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.