owned At Death.
1. R1. Policy on decedents own life included in GE IF (i) proceeds are
receivable by the executor; OR (ii) decedent possessed any
incidents of ownership at time of death.
a. Ex. of incidents of ownership: Right to change beneficiary, to
cancel or revoke the policy, to pledge or borrow against policy,
or policy w/ cash surrender value.
2. R2. Value of life insurance beneficially owned by decedent on life
of another will always be included in decedents GE.
3. Ex. D owned life insurance policy on his life, naming wife as primarily
beneficiary and daughter as secondary. Under the terms, he was
entitled to change beneficiaries. MUST include proceeds in GE.
4. Solution. A lot of people are putting these in irrevocable trusts but
problem is have to be able to trust trustee and problem of transfers
within 3 years of death.
5. R2. Policies Transferred Within Three Years of Death. Life
insurance policy that would have been included in decedents GE if had
retained it, will be swept back into GE if decedent transferred the
policy within three years prior to death.
a. Ex. Policy with face value of 1Mil and cash surrender value of
250K in year one when M transferred policy to an irrevocable life
insurance trust, naming S as beneficiary. If died in yr2 face value
included in GE. If died in yr5 not.
d. Valuation of Assets
i. Generally, gross estates assets will be valued at their FMV at time of
decedents death.
ii. Current farm or business use exception. Certain realty used in farming
or closely held business may be eligible for valuation at its current farm or
business use rather than its potential use.
e. Exclusions and Deductions [Note: if going to ask, may ask here]
i. Estate Tax Exemption. Decedents gross estate is entitled to an effective
exemption of $5Mil.
1. But recall: Lifetime gift tax credits used by decedent counts toward
estate exemption.
2. Ex. Ms GE $6Mil. After Estate tax exemption, $1Mil taxable. But if M
had made $1Mil of gifts for gift tax purpose, gets $4Mil estate tax
exemption, $2Mil taxable.
ii. Marital Deduction.
1. Portion of estate that passes to surviving spouse entitled to
100% marital deduction.
a. Ex. H and W held home title as joint tenants w/ right to
survivorship. At time of death, home FMV of 300K. Executor
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technically includes of home in federal estate tax return, but
also then deductible here so practically no estate tax.
2. Terminable Interest Exception. Unless executor makes an
irrevocable terminable interest election (often refered to as a Q-
TIP) (will then be includable in GE of surviving spouse), no marital
deduction is allowed for transfers to a surviving spouse if decedent
spouses property or interest may ultimately be received by someone
other than spouse (Terminablemay not end up in spouses estate).
a. Note: Same exception to marital deduction applies to estate
and gift transfers.
b. Ex. Jims will leaves his entire estate to wife, with remainder to
children. This is a terminable interest.
3. Q-TIP (Qualified terminable interest property). If Executor makes an
irrevocable terminable interest election, effect:
a. Decedents estate eligible for marital deduction RE the
terminable interest.
b. QTIP election is irrevocable.
c. Interest will be included in surviving spouses gross estate.
d. Eligibility requires:
i. Property must pass from decedent to surviving
spouse
1. Interest is considered passing if spouse receives
itamong other waysunder will, intestacy, inter
vivos transfer, proceeds of life insurance, surviving
JT.
ii. SS must be entitled to receipt of income from
property for life, payable annually or more frequently.
iii. No person can have power to appoint any part of property
to anyone but the spouse.
iv. Executor must make QTIP election on or before date for
filing decedents federal estate tax return.
e. See examples above; if executor filed a valid QTIP election,
would be marital deduction.
f. Ex. D plans to leave assets through estate to spouse with
remainder to his children. NOT advisable unless provides for
QTIP.
iii. Other Deductions, subtracted from estate before taxes(i) State Death
Taxes; (ii) Funeral and Administrative Expenses; (iii) Debts Owed by Decedent
at Death; (iv) Charitable contributions.
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Indiana Taxes
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