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Christopher Phelps
Christopher Phelps, Certified Public Accountant (CPA)
Category: Tax
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Experience:  CPA, CFP, PFS, Tax Practitioner 21 Years, Member AICPA/CSCPA Tax/Financial Planning Committee Member
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Long gift and estate tax homework problem

Resolved Question:

Can anyone help me with a long gift & estate tax homework problem?
Submitted: 11 years ago.
Category: Tax
Expert:  Christopher Phelps replied 11 years ago.
Christopher Phelps, Certified Public Accountant (CPA)
Category: Tax
Satisfied Customers: 2710
Experience: CPA, CFP, PFS, Tax Practitioner 21 Years, Member AICPA/CSCPA Tax/Financial Planning Committee Member
Christopher Phelps and 3 other Tax Specialists are ready to help you
Customer: replied 11 years ago.

John and Joanne Riley are US citizens and residents of California. They have four children: Kevin who is 25; Kerry (19); Shea (17); and Colin (23). Kevin is married to Margaret. They have one son, Connor, who is 2. John and Joanne were married in 1975.

John and Kevin were involved in a boating accident on August 25, 2004. Kevin died on the way to the hospital. John died three days later from injuries suffered in the accident. At the time of his death, John had the following property:

1. A residence in Fullerton held as community property with his wife, Joanne. The house was purchased in 1990 for $300,000, and had a value on the date of his death of $950,000. The house was purchased with money John had inherited from his father, Jack. The property was subject to an outstanding mortgage of $150,000.

2. A rental property in Anaheim held in the name of John and Joanne, as Trustees of the Riley Family Trust. (The Riley Family Trust is a revocable trust established by John and Joanne. It provides that on the death of the first of them, the trust will be divided into a Survivor’s Trust, a marital Trust and a Bypass Trust). John and Joanne purchased the property in 1978 shortly after they were married for $140,000 with funds they earned after their marriage. The property had a value on John’s death of $650,000 and was subject to an outstanding mortgage of $50,000. Kevin, Margaret and Connor were living in the house at the time of John’s death.

3. A checking account held in the names of John, Joanne and Kevin. John and Joanne had added Kevin’s name to the account in April 2004, before they went on vacation to Europe. At the date of John’s death, the account had a balance of $30,000, all of which had been contributed by Joanne from property she received from her mother, Rose.

4. 10,000 shares of stock in a biotech company started by Joanne’s brother, Patrick. The stock was held in Joanne’s name. Joanne purchased the stock for $.50 per share in 1995. The company went public in June 2003. The shares had a value on the date of John’s death of $10 per share.

5. A brokerage account in the name of John and Joanne as community property. At John’s death, the account had a value of $1,000,000.

6. An automobile in Joanne’s name with a date of death value of $50,000 against which there was a $20,000 loan.

7. A term life insurance on John’s life in the face amount of $2,000,000, naming Kevin, Colin, Kerry and Shea as the beneficiaries. If a child failed to survive John, the child’s share was to pass to his or her issue equally. The policy was the community property of John and Joanne.

8. A 401(k) plan in John’s name with a fair market value on the date of his death of $1,000,000. The plan named Joanne as the primary beneficiary, and the Riley Family Trust as the contingent beneficiary.

The following transactions took place during John’s life:

9. In 1999, shortly after Kevin was born, John transferred $10,000 of his separate property to an irrevocable trust for Kevin’s benefit. John retained the right to name additional beneficiaries other than himself, his estate, his creditors or the creditors of his estate. John named each of his children as additional beneficiaries when they were born. John released his power to name additional beneficiaries in January 2002 when the value of the trust corpus was $40,000. At John’s death, the value of the trust corpus was $160,000.

10. In December 2003, John transferred 1000 shares of stock in Patrick’s company to each of his children. Kevin and Colin received their shares outright, but John transferred the shares for Kerry and Shea to himself as Custodian to age 21 under the Uniform Transfer to Minors Act. The stock had a basis of $.50 per share, a value on the date of the transfer of $5 per share, and a value on the date of the death of $10 per share.

11. In February 2004, John, who had inherited 36 acres of land in Arizona from his father, made the following transfers:

a. A 4 acre parcel to Kevin

b. A 4 acre parcel to a trust for the benefit of Colin. The trust provides that Colin is to receive the net income annually. The principal is to be distributed to him when he turns 25. The parcel is undeveloped land currently leased to a rancher to graze cattle.

c. A 4 acre parcel to a trust for the benefit of Kerry. The trust provides that the income can be paid to Kerry at the discretion of the Trustee until she is 21. At 21, she is entitled to receive the net income annually. The principal is to be distributed to her when she turns 25. The parcel is undeveloped land currently leased to a rancher to graze cattle.

d. A 4 acre parcel to a trust for the benefit of Shea. The trust provides that the net income can be paid to Shea at the discretion of the Trustee to age 25. At age 25, Shea has the right to request a distribution of principal. However, the trustee has the right to deny a request for distribution if Shea is involved with drugs. Any property not distributed to Shea will be held in trust for her for her life and distributed to her children in equal shares on her death (Shea has had some trouble at school with drugs).

The basis of the land was $1,000 per acre. A 4 acre parcel of land adjoining John’s land sold in January for $2,500 per acre. There were rumors in the community that a developer was buying a large tract of land in the area to build a senior housing community and that Wal-Mart was putting in a super center.

12. Following John’s death, funeral expenses were incurred in the amount of $20,000. In addition, attorney fees of $35,000 were incurred in connection with the administration of the estate and accounting fees of $10,000 were incurred in connection with the preparation of the estate tax return. There was an outstanding Visa bill of $10,000. There was also a law suit against the boater who caused the accident. However, the boater was not insured.

John left a will that provided that all property passing under the Will was to be distributed as follows:

1. $100,000 to UCLA Foundation to establish a scholarship in his name for an accounting student.

2. The balance of John’s estate is to be added to the Riley Family Trust. The Trust provides that Joanne’s share of the property is to be added to the Survivor’s Trust. John’s share of the property is to be divided between the Bypass Trust and the Marital Trust. The Marital Trust is to be funded with the smallest fractional share of the trust estate necessary to eliminate the estate tax. The Bypass Trust is to be funded with the balance.

3. The Bypass Trust provides that Joanne, who is the trustee, may distribute income and principal to herself for reasonable health, support, care and maintenance. On Joanne’s death, the balance in the Bypass Trust will be divided into equal shares with one share for each of their living children and one share for the issue of each of their deceased children. Income will be distributed at the discretion of the Trustee to age 21 and quarterly thereafter. Principal will be distributed ½ at 25 and the balance at 30.

4. The Marital Trust provides that the net income is to be distributed to Joanne in quarter annual or more frequent installments during her life. On Joanne’s death, the trust gives her the power to distribute the balance remaining in the Marital Trust to their lineal descendants or charities. In the absence of appointment, the balance remaining in the Marital Trust will be added to the Bypass Trust and distributed as described above.

Please discuss the gift and estate tax issues presented for John. Please give reasons for your answers. Do not give only unsupported conclusions or calculations.

Expert:  Christopher Phelps replied 11 years ago.

As citizens residing in California, John and Joanne are subject to the community property laws of the state. This means on the death of the first spouse, 100% of the community property assets will receive a step-up in basis regardless if they are includible in the deceased spouse’s estate. Also, this means each spouse automatically has a 50% interest in property acquired with community property assets and a 50% interest in the other spouses’ income.

The existence of a grandchild creates the issue of generation-skipping ramifications for direct gifts and gifts in trust.

  1. For income tax purposes the house’s tax basis is stepped up to $950k. The house is community property despite the source of the funds because of the way it was held in title. Fifty percent of the equity is includible in John’s estate.

 

  1. The rental property is considered to be community property due to the timing of the purchase and the source of funds (i.e. purchased with community property assets). Fifty percent of the equity is includible in John’s estate. Pursuant to the terms of the trust the surviving trustee may subsequently title the property proportionately among the trust or allocate it to one trust by substituting other assets. The presence of family in the property implies a potential gift during the past three years to the extent the family paid less the fair market value rent. The amount by which the rent was below market during the past three years must be included in the estate.

 

  1. Naming Kevin on the checking account constitutes a gift by both spouses of a one-third interest in the account (i.e. $10k). However, because of the size of the gift and gift splitting rules, no Form 709 is necessary and this gift is not includible in John’s estate because of the $11,000 annual gift tax exclusion (this does not take into account the value of the rental home provided to Kevin and his family). One-third of the account is includible in John’s estate.

 

  1. Since Joanne purchased the shares for $0.50 per share in 1995, it’s likely she bought the stock with community property assets. Thus, the basis in the property is stepped up to its full fair market value. Also, fifty percent of the value is includible in John’s estate. It also will likely be treated as part of the living trust under the will’s pour-over provisions.

 

  1. Since the brokerage account was titled as community property, its cost basis is stepped up to its fair market value at date of death. Also, fifty percent of the value is includible in John’s estate. It also will likely be treated as part of the living trust under the will’s pour-over provisions.

 

  1. Generally, the automobile will be considered as community property as it was likely acquired with community property funds (the loan was probably paid for with CP funds). It will be poured-over into the trust and fifty percent of the value is includible in John’s estate.

 

  1. Because the life insurance was owned by John and Joanne as community property, fifty percent of the proceeds will be includible in John’s estate. The other half will be included in Joanne’s survivors trust. In fact, all of Joanne’s shares of the community property assets go to her Survivor’s trust.

 

  1. The 401(k) plan is includible in its entirety in john’s estate. Joanne will likely be treated as an alternate owner and will receive a distribution that she can roll into her own IRA. The 401(k) plan’s distribution rules will determine the treatment. Any distributions to Joanne not rolled over will be taxable as ordinary income to Joanne.

 

  1. Under the “Incidental Powers” concept the surrender of the power to name additional beneficiaries is not deemed to be a taxable power. Thus, the value as of the date of the surrender does not constitute a taxable gift and is not includible in John’s estate.

 

  1. The gift of the shares of stock to each child is valued at $5,000 which is well under the $11,000 annual exclusion. In and of themselves the gifts are not taxable. However, when combined with other gifts they may be required to be reported. The custodial accounts are irrevocable and beneficiaries cannot be changed, so they are not includible in John’s estate. Each child will have a carryover tax basis of $0.50 per share. The gifts would not be includible in John’s estate unless if taken together with other gifts, the annual exclusion is exceeded.

 

  1. Each 4 acre parcel carry’s a value of $10,000. Thus, the gifts, whether direct or in trust, are below the $11,000 annual exclusion and unless when combined with other gifts the totals exceed $11,000, are not required to be reported. However, given the nature of real estate, it would be wise to obtain an appraisal and file a gift tax return anyway in order to get the statute of limitations clock running on the valuation of the land. Particularly while its low and before the large developer comes in and drives up prices. The gifts in trust appear to be complete and are only includible in John’s estate by reason of the gift being made within three years of his death. Tax basis in each gift is $4,000.

 

  1. The funeral expenses are deductible against the value of the estate. The attorney and accounting fees are deductible on the estates income tax return.

 

  1. The $100,000 contribution to the UCLA Foundation is deductible against the value of the estate for estate tax purposes or can be deducted by the estate on its income tax return, not both.

The Trust splits into three parts with Joanne’s share of the community property assets and her separate property (if any) are funding the survivor trust. The bypass trust and marital trust is funded with John’s assets. As long as Joanne maintains the standards with respect to the bypass trust it will remain outside her estate. It should be funded with $1,500,000 in assets. John’s remaining assets will go in to the marital trust and provide income to Joanne for the rest of her life. The marital trust will be includible in Joanne’s estate along with her survivor trust. No estate tax will be due on John’s death since the property transferred to the marital trust is eligible to be treated as the marital deduction.

Customer: replied 11 years ago.

Would you be able to help me with these questions below?

Assumptions: Except as otherwise stated, A starts out with non-depreciable real property (a capital asset) worth $100 (adjusted basis $40) and ends up with cash of $50 plus a 50% interest worth $50 in X, a newly organized corporation that owns the property.

In each problem, determine the following:

1. A’s amount realized
2. A’s gain or loss realized
3. A’s gain or loss recognized and the character thereof
4. A’s basis in the X stock received
5. A’s holding period for the X stock received (tacked or not?)
6. X’s basis in the property received
7. X’s holding period for the property received (tacked or not?)
8. The amount and character of X’s gain if X immediately sells the property for $100

#1) A transfers the property to X in exchange for all of X’s stock. Shortly thereafter, A sells half of his X stock to B for $50 and either

a) The stock sale is a “separate” event from the prior incorporation transaction; or
b) The stock sale is an integral part of the incorporation plan

Would the results be different if X made an S election? What if the basis for A’s property were $200 rather than $40?

#2) A sells a half interest in the property to B for $50. A and B then jointly transfers their property interests to X in exchange for X’s stock.

#3) A and B jointly organize X. A transfers his property to X in exchange for $50 in cash and half of X’s stock. B transfers $50 in cash to X in exchange for the other half of X’s stock.

#4) What would result in (3) above if A received $50 in five-year notes instead of cash? Assume the notes are debt and not equity.

#5) What would result in 1(a) above if A receives only “pure preferred” stock of X that is required to be redeemed in 5 years for $100?

#6) A borrows $50 from L (nonrecourse) on the security of the property. Shortly thereafter, A transfers the property to X (subject to this debt) in exchange for half of X’s stock, and B transfers $50 in cash to X in exchange for the other half of X’s stock. X subsequently uses the $50 cash to repay L.

#7) Same as (6) but the debt is recourse as to A and X does not assume it and A receives 100 shares and B receives 50 shares.

#8) A transfers $100 in uncollected customer accounts receivable (from A’s cash-basis service business) to X in exchange for half of X’s common stock plus X’s assumption of $50 of accounts payable attributable to the service business (which $50 A could have deducted upon payment in cash). B transfers $50 in cash to X in exchange for the other half of X’s stock. X uses this cash to pay off the assumed accounts payable.

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