Ask the Experts – April 11

Ask the Experts!

The professionals at Advanced Underwriting Consultants (AUC) answer the tax and technical questions posed by producers. Here’s the question of the day.

Question: My client transferred his life insurance policy to an ILIT to avoid having the death benefit included in his gross estate. I’ve heard that if he dies within three years from the transfer, the death benefit will be brought back into his estate. Is this correct? Does the fact that he paid a gift tax based on the cash value affect the amount he would owe for estate tax purposes?

Answer: Yes, under Section 2035, the entire death benefit will be included in your client’s gross estate if he dies within three years from the date of the transfer to the ILIT. However, the fact that your client paid a gift tax (or used a portion of his unified credit to pay the tax) would lower the amount he owes for estate taxes.

For example, let’s say your client has given away enough money that he’s already used up his $5.34 million lifetime exclusion amount (as of 2014). Also suppose he owns a life insurance policy with a cash value of $600,000 and a death benefit of $1 million. If he transfers the policy to his ILIT in 2014, he will incur a $240,000 (40% of $600,000) gift tax in 2014. If he survives for three more years, the entire $1 million death benefit will be excluded from his gross estate.

On the other hand, let’s say he dies within three years from the transfer. Section 2035 brings the full value of the death benefit back into his gross estate, and ordinarily the $1 million death benefit would incur a $400,000 estate tax (40% of $1 million); however, your client would get credit for the $240,000 gift tax he has already paid, resulting in an estate tax of $160,000 ($400,000 less $240,000).

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Ask the Experts – February 27

Ask the Experts!

The professionals at Advanced Underwriting Consultants (AUC) answer the tax questions posed by producers. Here’s the question of the day.

Question: A client’s husband died in 2011 leaving his entire estate to her. His estate was small enough that no estate tax return was filed. Does the deceased husband’s unused estate tax exclusion amount automatically transfer to his surviving spouse? If not, is it too late to elect to have it transfer?

Answer: The deceased spouse’s unused exclusion amount (or “DSUE amount”) doesn’t transfer to his surviving spouse automatically—she must file an estate tax return (Form 706) on behalf of the deceased spouse’s estate. However, she should still have until the end of 2014 to make the portability election.

Portability is an estate planning option that allows a deceased spouse to transfer his unused estate tax applicable exclusion amount ($5.34 million in 2014, indexed for inflation) to his surviving spouse.

For example, if your client’s husband died in 2011 without having used any of his $5 million exclusion amount, his wife can add her husband’s full $5 million unused exclusion amount to her own current $5.34 million exclusion amount. Therefore, when the wife dies, she can pass up to $10.34 million.

Generally, to make the portability election, an estate tax return must be filed within 9 months from the deceased spouse’s date of death. Since no estate tax return was filed on behalf of her deceased spouse’s estate, she missed the 9-month window.

Ordinarily, your client would be out of luck, but the IRS recently issued Revenue Procedure 2014-18, extending the 9-month deadline for spouses who died in 2011, 2012 or 2013 and who were not required to file a federal estate tax return—qualifications your client probably meets.

Therefore, for taxpayer in the same position as your client, instead of the 9-month deadline, the deceased spouse’s estate has until the end of 2014 to file Form 706. For a spouse who died this year (or who dies thereafter), the ordinary 9-month rule still applies.

For those filing Form 706 late pursuant to Revenue Procedure 2014-18, the following language must be included at the top of the form in capital letters:

FILED PURSUANT TO REV. PROC. 2014-18 TO ELECT PORTABILITY UNDER § 2010(c)(5)(A).

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Question of the Day – June 22

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Here’s the question of the day.

Question: Do Native Americans living on a reservation pay federal income taxes and estate taxes?

Answer: Yes. As U.S. citizens, Native Americans are subject to U.S. income and estate tax law.

Here’s an excerpt from the Bureau of Indian Affairs website:

Are American Indians and Alaska Natives citizens of the United States?
Yes. As early as 1817, U.S. citizenship had been conferred by special treaty upon specific groups of Indian people. American citizenship was also conveyed by statutes, naturalization proceedings, and by service in the Armed Forces with an honorable discharge in World War I. In 1924, Congress extended American citizenship to all other American Indians born within the territorial limits of the United States. American Indians and Alaska Natives are citizens of the United States and of the individual states, counties, cities, and towns where they reside. They can also become citizens of their tribes or villages as enrolled tribal members.

Do American Indians and Alaska Natives pay taxes?
Yes. They pay the same taxes as other citizens with the following exceptions:

Federal income taxes are not levied on income from trust lands held for them by the U.S.
State income taxes are not paid on income earned on a federal Indian reservation.
State sales taxes are not paid by Indians on transactions made on a federal Indian reservation.
Local property taxes are not paid on reservation or trust land.

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Question of the Day – December 20

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Here’s the question of the day.

Question: My client owns a working farm, which is also a prime parcel of real estate for residential development. How would the farm be valued for federal estate tax purposes?

Answer: Most assets are valued at their fair market value, which means that it’s the price a willing buyer would pay a willing seller.

Section 2032A of the Revenue Code provides that the administrator of an estate can elect a special use valuation for a farm under certain circumstance. That means the land can be valued as a working farm—often yielding a low value—rather than as a potential parcel for development, which would produce a higher value for estate tax purposes.

Here are the requirements for making the Section 2032A election:

1. On the date of the decedent’s death, the property must be in use as a farm or in a trade or business other than farming.

2. The net value of the property must equal at least 50% of the decedent’s gross estate.

3. At least 25% of the gross estate (less debts and unpaid mortgages on all property in the gross estate) must be qualified farm or closely held business real property.

4. The property must pass to a member of the decedent’s immediate family.

5. The real property must have been owned by the decedent or a member of his family and used as a farm or in a closely held business for an aggregate of five years or more of the eight year period ending on the date of the decedent’s death.

The maximum reduction of the decedent’s gross estate under this provision is $1,000,000, indexed for inflation. The indexed amount for 2011 is $1,020,000.

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Question of the Day – October 7

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The professionals at Advanced Underwriting Consultants (AUC) answer the tax and technical questions posed by producers. Here’s the question of the day.

Question: I am working with a couple where one of the spouses is not a U.S. citizen. What special federal estate tax rules do I need to be worried about?

Answer: The 1988 Tax Act eliminated the marital deduction for estate owners whose surviving spouses are not U.S. citizens. At-death transfers from a citizen to a non-U.S. citizen spouse do not have the same tax treatment as transfers between two citizen spouses since the unlimited estate tax marital deduction is unavailable.

There are two exceptions to the general rule. The marital deduction is available:

(1) if the surviving spouse becomes a citizen before the decedent spouse’s estate tax return is filed and she was a U.S. resident at all times after decedent’s death; or

(2) if the property passing to the surviving spouse is transferred to a Qualified Domestic Trust (QDT).

The deceased spouse’s unified gift and estate tax credit – currently equivalent to an exemption of $5,000,000 in 2011 – can be applied against any at-death transfers that fail to qualify for the marital deduction.

A QDT is a trust meeting the following requirements:

The trust is created and maintained under the laws of the United States, any state or the District of Columbia.

The trust meets the regular marital deduction requirements; that is; it is either a general power of appointment trust, an estate trust, a qualified terminable interest property (QTIP) trust, or a special rule, charitable remainder trust.

At least one trustee is an individual who is a United States citizen or a domestic corporation.

The trust instrument provides that no distributions of trust principal will be made unless the trustee withholds the estate tax due on the distribution.

Distributions of trust income from a QDT to a surviving spouse are subject to a special estate tax on distributions from a QDT in the following circumstances:

1. On distributions of trust principal to the surviving spouse during her lifetime. Distributions of principal made on account of hardship are not subject to the special estate tax. A distribution is made on account of hardship if made in response to an immediate and substantial financial need relating to health, maintenance, or support. The spouse first must exhaust other reasonably available resources prior to requesting a hardship distribution.

2. On trust assets remaining at the death of the surviving spouse.

3. On trust assets remaining at the time the trust fails to qualify as a QDT, e.g. when there is no longer a U.S. trustee.

The estate tax due is the tax, which would have been collected, had the distribution been included in the decedent’s estate.

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