Recent Gift and Estate Tax Changes

Overview of the new law. The 2012 Taxpayer Relief Act made permanent many estate, gift and GST tax provisions, including the ability to transfer any unused estate exemption amount between spouses (referred to as “portability”), that were due to expire on Dec. 31, 2012. The Act also increased the maximum estate, gift and GST tax rate to 40%. Higher rate and higher exemption for 2013. For estates of individuals dying and gifts made in 2013, the top transfer tax rate is 40%.


Old GST Tax Rates

Before the 2012 Taxpayer Relief Act, the top rate was to rise to 55% for estates of individuals dying and gifts made after 2012. So, although the 40% rate is less beneficial than 35% rate applicable for 2012 transfers, it is much better than the 55% rate that would have existed if Congress had not taken action. Further, the 2012 Taxpayer Relief Act made permanent the $5 million exemption from 2011, adjusted annually for inflation. The exemption amount is $5.25 million in 2013, which is far more advantageous than the $1 million exemption that was expected to apply in 2013 in the absence of new legislation.


GST tax changes made permanent.

GST tax changes made permanent. The GST tax is an additional tax on gifts and bequests to grandchildren when their parents are still alive. The 2012 Taxpayer Relief Act prevented the GST exemption amount from returning to $1 million (which would have been adjusted for inflation and been $1.36 million in 2013). Instead, the Act increased the maximum GST tax rate to 40%. Additionally, the Act made permanent many of the technical provisions that were set to expire, including those regarding automatic and retroactive allocation of GST exemption in some circumstances, valuation in determining the inclusion ratio, qualified severances, and relief for late elections Continuation of portability.


Portability Provisions for Surviving Spouse Estate Tax

The 2012 Tax Relief Act also made permanent the election for a surviving spouse to use any exemption that remains unused as of the death of the first spouse, in addition to his or her own $5.25 million exemption (the exemption amount for 2013) for taxable transfers made during life or at death. If this portability feature had expired at the end of 2012 as was scheduled, the exemption of the first spouse to die would have been lost if not used, or if proper planning (such as the creation of a credit shelter trust) was not done.

What is the Portability of Estate Tax?

While this portability rule may make credit shelter trusts unnecessary in some cases, credit shelter trusts can be beneficial because they may shield some appreciation from estate tax and offer protection from creditors. Note that the transferred exemption may be lost if the surviving spouse remarries and is again widowed. Conclusion. The 2012 Taxpayer Relief Act made many estate, gift and GST tax rules permanent by repealing the sunset language that was in place in previous legislation, and thereby eliminated the uncertainty as to what the state of transfer tax law would be in 2013 and beyond. Although benefits such as the large exemption amount and portability remain and protect significant assets from transfer tax,

Frequently Asked Questions on IRS Gift Taxes

Below are some of the more common questions and answers about Gift Tax issues. You may also find additional information in Publication 559 or some of the other forms and publications offered on our Forms Page. Included in this area are the instructions to Forms 706 and 709. Within these instructions, you will find the tax rate schedules to the related returns. If the answers to your questions can not be found in these resources, we strongly recommend visiting with a tax practitioner.

Who pays the gift tax?

The donor is generally responsible for paying the gift tax. Under special arrangements the doneemay agree to pay the tax instead. Please visit with your tax professional if you are considering this type of arrangement. The person who makes the gift files the gift tax return, if necessary, and pays any tax. If someone gives you more than the annual gift tax exclusion amount ($14,000 in 2015 and 2016), the giver must file a gift tax return. That still doesn’t mean they owe gift tax


What is considered a gift?

Any transfer to an individual, either directly or indirectly, where full consideration (measured in money or money’s worth) is not received in return. A gift tax is a tax imposed on the transfer of ownership of property. The United States Internal Revenue Service says, a gift is “Any transfer to an individual, either directly or indirectly, where full consideration (measured in money or money’s worth) is not received in return.”


What can be excluded from gifts?

The general rule is that any gift is a taxable gift. However, there are many exceptions to this rule. Generally, the following gifts are not taxable gifts.

  1. Gifts that are not more than the annual exclusion for the calendar year.
  2. Tuition or medical expenses you pay for someone (the educational and medical exclusions).
  3. Gifts to your spouse.
  4. Gifts to a political organization for its use.

In addition to this, gifts to qualifying charities are deductible from the value of the gift(s) made.

May I deduct gifts on my income tax return?

Making a gift or leaving your estate to your heirs does not ordinarily affect your federal income tax. You cannot deduct the value of gifts you make (other than gifts that are deductible charitable contributions). If you are not sure whether the gift tax or the estate tax applies to your situation, refer to Publication 559, Survivors, Executors, and Administrators. You generally cannot deduct a gift to family member.


How many annual exclusions are available?

The annual exclusion applies to gifts to each donee. In other words, if you give each of your children $11,000 in 2002-2005, $12,000 in 2006-2008, $13,000 in 2009-2012 and $14,000 on or after January 1, 2013, the annual exclusion applies to each gift. The annual exclusion for 2014, 2015, and 2016 is $14,000.


What if my spouse and I want to give away property that we own together?

You are each entitled to the annual exclusion amount on the gift. Together, you can give $22,000 to each donee (2002-2005) or $24,000 (2006-2008), $26,000 (2009-2012) and $28,000 on or after January 1, 2013 (including 2014, 2015, and 2016).


What other information do I need to include with the return?

Refer to Form 709 (PDF), 709 Instructions and Publication 559. Among other items listed:

  1. Copies of appraisals.
  2. Copies of relevant documents regarding the transfer.
  3. Documentation of any unusual items shown on the return (partially-gifted assets, other items relevant to the transfer(s)).


What is “Fair Market Value?”

Fair Market Value is defined as: “The fair market value is the price at which the property would change hands between a willing buyer and a willing seller, neither being under any compulsion to buy or to sell and both having reasonable knowledge of relevant facts. The fair market value of a particular item of property includible in the decedent’s gross estate is not to be determined by a forced sale price. Nor is the fair market value of an item of property to be determined by the sale price of the item in a market other than that in which such item is most commonly sold to the public, taking into account the location of the item wherever appropriate.” Regulation §20.2031-1.


Whom should I hire to represent me and prepare and file the return?

The Internal Revenue Service cannot make recommendations about specific individuals, but there are several factors to consider:

  1. How complex is the transfer?
  2. How large is the transfer?
  3. Do I need an attorney, CPA, Enrolled Agent (EA) or other professional(s)?

For most simple, small transfers (less than the annual exclusion amount) you may not need the services of a professional.

However, if the transfer is large or complicated or both, then these actions should be considered; It is a good idea to discuss the matter with several attorneys and CPAs or EAs. Ask about how much experience they have had and ask for referrals. This process should be similar to locating a good physician. Locate other individuals that have had similar experiences and ask for recommendations. Finally, after the individual(s) are employed and begin to work on transfer matters, make sure the lines of communication remain open so that there are no surprises.


Gift and Estate Tax Planning

Finally, people who make gifts as a part of their overall estate and financial plan often engage the services of both attorneys and CPAs, EAs and other professionals. The attorney usually handles wills, trusts and transfer documents that are involved and reviews the impact of documents on the gift tax return and overall plan. The CPA or EA often handles the actual return preparation and some representation of the donor in matters with the IRS. However, some attorneys handle all of the work. CPAs or EAs may also handle most of the work, but cannot take care of wills, trusts, deeds and other matters where a law license is required. In addition, other professionals (such as appraisers, surveyors, financial advisors and others) may need to be engaged during this time


Do I have to talk to the IRS during an examination?

You do not have to be present during an examination unless IRS representatives need to ask specific questions. Although you may represent yourself during an examination, most donors prefer that the professional(s) they have employed handle this phase of the examination. You may delegate authority for this by executing Form 2848 “Power of Attorney.”


What if I disagree with the examination proposals?

You have many rights and avenues of appeal if you disagree with any proposals made by the IRS.  See Publications 1 and 5 (PDF) for an explanation of these options.

What if I sell property that has been given to me?

The general rule is that your basis in the property is the same as the basis of the donor. For example, if you were given stock that the donor had purchased for $10 per share (and that was his/her basis), and you later sold it for $100 per share, you would pay income tax on a gain of $90 per share. (Note: The rules are different for property acquired from an estate).

Most information for this page came from the Internal Revenue Code: Chapter 12–Gift Tax (generally Internal Revenue Code §2501 and following, related regulations and other sources)


Can a married same sex donor claim the gift tax marital deduction for a transfer to his or her spouse?

For federal tax purposes, the terms “spouse,” “husband,” and “wife” includes individuals of the same sex who were lawfully married under the laws of a state whose laws authorize the marriage of two individuals of the same sex and who remain married.  Also, the Service will recognize a marriage of individuals of the same sex that was validly created under the laws of the state of celebration even if the married couple resides in a state that does not recognize the validity of same-sex marriages.

Same Sex Spouse Gift Tax

However, the terms “spouse,” “husband and wife,” “husband,” and “wife” do not include individuals (whether of the opposite sex or the same sex) who have entered into a registered domestic partnership, civil union, or other similar formal relationship recognized under state law that is not denominated as a marriage under the laws of that state, and the term “marriage” does not include such formal relationships.

Common Estate and Gift Tax Terms and IRS Definitions

U.S. Estate Tax

Estate Tax – The estate tax is a tax on your right to transfer property at your death. It consists of an accounting of everything you own or have certain interests in at the date of death.


Form 706, United States Estate (and Generation-Skipping Transfer) Tax Return

Form 706, United States Estate (and Generation-Skipping Transfer) Tax Return – The executor of a decedent’s estate uses Form 706 to figure the estate tax imposed by Chapter 11 of the Internal Revenue Code. This tax is levied on the entire taxable estate and not just on the share received by a particular beneficiary. Form 706 is also used to figure the generation-skipping transfer (GST) tax imposed by Chapter 13 on direct skips (transfers to skip persons of interests in property included in the decedent’s gross estate).


Generation-Skipping Transfer (GST) Tax

Generation-Skipping Transfer (GST) Tax – The tax is imposed (with certain exemptions) on the occurrence of any one of three taxable events: a taxable termination, a taxable distribution (including distributions of income), and a direct skip (an outright transfer to or for the benefit of a person at least two generations below that of the transferor).


U.S. Gift Tax Definition

Gift Tax – The gift tax is a tax on the transfer of property by one individual to another while receiving nothing, or less than full value, in return. The tax applies whether the donor intends the transfer to be a gift or not.


Marital Deduction

Marital Deduction – One of the primary deductions for married decedents is the Marital Deduction. All property that is included in the gross estate and passes to the surviving spouse is eligible for the marital deduction. The property must pass “outright.” In some cases, certain life estates also qualify for the marital deduction.


Portability Election Between Spouses

Portability Election – The portability election passes along a decedent’s unused estate and gift tax exclusion amount to a surviving spouse.


Schedule PC, Protective Claim for Refund

Schedule PC, Protective Claim for Refund – A protective claim for refund preserves the estate’s right to a refund of tax paid on any amount included in the gross estate which would be deductible under section 2053 but has not been paid or otherwise will not meet the requirements of section 2053 until after the limitations period for filing the claim has passed.

New IRS Form 706 Gift Tax and Estate Tax

The revision of the Form 706 contains several important changes to the form that are the direct result of the new law. These changes can be summarized as three items: one, changes made to page one to allow for a computation of the applicable credit; two, a new page has been added for the portability election and portability election computations; and three, there is a new Schedule PC, which allows for the filing of protective claims. And these are the three areas that we will be focusing on during the presentation. I would encourage you, however, to take a look at the new instructions that are associated with the form. They are also, of course, available on


Biggest Changes to Gift Tax Form 706

The top of page one of the Form 706 really does not, for the most part, look very different than it has over recent years. Of course, there’s always the general information that is required, for example, the name of the decedent and the executor, the addresses and Social Security numbers and so forth. It’s vitally important that this portion of the return be prepared correctly. It’s, sometimes, easy to, kind of, skip over this because it seems to be so simple.


Wrong Social Security Number on Gift and Estate Tax Form

But, for example, if you put the wrong Social Security number in your tax form, it’s going to create a lot of problems down the road, not only with the filing of the return, but also with things such as posting information, posting payments and refunds and so forth to the account. Also, it’s important that you include the name, address and information for every executor of the estate on the Form 706.


Other Changes to Form 706

But, one thing I do want to point out to you, and it’s highlighted in yellow on the slide there, is there is a new line 11. This line asks the executor to indicate whether or not the executor is estimating the value of assets of the gross estate pursuant to Treasury Regulation 20.2010-2(a)(7). This line is the result of the regulations that were recently issued dealing with the portability election. If the executor is not making a portability election, then this box should not be checked. Likewise, if the executor is electing portability but is not subject to these particular regulations, then this box should not be checked as well.


Changes to Form 706

Now, basically, what this regulation provides is it provides a simplified method in certain circumstances for the executor to report the value of certain assets that are subject to the portability election. And, basically, just to, kind of, tell you what this election involves or what these regulations involve; under the new portability law, in order to elect portability, you must file an estate tax return even if you would not normally be required to file an estate tax return. And let me just give you a quick example here.

On page one of Form 706, part two, this is where the executor computes the amount of tax that is due. Of course, one of the major inputs into the computation is the amount of the applicable credit. And, just as a reminder, again, the applicable credit is the amount that is equal to the amount of tax that would be paid on the applicable exclusion amount. This applicable credit, then, is applied against the estate tax calculated on the taxable estate to reduce the estate tax for the applicable exclusion.

Estate Tax Exclusion Amount Form 706

As a result, part two of page one of the Form 706 has been changed, and you can see there highlighted in yellow, the applicable exclusion amount now includes the basic exclusion amount, which is $5,120,000.00 or, rather, I should say the amount of tax or, I’m sorry, the $5,120,000.00 plus line 9(b), any deceased spouse’s unused exclusion amount. You add those two amounts together on line 9(c), and then you are required on line 9(d) to compute the amount of tax that would be owed on this gross amount. And then, this amount of tax is what is eventually going to be subtracted from the overall estate tax in order to give your client their exclusion amount.

Form 706 Estate Tax Exclusions

Now, moving on through the Form 706, we get to page two and we see that page two, part three, allows the executor to make a number of different elections for the estate. For example, if the estate is electing the alternate valuation election, the special use election, or the 6166 election, those elections are made in this portion of the estate tax return. You will notice, however, that at the very top, there’s a little note there that tells the executor or the person preparing the return, that the portability election is found in a different section. The portability election, as we’re going to see in a few minutes, is actually in a different part of the return. It’s on page four, okay? There’s a whole new page that deals with nothing but portability. And so, if you’re looking for the portability election and you’re used to looking for elections in this part of the return, it’s not there.


Summary of IRS Form 706

As we move on to page three of the return, page three of the return includes, at the very bottom, the recapitulation, okay? The recapitulation is, basically, the portion of the form where the executor recaps all of the assets and the deductions for the estate. For those of you who may have never prepared a Form 706, the Form 706 consists, primarily, most of the pages consist of different schedules on which assets and deductions are reported.

Deceased spousal unused exclusion amount, or “DSUEA”

Deceased spousal unused exclusion amount, or “DSUEA”

Now, applicable exclusion amount is defined as the basic exclusion, which is the $5 million or the $5,120,000.00, plus the deceased spousal unused exclusion amount, or “DSUEA.” This, in effect, increases the applicable exclusion amount of an electing surviving spouse by any unused exclusion of an electing predeceased spouse. The portability provisions allow the surviving spouse to use the predeceased spouse’s unused exemption regardless of whether or not a bypass trust was established. The way that you determine what the deceased spousal unused exclusion amount is, is you basically compute the gross estate – or rather the taxable estate of the first spouse. Then, subtract out the basic exclusion amount, and the difference is the deceased spousal unused exclusion amount. Now, this amount is limited to the basic exclusion amount of $5 million.


Estate Tax and Spouses

If we assume that the first spouse dies with a taxable estate of $1 million and has no adjusted taxable gifts, then the surviving spouse will die, and if the surviving spouse dies with a taxable estate of $7 million and no adjusted taxable gifts; without portability what will happen is that if the first spouse leaves his or her estate to the survivor, then the survivor’s estate would be an $8 million taxable estate. The estate of the survivor would then owe tax on $3 million, or $8 million minus the $5 million, in 2011. However, under the portability provisions, if the proper elections are made, then the applicable exclusion amount of the surviving spouse will be the basic exclusion of $5 million, plus the predeceased spouse’s unused exclusion, which is $4 million. Well, how did I get that?


Estate Tax Exemption

Well, it’s $5 million minus the first spouse’s $1 million taxable estate, so $4 million. You add that to the basic exclusion amount of the surviving spouse, and you get $9 million. Therefore, there is more than enough applicable exclusion amount to cover the surviving spouse’s $8 million taxable estate. Therefore, there is no estate tax due at either spouse’s death. In effect, what portability does is it allows both spouses to pass a combined amount of $10 million estate and gift tax-free in 2011, or $10,240,000.00 for this year. Note, however, that the DSUEA does not affect the survivor’s filing requirements.


What are the Estate Tax Filing Requirements?

The filing requirements now are redefined to be based upon the basic exclusion amount, not the applicable exclusion amount. So, in my last example, if the decedent had had a gross estate of only say, $6 million, the surviving spouse would still have to file an estate tax return, even though he or she might have enough basic exclusion, plus DSUEA, to offset any tax that would be owed on that surviving spouse’s estate. Okay. One very important drawback on portability is the way the limitations periods work. As you know, with the estate and the gift tax law, there is a three-year period of limitations from the filing of the estate or the gift tax return. What this means is that if the Internal Revenue Service is going to examine that estate or gift tax return, they must do it within three years of time from the time that that return is filed.


Estate Tax Portability

One of the things that the portability legislation does is it opens up the limitations period for the first surviving spouse. The first surviving spouse, when they file their estate tax return in order to make this portability election – and we’ll talk about that in a few minutes – but when they file this estate tax return, the limitations period on that return will remain open until such time as the limitations period on the second spouse passes. So, let’s say, for example, the first spouse dies in 2010. If we assume that Congress continues to extend the portability provisions into future years, and the second spouse does not die until, say, 2020, that statute of limitations period will remain open until three years after the second spouse’s return is filed.


Limitations and DSUEA Amount

I would like to note, however, that that limitations period is only open for purposes of determining the amount of the unused exclusion amount, or the DSUEA amount. Okay. So, the IRS can’t come back 10 years later and assess additional tax. But you will not have any finality on what the DSUEA is until after the limitations period on the second spouse actually passes.

Summary for Estate Tax Portability Changes

Another drawback with respect to the portability provisions is this: in order to elect portability, the executor of the first spouse must file timely a Form 706 for that first spouse. Now, this is true, even though the first spouse might not normally have a filing requirement. Going back to one of my previous examples, if the first spouse’s estate is $1 million, normally there would not be a filing requirement there because the exclusion is $5 million. But if the taxpayer wants to elect portability, they must go ahead and file a Form 706 for that $1 million estate.


Electing Portability Election

If the executor makes that election, then the election is irrevocable. Another thing about portability I want to mention is that portability is only effective for estates of decedents dying after December 31, 2010. That applies to both the first spouse, as well as the second spouse. On this slide, there is a citation to Notice 2011-82, which the IRS issued on October 17, 2011. This notice provides guidance to taxpayers on how to go about electing portability.

Generation-skipping transfer tax, or GST tax.

Now, in addition to both the gift tax and the estate tax, there is what we call the “generation-skipping transfer” tax, or GST tax. The GST tax is an additional tax that is applied in a case of any transfer either during the lifetime of the transferor, or at the death of the transferor to any individual who is more than one generation below the transferor. The GST tax, again as I mentioned a moment ago, applies whether the transfer is made during the life or at the transferor’s death.


GST Exemption Amount

Now, there is an additional GST exemption which is also equal to the amount of the estate tax applicable exclusion. So, in addition to the estate and gift tax exclusions there is an additional exemption of GST which is $5,120,000.00 for 2012. So, these three taxes combined, the gift tax, the estate tax and the GST tax are sometimes referred to collectively as “transfer taxes.” The computations are such that basically what we are trying to get at is a single tax that is paid on all three types of transfers, although that tax may be paid at various moments during the lifetime of the transferor or at the transferor’s death.


Changes to GST Tax

Let’s talk about the GST tax. Under EGTRRA, the estate tax was repealed for 2010. But also, the GST tax was repealed for 2010. Under the 2010 Tax Relief Act, the GST tax was retroactively reinstated effective for GST transfers occurring after December 31, 2009, with a $5 million exemption. This is not surprising because the GST exemption is statutorily tied to the estate tax exclusion. However, in an interesting twist, for 2010, the applicable rate for GST transfers was set at zero percent. Now, the applicable rate is not the same thing as the tax rate, okay.


Applicable GST Rate

For those of you who may do a lot of GST tax work, you probably know that the applicable rate is basically the product of the maximum federal estate tax rate, as well as the inclusion ratio with respect to the transfer. I won’t get into all of the details of that. But let me just say to those of you who may work in this area, that the IRS interprets that zero percent as being a zero percent tax rate, not a zero percent inclusion ratio.


Changes in GST Tax Rate

The effect for 2010 is that any generation-skipping transfers were effectively taxed at a zero percent rate. So, there was no GST tax for 2010. For 2011 and following, however, the GST exemption amount is $5 million. Again, with the inflation adjustment for 2012, it’s $5,120,000.00. You will also see that the rate for the GST tax is 35 percent.

What is the Gross Estate for IRS Purposes?

Simply stated, the gross estate includes all property subject to the Federal estate tax. Thus, the gross estate depends on the provisions of the Internal Revenue Code as supplemented by IRS pronouncements and the judicial interpretations of Federal courts. In contrast to the gross estate, the probate estate is controlled by state (rather than Federal) law. The probate estate consists of all of a decedent’s property subject to administration by the executor or administrator of the estate. The administration is supervised by a local court of appropriate jurisdiction (usually called a probate court). An executor is the decedent’s personal representative appointed under the decedent’s will.

What is the Gross Estate for IRS Purposes?

When a decedent dies without a will or fails to name an executor in the will (or that person refuses to serve), the local probate court appoints an administrator. The probate estate is frequently smaller than the gross estate. It contains only property owned by the decedent at the time of death and passing to heirs under a will or under the law of intestacy (the order of distribution for those dying without a will). As noted later, such items as the proceeds of many life insurance policies and distributions from retirement plans become part of the gross estate but are not included in the probate estate. All states provide for an order of distribution in the event someone dies intestate (i.e., without a will). After the surviving spouse receives some or all of the estate, the preference is usually in the following order: down to lineal descendants (e.g., children and grandchildren), up to lineal ascendants (e.g., parents and grandparents), and out to collateral relations (e.g., brothers, sisters, aunts, and uncles).


Property Owned by the Decedent (§ 2033)

Property owned by the decedent at the time of death is included in the gross estate. The nature of the property or the use to which it was put during the decedent-owner’s lifetime has no significance as far as the estate tax is concerned. Thus, personal effects (such as clothing), stocks, bonds, mutual funds, furniture, jewelry, bank accounts, and certificates of deposit are all included in the deceased’s gross estate. No distinction is made between tangible and intangible, depreciable and nondepreciable, or business and personal assets. However, a deceased spouse’s gross estate does not include the surviving spouse’s share of the community property.


Other Items Included in Gross Estate

In addition to the items noted above, § 2033 operates to include in the gross estate many assets that can be of significant value. Examples include:

• Real estate holdings (but see § 2040 for jointly owned property).
• Present value of future royalty rights (e.g., patents, copyrights, and mineral interests).
• Interests in a business (i.e., sole proprietorship and partnership).
• Collectibles (e.g., works of art and coin collections).
• Renewal value of leasehold interests.
• Terminable interests (e.g., life estates in realty or trusts) held by a surviving spouse as to which a deceased spouse’s estate has made a QTIP election (discussed later in this chapter).
• Unmatured insurance policies on the lives of others.
• Proceeds from casualty and life insurance policies payable to the estate.
• Present value of pending and potential lawsuits or past judgments rendered.

Income in respect of a decedent IRD Calculation

What is Income in respect of a decedent IRD and how to calculate?

For the most part, property you inherit is not included in your income for tax purposes. Items which are IRD, however, do have to be included in your net income, although you may also be entitled to an IRD deduction on account of them. This can happen when a spouse dies in the middle of a tax year


What is IRD?

IRD is income which the decedent (the person from whom you inherit the property) would have taken into his income on his final income tax return except that death interceded. The most common IRD item is the decedent’s last paycheck, received after death. It would have normally been included in the decedent’s income on his final income tax return. However, since the decedent’s tax year closed as of the date of death, it was not included. As an item of IRD, it is taxed as income to whomever does receive it (the estate or another individual).

Income in respect of a decedent IRD Calculation

Not just the final paycheck, but any compensation-related benefits paid after death such as accrued vacation pay or voluntary employer benefit payments, will be IRD to the recipient. Other common IRD items include pension benefits and amounts in a decedent’s individual retirement accounts (IRAs) at death as well as a decedent’s share of partnership income up to the date of death. If you receive these IRD items, they are included in your income during the same tax year.


The IRD deduction

Although IRD must be included in the income of the recipient, a deduction may come along with it. The deduction is allowed (as an itemized deduction) to lessen the “double tax” impact that is caused by having the IRD items subject to the decedent’s estate tax as well as the recipient’s income tax. Although the deduction helps, it does not totally fix the problem of income in respect to decedent (IRD).


Calculate IRD Deduction

To calculate the IRD deduction, the decedent’s executor may have to be contacted for information. The deduction is determined as follows: First, you must take the “net value” of all IRD items included in the decedent’s estate. The net value is the total value of the IRD items in the estate, reduced by any deductions in respect of the decedent. These are items which are the converse of IRD: items the decedent would have deducted on his final income tax return, but for death’s intervening.


Calculating Tax from Income in respect of a decedent IRD Calculation

Next you determine how much of the federal estate tax was due to this net IRD by calculating what the estate tax bill would have been without it. Your deduction is then the percentage of the tax that your portion of the IRD items represents.

Qualified Personal Residence Trust (QPRT)

A special kind of irrevocable trust can be used to transfer your residence to your children at a significantly reduced gift tax cost and with no estate tax, yet allow you to continue to live in the residence for as long as you wish.


What is a qualified personal residence trust (QPRT)?

This special type of trust is known as a qualified personal residence trust (QPRT). (QPRTs are sometimes also referred to as “residence GRITs” or “house GRITs”.) These special trusts should be created with the skilled lawyer who is familiar with their tax consequences.


Transferring Residence into Trust

During your lifetime, you transfer your residence to the trustee, who (if state law permits) can be yourself. The trustee must allow you to continue to use the residence rent-free for a fixed number of years specified in the trust instrument (the “fixed term”), which should be a term you are likely to survive.


Why transfer residence into a trust for taxes?

During the fixed term, you will continue to pay mortgage expenses, real estate taxes, insurance, and expenses for maintenance and repairs, and will continue to deduct mortgage interest and real estate taxes on your individual income tax return. When the fixed term ends, the residence is distributed to your children, or remains in further trust for them.

Residence Trust

Even after the fixed term ends, you can continue to use the residence in one of two ways. First, rather than immediately distributing the residence to your children, the residence can be retained in trust for your spouse’s lifetime, thus assuring that the residence is available to you. Second, you can enter into a lease with your children which will allow you to live in the residence for as long as you wish. (If you do so, however, you must pay fair market value rent to your children after the fixed term ends in order to keep the residence from being subject to estate tax on your death.)


Taxable Gifts and Trusts

Although your transfer of the residence to the trust is a taxable gift, you are allowed to subtract, from the fair market value of the residence, the value of your right to live rent-free in the residence for the fixed term. Thus, the amount of the taxable gift will usually be substantially less than the fair market value of the residence. If the amount of the gift is less than your available exclusion from the gift tax ($5,250,000 in 2013, reduced by amounts allowed for gifts in previous years), no gift tax will be due as a result of your gift to the trust.


QPRT Trust Effect

If you survive the fixed term of the QPRT, the value of the residence will not be included in your estate for estate tax purposes. Even if you don’t survive the fixed term, the estate tax consequences will be no worse than they would have been if you hadn’t created the trust in the first place. A QPRT is an effective way to remove a residence’s value from your estate at a greatly reduced gift tax cost.

Estate Planning Techniques and Tax Strategies

Individuals might begin thinking about their estate plan, regardless of how soon it is likely to be used. Advance planning will help minimize the amount of tax paid and ensure that all distributions of property and money occur according to the decedent’s personal wishes.

Why do you need an estate plan?

If the individual has a business, middle age is the time to start thinking about a succession plan that will dictate what happens with the business upon retirement. Instead of continuing the business, another option is to sell the business and use the sale proceeds for retirement or bequests to subsequent generations.


When to start an Estate Plan?

As adults enter middle-age, they should begin to think about formulating an estate plan or revising an existing plan. An individual’s assets and goals influence the need for estate planning. By middle-age, adults may have children and extended family that they need to provide for and hopefully they have sufficient assets to accomplish this goal. Various estate planning techniques can be used to help a taxpayer prepare to pass her estate while lowering the potential tax imposed on her estate.


Life Insurance and Estate Planning

The impact of life insurance on an estate or an estate plan depends on who is named as the insurance beneficiary. If the estate or the executor of the estate is the beneficiary, the value of the life insurance must be included in the estate. If the beneficiary of the life insurance is not the estate, the proceeds are not included in the estate. However, even if there is a nonestate beneficiary, the proceeds are included in the estate if the estate has any “incidents of ownership.” Among the possible incidents of ownership that will require the inclusion of the insurance proceeds in the estate are:

  • A reversionary interest that is greater than five percent of the value of the policy.
  • The power to change the beneficiary.
  • The power to cancel the policy.
  • The power to surrender the policy.
  • The right to use the policy as security on a loan or to borrow against the policy.
  • The power to assign the policy.
  • The power to rescind an assignment of the policy.
  • The power to change, convert, or purchase a policy.
  • The power to receive dividends on the policy.
  • The right to choose among settlement options.


Creating Trusts for Estate Planning

Trusts are frequently used as a means to transfer assets at the death of the trustor. Under state law, the trust assets generally pass outside the probate estate, often smoothing the transfer process. The comparative convenience of transfer makes this technique appealing to those planning their estates.


Why Create a Trust for Estate Planning?

Trusts can also be used to accomplish a variety of goals. For instance, a charitable remainder trust allows the grantor to receive a charitable deduction for the present value of the charitable remainder. This is the case unless it is likely that the value of the remainder will be five percent or less than the trust’s value. Charitable remainder trusts can be in the form of an annuity trust or a unitrust.


Current Transfers of Property and Gift Tax

Current transfers as well as future transfers should be considered as part of the estate planning process. The most important consideration in determining whether inter vivos transfers need to be considered and planned for is the individual’s goals. Among the objectives that will influence the choice of inter vivos or post mortem transfers are:

  • Desire to keep a business in the family.
  • Desire to provide for children, grandchildren, or others both before and after death.
  • Desire to minimize the amount of estate taxes that are paid.
  • Desire to retain as much control as possible for as long as possible.