Basic Estate
Tax
Planning
Professor Angela M. Vallario, Editor
Table of Contents
Chapter
One
Basic Principles and General
Planning Considerations
I.
[§ 1.1]
Overview
............................................................................................................... 1
II.
[§ 1.2]
THE
ESTATE TAX OBJECTIVES .......................................................................... 1
III.
[§ 1.3]
THE
METHODS ....................................................................................................... 1
IV.
ADDITIONAL
ESTATE-PLANNING COMPONENTS ........................................................ 2
A.
[§ 1.4]
Liquidity
....................................................................................................................... 2
1.
[§ 1.5]
Life
insurance ......................................................................................................... 3
2.
[§ 1.6]
Jointly
owned property ............................................................................................. 4
B.
[§ 1.7]
Valuation
...................................................................................................................... 4
1.
[§ 1.8]
Alternate
valuation .................................................................................................. 4
2.
[§ 1.9]
I.R.C.
§ 2032A — special use valuation ................................................................... 5
C.
[§ 1.10]
Domicile
....................................................................................................................... 5
Chapter
Two
Tax Planning
I.
[§ 2.1]
OVERVIEW
OF FEDERAL ESTATE AND GIFT TAX LAW AND
STATE ESTATE TAX ............................................................................................... 9
A.
The
Federal Tax Base ................................................................................................................. 9
1.
[§ 2.2]
Gift
tax ................................................................................................................... 9
2.
[§ 2.3]
Estate
tax ............................................................................................................... 9
B.
[§ 2.4]
Basis
.......................................................................................................................... 11
C.
[§ 2.5]
The
Maryland Estate Tax Decoupled from the Federal Estate Tax ................................. 11
D.
[§ 2.6]
The
Federal Marital Deduction ..................................................................................... 12
E.
[§ 2.7]
Planning
with the Unified Credit ................................................................................... 13
F.
[§ 2.8]
Disclaimers
................................................................................................................. 14
II.
THE
MARITAL DEDUCTION AND CREDITS AGAINST ESTATE TAX ....................... 15
A.
Qualifying
for the Unlimited Marital Deduction ............................................................................ 15
1.
[§ 2.9]
The
elements ........................................................................................................ 15
2.
[§ 2.10]
Interest
passing from decedent ............................................................................... 15
3.
[§ 2.11]
Terminable
interest ................................................................................................ 15
4.
[§ 2.12]
Valuation
.............................................................................................................. 16
B.
[§ 2.13]
Credits
........................................................................................................................ 16
1.
[§ 2.14]
Unified
credit ........................................................................................................ 16
2.
[§ 2.15]
State
death tax credit ............................................................................................. 16
C.
Formula
Clauses — Uses and Purposes ...................................................................................... 17
1.
[§ 2.16]
What
is a formula clause? ...................................................................................... 17
2.
[§ 2.17]
Operation
of formula clauses .................................................................................. 17
D.
[§ 2.18]
Where
are Formula Clauses Used? .............................................................................. 17
1.
[§ 2.19]
QTIP
election ....................................................................................................... 17
2.
[§ 2.20]
Disclaimer
............................................................................................................ 17
E.
[§ 2.21]
Ineffective
or Inappropriate Uses of Formula Clauses .................................................... 18
1.
[§ 2.22]
Lack
of assets to be divided ................................................................................... 18
2.
[§ 2.23]
Pre-death
funding of equivalent exempt amount for each spouse .............................. 18
3.
[§ 2.24]
Formula
clause undesirable .................................................................................... 18
a.
Postponing decision until after death of
first spouse to die ............................................................ 18
b.
Estate equalization .................................................................................................................... 19
c.
Cutback on formula .................................................................................................................. 19
F.
[§ 2.25]
Types
of Formula Clauses ............................................................................................ 19
1.
[§ 2.26]
Pecuniary
marital deduction disposition ................................................................... 19
a.
Operation of formula in determining
amount of legacy ................................................................. 20
b.
Allocation of gains and losses .................................................................................................... 21
c.
Allocation of income during
administration .................................................................................. 21
d.
Income tax considerations for marital
deduction pecuniary bequest .............................................. 23
2.
[§ 2.27]
Credit
shelter pecuniary disposition ......................................................................... 25
a.
Operation of credit shelter pecuniary
disposition .......................................................................... 25
b.
Allocation of gains and losses .................................................................................................... 26
c.
Allocation of income during
administration .................................................................................. 26
d. Income tax considerations for credit shelter
pecuniary bequest .................................................... 27
3.
[§ 2.28]
Fractional
share disposition ..................................................................................... 27
a.
Operation of fractional share ..................................................................................................... 27
b.
Definition of residuary estate ..................................................................................................... 27
c.
Allocation of income during
administration .................................................................................. 27
G.
Funding
Problems and Solutions .................................................................................................. 29
1.
[§ 2.29]
Funding
the fractional share of residue disposition .................................................... 29
2.
[§ 2.30]
Pecuniary
amount dispositions — distributions in kind ............................................... 29
a.
“True Worth” funding ............................................................................................................... 29
b.
Rev. Proc. 64-19 — Fairly representative
value funding .............................................................. 29
c.
Minimum-worth funding provisions for
marital deduction pecuniary dispositions ............................. 30
3.
[§ 2.31]
Avoiding
recognition of I.R.C. § 691 income ........................................................... 30
H.
Choosing
the Formula Clause ...................................................................................................... 31
1.
[§ 2.32]
Credit
shelter or marital deduction pecuniary formula ............................................... 31
2.
[§ 2.33]
Marital
deduction pecuniary or fractional share formula ........................................... 32
I.
[§ 2.34]
Other
Reading ............................................................................................................. 32
III.
USE
OF MARITAL TRUSTS ................................................................................................ 32
A.
[§ 2.35]
Why
Use a Trust for the Marital Deduction? ................................................................. 32
B.
[§ 2.36]
General
Background .................................................................................................... 33
C.
Types
of Marital Deduction Trusts .............................................................................................. 33
1.
[§ 2.37]
General
power of appointment trusts ....................................................................... 33
a.
Requirements ........................................................................................................................... 33
b.
Advantages .............................................................................................................................. 33
c.
Disadvantages .......................................................................................................................... 33
d.
Drafting suggestions ................................................................................................................. 34
2.
[§ 2.38]
Estate
Trusts — Treas. Regs. § 20.2056(c)-1(b) ..................................................... 34
a.
Requirements ........................................................................................................................... 34
b.
Advantages .............................................................................................................................. 34
c.
Disadvantages .......................................................................................................................... 35
d.
Drafting suggestions ................................................................................................................. 35
3.
[§ 2.39]
Qualified
terminable interest property (“QTIP”) trusts ............................................. 35
a.
Requirements ........................................................................................................................... 36
b.
Advantages .............................................................................................................................. 41
c.
Disadvantages .......................................................................................................................... 42
d.
Drafting suggestions ................................................................................................................. 42
e.
Partial QTIP elections ............................................................................................................... 43
f.
Subsequent tax treatment of QTIP
property ............................................................................... 44
4.
[§ 2.40]
Marital
Deduction Charitable Remainder — Trusts .................................................. 45
5.
[§ 2.41]
Irrevocable
Inter-Vivos QTIP Trusts — I.R.C. § 2523(f) ........................................ 45
a.
Considerations .......................................................................................................................... 45
b.
Requirements ........................................................................................................................... 45
c.
Tax consequences .................................................................................................................... 46
6.
[§ 2.42]
Qualified
Domestic Trust (“QDT”) — I.R.C. § 2056A ............................................ 46
a.
Requirements ........................................................................................................................... 46
b.
Subsequent tax treatment of QDT property
................................................................................ 46
c.
Drafting and planning suggestions .............................................................................................. 47
IV.
“BYPASS”
OR “CREDIT SHELTER” TRUSTS ................................................................. 47
A.
[§ 2.43]
Reasons
for a Bypass Trust ......................................................................................... 47
B.
To
what extent can the surviving spouse have an interest in the bypass trust and
still not have
that interest taxed in that spouse’s estate? ................................................................................... 48
1.
[§ 2.44]
The
problem — general powers of appointment ....................................................... 48
2.
[§ 2.45]
Ascertainable
standards — first exception to the general power of
appointment rule .................................................................................................... 49
3.
[§ 2.46]
The
five and five power — second exception to the general power of
appointment rule .................................................................................................... 50
4.
[§ 2.47]
Can
the spouse or another beneficiary be the trustee of the bypass trust
without unfavorable estate tax consequences? ......................................................... 51
5.
[§ 2.48]
Can
the spouse be given power to remove the trustee of the bypass trust? ................ 52
6.
[§ 2.49]
Gift
tax problems associated with powers of appointment ......................................... 53
7.
[§ 2.50]
Income
tax consequences of five and five powers — A dilemma ............................. 54
V.
Disclaimers
..................................................................................................................... 55
A.
[§ 2.51]
Generally
.................................................................................................................... 55
B.
[§ 2.52]
Disclaimers
................................................................................................................. 55
1.
[§ 2.53]
The
federal law ..................................................................................................... 56
2.
[§ 2.54]
The
Maryland disclaimer law ................................................................................. 56
VI.
Appendix
............................................................................................................................. 58
Form 2-1.
[§ 2.55]
Disclaimer
by Spouse to Bypass Trust (“Yuppie Will”) ...................................... 59
Form 2-2.
[§ 2.56]
Pecuniary
Marital Deduction Formula Bequest .................................................. 59
Form 2-3.
[§ 2.57]
Pecuniary
Credit Shelter Formula Bequest ........................................................ 60
Form 2-4.
[§ 2.58]
Fractional
Share Formula Bequest .................................................................... 60
Form 2-5.
[§ 2.59]
Standard
QTIP Marital Trust Funding Formula (Pecuniary Marital Trust) ........... 61
Form 2-6.
[§ 2.60]
Marital
QTIP Trust Provisions for Partial or Full QTIP Election ......................... 62
Form 2-7.
[§ 2.61]
Standard
Credit (or “By Pass” ) Trust .............................................................. 63
Form 2-8.
[§ 2.62]
Clayton
QTIP Trust with Election Into Credit Trust ........................................... 64
Form 2-9.
[§ 2.63]
Alternate
Spray Provision for Credit Trust During Spouse’s Life ........................ 66
Form 2-10.
[§ 2.64]
Trustee
Limitation Provision ............................................................................. 67
Form 2-11.
[§ 2.65]
Pecuniary
Credit Trust Limited to Amount That Can Pass Free of State
Estate Tax Balance of Estate Divided Into QTIP Trust Equal to Balance of
Federal Credit and a Marital Share QTIP .......................................................... 67
Form 2-12.
[§ 2.66]
Specific
Bequest of Amount of Federal Estate Tax Exemption in Excess of
Domiciliary State Exemption to Separate QTIP Trust ........................................ 68
Form 2-13.
[§ 2.67]
Disclaimer
...................................................................................................... 69
Form 2-14.
[§ 2.68]
Disclaimer
...................................................................................................... 69
Form 2-15.
[§ 2.69]
Disclaimer
...................................................................................................... 69
Form 2-16.
[§ 2.70]
Disclaimer
...................................................................................................... 70
Chapter
Three
Coordination of Asset Disposition, Will
Provisions,
and Ownership to Accomplish the Overall Estate Plan
I.
[§ 3.1]
THE
QUESTIONS ................................................................................................... 71
II.
[§ 3.2]
THE
TYPICAL PROBLEM SITUATIONS ........................................................... 72
III.
TITLING
OF ASSETS ........................................................................................................... 73
A.
General
Rules ............................................................................................................................ 73
1.
[§ 3.3]
Liability
concerns .................................................................................................. 73
2.
[§ 3.4]
Utilize
individual exclusions .................................................................................... 73
3.
[§ 3.5]
Avoid joint ownership with children ........................................................................ 73
B.
Real
Estate ................................................................................................................................ 73
1.
[§ 3.6]
Residence
............................................................................................................. 73
2.
[§ 3.7]
Other
real estate located in state of domicile ........................................................... 74
3.
[§ 3.8]
Other
real estate located outside state of domicile .................................................... 74
C.
Bank
Accounts .......................................................................................................................... 74
1.
[§ 3.9]
Multiple
party accounts — in general ...................................................................... 74
2.
[§ 3.10]
Joint accounts ...................................................................................................... 74
3.
[§ 3.11]
Convenience
or power of attorney accounts ............................................................ 74
4.
[§ 3.12]
Trust
accounts ...................................................................................................... 74
5.
[§ 3.13]
Payable
on death accounts ..................................................................................... 74
D.
Tangible Personal Property of Domestic or
Personal Use ............................................................ 75
1.
[§ 3.14]
Tangible
personal property ..................................................................................... 75
2.
[§ 3.15]
Contradictory
ownership statements ....................................................................... 75
3.
[§ 3.16]
Distribution
provisions ............................................................................................ 75
E.
[§ 3.17]
Community
Property .................................................................................................... 75
F.
[§ 3.18]
Stocks,
Bonds and Other Investment Assets ................................................................. 75
G.
[§ 3.19]
Revocable
Trusts ........................................................................................................ 75
IV.
COORDINATION
BETWEEN HUSBAND’S AND WIFE’S WILLS .................................. 75
A.
[§ 3.20]
Marital
Deduction ........................................................................................................ 75
B.
[§ 3.21]
Pour
Overs and Mergers ............................................................................................. 76
C.
[§ 3.22]
Presumption
of Survivorship ......................................................................................... 76
D.
[§ 3.23]
Fiduciary
Appointments ............................................................................................... 76
E.
[§ 3.24]
Generation-Skipping
..................................................................................................... 76
V.
LIFE
INSURANCE ................................................................................................................ 77
A.
Ownership/Beneficiary
Designation — Single Life Policy ............................................................. 77
1.
[§ 3.25]
Insured
as owner ................................................................................................... 77
2.
[§ 3.26]
Insured’s
spouse as owner ..................................................................................... 79
3.
[§ 3.27]
Children
of insured as owners ................................................................................ 81
4.
[§ 3.28]
Irrevocable
insurance trust as owner ...................................................................... 81
5.
[§ 3.29]
Corporation
as owner ............................................................................................ 82
6.
[§ 3.30]
Other
stockholders as owners ................................................................................ 84
B.
[§ 3.31]
Ownership/Beneficiary Designation — Second to
Die Policy ........................................ 84
1.
[§ 3.32]
Both
insureds as owners — husband and wife situation ............................................ 84
2.
[§ 3.33]
Children
of insureds (husband and wife) as owners .................................................. 85
3.
[§ 3.34]
Irrevocable
Insurance Trust as Owner .................................................................... 85
VI.
QUALIFIED
PLAN BENEFITS AND IRAs ........................................................................ 85
A.
Tax
Consequences ..................................................................................................................... 85
1.
[§ 3.35]
Estate
tax ............................................................................................................. 85
2.
[§ 3.36]
Income
tax ............................................................................................................ 86
B.
[§ 3.37]
Beneficiary
Designations ............................................................................................. 86
VII.
[§ 3.38]
CLOSELY
HELD BUSINESS INTERESTS ........................................................... 87
A.
Corporation
............................................................................................................................... 88
1.
[§ 3.39]
Redemption
........................................................................................................... 88
2.
[§ 3.40]
Buy-Sell
................................................................................................................ 88
3.
[§ 3.41]
Retention
in trust — QSST or ESBT ...................................................................... 88
B.
Partnership
................................................................................................................................ 88
1.
[§ 3.42]
Successor in interest ............................................................................................. 88
2.
[§ 3.43]
Buy-Sell
................................................................................................................ 88
C.
Sole
Proprietorship — Buy Out ................................................................................................... 88
VIII.
[§ 3.44]
POWERS OF APPOINTMENT ......................................................................... 89
IX.
ANCILLARY
DOCUMENTS ................................................................................................ 89
A.
Power
of Attorney ..................................................................................................................... 89
1.
[§ 3.45]
Generally
.............................................................................................................. 89
2.
[§ 3.46]
Agent’s
relationship with principal’s guardian .......................................................... 90
3.
[§ 3.47]
Termination
of agent’s authority ............................................................................. 90
B.
[§ 3.48]
Advance
Directive ...................................................................................................... 90
C.
[§ 3.49]
Successor
Custodian under the Uniform Transfers to Minors Act ................................... 91
X.
Appendix
............................................................................................................................. 91
Form 3-1.
[§ 3.50]
Will
Provisions ................................................................................................ 91
Form 3-2.
[§ 3.51]
Marital Bequest in