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1 ESTATE PLANNING 2017 Published by: KEIR EDUCATIONAL RESOURCES 4785 Emerald Way Middletown, OH FAX

2 TABLE OF CONTENTS Title Page Estate Planning (Topics 63-72) Topic 63: Characteristics and Consequences of Property Titling Topic 64: Strategies to Transfer Property Topic 65: Estate Planning Documents Topic 66: Gift and Estate Tax Compliance and Tax Calculation Topic 67: Sources for Estate Liquidity Topic 68: Types, Features, and Taxation of Trusts Topic 69: Marital Deduction Topic 70: Intra-Family and Other Business Transfer Techniques Topic 71: Postmortem Estate Planning Techniques Topic 72: Estate Planning for Non-traditional Relationships Keir Educational Resources

3 TABLE OF CONTENTS, CONTINUED Title Page Appendix Bartlett Case Appendix 1 Marshall Case Appendix 9 Webster Case Appendix 20 Unser Case Appendix 31 Tingey Case Appendix 42 Lytle Case Appendix 45 Beals Case Appendix 51 Mocsin Case Appendix 64 Young Case Appendix 71 Borelli Case Appendix 82 Cunningham Case Appendix 94 Ferris Case Appendix 109 Wyatt Estate Plan Appendix 144 Williams Hypothetical Estate Tax Return Appendix 159 Gantry Hypothetical Gift Tax Return Appendix 164 Worthington Hypothetical Gift Tax Return with GST Tax Appendix 170 Johns Hypothetical Estate Tax Return with GST Tax Appendix 176 Selected Facts and Figures Appendix Topic List Appendix 209 Glossary Glossary 1 Index Index Keir Educational Resources

4 ESTATE PLANNING Topics [Note: This textbook, along with the other Keir textbooks (General Financial Planning Principles, Risk Management and Insurance Planning, Investment Planning, Tax Planning, and Retirement Savings and Income Planning), is structured to follow CFP Board s 72 Principal Topics list. Estate Planning consists of Topics in that list. Therefore, this publication, rather than being broken into chapters and starting with chapter 1, will be presented as Topics ] 2017 Keir Educational Resources

5 ESTATE PLANNING Characteristics and Consequences of Property Titling (Topic 63) CFP Board Student-Centered Learning Objectives (a) Compare and contrast the most common types of titling property (sole ownership, joint tenancy with rights of survivorship, tenants in common, tenants by the entirety, and community property). (b) Recommend the appropriate property titling mechanism given the client s lifetime and estate distribution objectives, and relevant state laws. Characteristics and Consequences of Property Titling A. Community property vs. non-community property B. Sole ownership C. Joint tenancy with right of survivorship (JTWROS) D. Tenancy by the entirety E. Tenancy in common F. Trust ownership Community Property vs. Non-Community Property Community property laws apply in ten states: Alaska, Arizona, California, Idaho, Louisiana, Nevada, New Mexico, Texas, Washington, and Wisconsin. In these states, community property is the ownership interest of the husband and wife in any property acquired by the couple during their marriage. When married couples take title to property concurrently in states that follow the common law, they usually become tenants by the entirety or joint tenants with right of survivorship. We will discuss community property in more detail at the end of this Topic, after we review the common-law forms of ownership. Sole Ownership Sole ownership means one person holds the title to the property and has full ownership rights. For real estate, this full ownership title is referred to as a fee simple. The sole owner has complete control over the property and can sell, mortgage, or give it away during his or her lifetime without the consent of any other person. At death, the sole owner can dispose of the property by will; in the absence of a will, the property is distributed according to intestacy laws. One of the main advantages of sole ownership is the owner s complete control over the handling and disposition of the property Keir Educational Resources

6 During the owner s lifetime, the property can be the subject of gifts to any person, organization, or charity. At death, the owner similarly has complete testamentary control over the property. In estate planning, sole ownership affords the most flexibility in meeting a client s objectives. The sole owner is entitled to all income from the property, so the sole owner is also subject to the income tax on all of this income. At the owner s death, the full value of the property is included in the probate estate, as well as in the gross estate, for federal estate tax calculation. Property of the sole owner is fully subject to the claims of creditors, both during lifetime and during probate administration. Joint Tenancy WROS When title to property is held by two or more persons in joint tenancy with right of survivorship, each joint tenant has an equal ownership interest in the property. The ownership reflects the four unities: interest, title, time, and possession. The joint tenants acquire the same interest, in the same property, at the same time, and they take possession simultaneously. The unique feature of joint tenancy WROS is that ownership of the property passes by operation of law to the surviving tenant(s). When a joint tenant dies, the ownership interest passes outside probate and is not subject to testamentary disposition. Nevertheless, during a joint tenant s lifetime, the interest can be sold or disposed of by converting the joint tenancy to a tenancy in common. Property held in joint tenancy WROS will avoid the expense, delay, and publicity of probate proceedings. Property passing to the surviving joint tenant can also avoid the spouse s elective share, will contests, and claims of creditors in probate. Joint tenancy property also has the potential income tax advantage of splitting the income from the property among the joint tenants. This income-splitting can result in income tax reduction when some of the joint tenants are in lower marginal income tax brackets. A joint tenant WROS does not have the same control over the property that a sole owner has. At death, the joint tenant has no ability to dispose of the property, and it passes by operation of law to the other joint tenant(s). During the joint tenant s lifetime, income must be split with the other joint tenants. When persons who are not spouses sell property owned in joint tenancy WROS, each joint tenant must report a proportionate share of the gain for income tax purposes. If there are three joint tenants, for example, each must report one-third of the gain. Even when 2017 Keir Educational Resources

7 one joint tenant receives more than his or her proportionate share of the proceeds, each tenant must report the proportionate amount. Unless the interest a joint tenant acquires is proportionate to his or her contribution to the purchase price, the creation of a joint tenancy can give rise to a taxable gift. The creation of joint tenancies between spouses, however, will not result in gift tax liability, due to the unlimited gift tax marital deduction. For estate tax purposes, the full value of jointly held property will be included in the gross estate of the first joint tenant to die, except to the extent that the survivor can show consideration furnished for the purchase of the property. In other words, if the decedent contributed 1/3 of the purchase price, and the other joint tenants contributed 2/3, then 1/3 of the value of the jointly owned property will be included in the decedent s gross estate. When joint tenancy property is received as a gift or inheritance, only the decedent s fractional interest is included in the gross estate. When the joint tenancy is between spouses, one-half of the value of the property is included in the decedent s gross estate, regardless of the consideration furnished by the parties for the purchase. Showing that the surviving spouse furnished the entire purchase price will not reduce the included amount below 50%. REMEMBER: IF JOINT TENANTS ARE SPOUSES, ONE-HALF OF THE PROPERTY S FAIR MARKET VALUE AT DEATH IS INCLUDED IN THE DECEDENT S GROSS ESTATE. IF JOINT TENANTS ARE NOT SPOUSES, THE PERCENTAGE-OF- CONTRIBUTION RULE APPLIES. Since one-half of spousal joint tenancy property will be included in the gross estate of the first spouse to die, there is a step-up in basis to the date-of-death value on one-half of the property. For nonspousal joint tenancy property, there is a step-up in basis equal to the amount of property included in the decedent s gross estate Keir Educational Resources

8 Practice Question Which of the following statements concerning joint tenancy WROS is correct? A. If the joint tenants are spouses, the entire value of the property may be included in the gross estate of the first to die. B. If the joint tenants are not spouses, the entire value of the property will be included in the gross estate of the first to die. C. If the joint tenants are spouses, the first to die does not have testamentary control over any of the property, regardless of any contribution to the purchase price. D. If the joint tenants are not spouses, the tenant who contributed the purchase price will report the income from the property. Answer: If the joint tenants are spouses, the first to die does not have testamentary control over any of the property, regardless of any contribution to the purchase price. One-half of entire value of the property will be included in the gross estate of the first to die. If the joint tenants are not spouses, the entire value of the property will be included in the gross estate of the first to die only where the survivor cannot show any contribution to the purchase price. The joint tenants will report equal shares of the income. The answer is C. Tenancy by the Entirety Tenancy by the entirety is joint tenancy ownership of property by spouses. The same rules generally apply to tenancy by the entirety as apply to joint tenancy WROS. When a spouse dies, the surviving spouse becomes the sole owner of the property by operation of law. For federal estate tax calculation, one-half of the value of the property will be included in the gross estate of the first spouse to die. Of course, no estate tax will be owed because the property passes to a spouse and is eligible for the marital deduction. Since only one-half of the property held in tenancy by the entirety is included in the gross estate of the first spouse to die, there is a step-up in basis to the date-of-death value for only onehalf of the property. The major difference between tenancy by the entirety and joint tenancy WROS is that any sale or transfer of the entireties property requires the consent of both spouses. Since the concurrence of both spouses is required for transfers, property held in tenancy by the entirety is not subject to the creditors of an individual spouse Keir Educational Resources

9 Tenancy in Common Property is held in tenancy in common when two or more persons own an undivided, fractional interest in the property. The fractional interests may be unequal. Each co-tenant owns a portion of the property separately and can transfer that interest at any time, without the consent of the other co-tenants. Each co-tenant has testamentary control over his or her share of the property, and the fractional interest is included in the deceased owner s probate estate and in his or her gross estate. In some states, concurrent ownership is presumed to be tenancy in common rather than joint tenancy WROS. The intent to provide for a right of survivorship must be clearly stated. Use of the words joint tenants alone may be deemed to be a tenancy in common. The additional words with right of survivorship should be stated when the intent is for the title to pass automatically to the surviving tenant(s). The income from property owned by tenants in common will be split according to the fractional interests of the co-tenants. When property is transferred from sole ownership to tenancy in common, the income-splitting can result in income tax reduction. Each tenant in common has control over his or her own fractional interest in the property and can sell it or give it away at any time. Each co-tenant has full testamentary power over the interest and can dispose of the interest by will. Since the fractional interest will be included in the deceased co-tenant s gross estate, it will receive a full step-up in basis. When the sole owner transfers property to tenancy in common, there is a loss of control over the property. One co-tenant cannot sell, transfer, mortgage, or give away another co-tenant s interest, so the owner has given up these rights to the co-tenant. In addition, the owner loses a portion of the income that was previously received from the property. As in joint tenancy WROS, creation of the tenancy in common can give rise to a taxable gift unless each tenant in common contributed proportionately to the purchase price. In contrast with joint tenancy WROS ownership, any property owned by a decedent as a tenant in common will be subject to probate Keir Educational Resources

10 KEY SUMMARY 63 1 Property Ownership in Common-Law States Sole Tenancy in Ownership Common (Fee Simple) Who can own? Anyone, but only one Anyone and any number Joint Tenancy WROS Anyone and any number Tenancy by the Entirety Husband and wife only What is the ownership percentage? Is consent of others needed for a sale or gift? Can an owner transfer at death? Is probate required? 100% Can be equal or unequal, as stated in title No No, but can only transfer the portion owned Yes Yes, to extent of ownership interest Equal Yes, but can transfer portion after converting to tenancy in common No, passes by right of survivorship Equal for spouses Yes Yes Yes No No No, passes by right of survivorship Community Property Separate Property Community property is the separate, undivided, and equal ownership interests of husband and wife in any property acquired by the couple during marriage. Property acquired with the earnings of one spouse is still deemed community property even when the title is placed in the name of only one spouse. Unlike joint tenancy WROS and tenancy by the entirety, there is no right of survivorship in community property. Each spouse has the right of disposition over one-half of the community property. Property acquired by either spouse before marriage or by gift or inheritance during the marriage is treated as separate property. Interest earned in a separate bank account is separate property, but the earned income of either spouse during the marriage is community property. A recovery of damages for personal injuries suffered by one spouse during marriage is also separate property. If separate property is used to acquire property, the newly acquired property is also separate property. Thus, property can be traced even when it is mixed with community property. When separate property is commingled with community property so that they become indistinguishable, however, courts will apply the presumption that property acquired during marriage is community property. For example, where a separately-owned business increases in value, resulting from efforts of one or both spouses 2017 Keir Educational Resources

11 during marriage, the increase in value is usually held to be community property. Practice Question Jim and Kathy Fields have been married for 15 years and live in a community-property state. Which one of the following items belonging to them is community property? A. A municipal bond inherited from Jim s mother B. A Roth IRA in Jim s name, funded by Jim s earnings C. A sailboat given to Kathy 5 years ago by her father D. A rental property purchased by Kathy before their marriage Answer: Property acquired during the marriage by the earnings of either spouse is community property. The Roth IRA is community property even though the money comes only from Jim s earnings. Separate property is any inheritance or gift and any property acquired before the marriage. B is the answer. Life Insurance in Community- Property States Gifts of Community Property Life insurance policies purchased during marriage are community property, and if the insured dies, one-half of the death benefit will be included in the insured s gross estate. If the life insurance policy was separate property but the premiums were paid during marriage with community property, the states have made different rules. In California and Washington, an apportionment rule is followed, and the portion of premiums paid from community property determines the portion of death proceeds that is community property. In Texas, Louisiana, and New Mexico, the courts follow the inception-oftitle rule, and the policy remains the separate property of the original purchaser, despite the payment of premiums from community funds. The surviving spouse can receive reimbursement for the amount of premiums paid from community property but does not share in the growth of the policy s value. In most community-property states, one spouse may not make a gift of community property without the other spouse s consent. Gifts of separate property, however, may occur without a spouse s consent. One-half of the value of a gift of community property is considered made by each spouse even if the spouses elect not to split gifts. Splitting gifts only applies to separate property. If separate property is converted to community property, there is a gift, but it is not subject to gift tax because of the unlimited marital deduction Keir Educational Resources

12 One-Half of Community Property Is Included in the Gross Estate Full Step-Up in Basis for Community Property When a spouse domiciled in a community-property state dies, onehalf of the community property is included in the decedent s estate. The decedent can make testamentary disposition of the one-half interest in the community property, so the interest can be left to children, heirs, the surviving spouse, or anyone the decedent designates by will. The one-half interest in the community property is also subject to probate. For federal estate tax purposes, one-half of the value of the community property is included in the gross estate, but the whole property receives a step-up in basis. This full step-up in basis is one of the main advantages of the community-property form of ownership. KEY SUMMARY 63 2 Property Ownership in Community-Property States Separate Property Community Property How is it acquired? Before marriage Gift By earnings of spouses during marriage even if only one spouse Inheritance is on the title and has all the Personal injury earnings Is consent required for No Yes a sale or gift? Can the owner transfer Yes Yes, one-half the interest at death? Is probate required? Yes Yes Does basis receive a full step-up at death? Yes Yes Quasi-Community Property Quasi-community property exists in only five states. California, Washington, Idaho, Arizona, and Wisconsin. When a married couple moves from a common-law state to one of these community-property states, their separate property may be treated as quasi-community property. If the separate property would have been community property had the couple lived in the state at the time it was acquired, then it will be treated as quasi-community property. In general, quasi-community property is subject to the same rules as community property. In the community-property states that have not adopted the quasicommunity-property concept, separate property acquired in a common-law state remains separate property when a couple moves to the state. When a couple sells a home owned in joint tenancy WROS in a common-law state and moves to a community Keir Educational Resources

13 property state, the sale proceeds remain separate property of the spouses. Similarly, when a couple sells a home owned as community property and moves to a common-law state, the sale proceeds remain community property. Recommendations for Titling Property Interests When a high-income family member seeks income tax reduction, a transfer of title from sole ownership to joint tenancy or to tenancy in common with a family member in a lower income tax bracket may be recommended. In community-property states, a transfer of separate property to community property (by commingling separate funds with community property) may have a similar effect. Such transfers will cause the income from the property to be split among the owners, and some of the income will be taxed at a lower income tax bracket. Joint tenancy WROS is an inexpensive way to avoid probate. In a business transaction, when several owners take title to property, tenancy in common should be used, rather than joint tenancy. Each owner then can make disposition of his or her interest either during lifetime or at death. KEY SUMMARY 63 3 Comparison of Spousal Joint Tenancy WROS and Community Property Joint Tenancy WROS Community Property Subject to probate? Pass to surviving spouse? Can it pass to heirs or persons other than the spouse? What amount is included in the decedent s gross estate? What amount receives a step-up in basis? No Yes No, passes by operation of law to the spouse One-half One-half Yes No, but it can be left by will to the spouse Yes, one-half can be left by will to heirs or others One-half All Trust Ownership With trusts, ownership interests in the trust property are divided among the parties to the trust: the grantor, the trustee, and the beneficiaries. The trustee takes legal title to the trust property, but the beneficiaries are granted the right to enjoy the beneficial interest or equitable interest in the property Keir Educational Resources

14 Present and Future Interests Reversions and Remainders A beneficial interest may be a present interest or a future interest. If the beneficiary has the right to the immediate enjoyment and possession of the property or income, there is a present interest. If the beneficiary s right to enjoy the property is delayed to some future date or until the occurrence of a future event, it is a future interest. When a grantor establishes a trust with income payable to his or her children for their lives, the children have received a present interest of a life income. The most common future interests are reversions and remainders. When a future interest is retained by the grantor or transferor, it is a reversion. A reversion gives the grantor or transferor the right to regain the property at a future time, after other interests have terminated. For example, suppose a grantor transfers a home to his sister for her life, but the home will become the grantor s property again at the sister s death, the grantor has retained a reversionary interest. When the future interest is held by someone other than the grantor or transferor, it is a remainder interest. A remainder interest is the right to possess or enjoy property after another interest ends. For example, the grantor transfers property to his or her children for their lives and at their deaths to the grantor s grandchildren. The children have life estates, and the grandchildren have remainder interests. A vested remainder cannot be forfeited. While the right to possess or enjoy the property is delayed to a time in the future, it does not depend on the occurrence of any event. For example, the grantor transfers Blackacre property to his or her son for life, and at the son s death, it will pass to the grantor s granddaughter. The granddaughter has a vested remainder interest. A contingent remainder is a right that depends upon the happening of a future event. For example, a grantor conveys Blackacre property to his or her sister for her life, and at her death, to the grantor s son, if the son is living. The grantor s son has a contingent remainder interest because if he dies before the grantor s sister, he does not obtain Blackacre. Remainderpersons and Income Beneficiaries Transfers in trusts typically involve a division of interests between the income beneficiaries and the remainderpersons. The income beneficiaries have a right to receive income from the trust for life (life estate) or for a specified number of years (estate for years). The remainderpersons are entitled to the trust assets remaining after the death or the termination of the income interests Keir Educational Resources

15 1. When David and Jill Rooney moved from Oregon, a common-law state, to California, a community-property state, they sold the home they had owned as joint tenants WROS during the 10 years of their marriage. They used the proceeds, totaling $200,000, to buy a new home in California. At the time of the move, David owns common stock, valued at $100,000, in a brokerage account in his name, which was purchased for $40,000 from his earnings over the past 6 years. He also owns $20,000 in mutual funds that he bought for $10,000 before he was married, using his earnings. David is also one of five investors in a limited partnership valued at $100,000 (his share is $20,000). David s interest in the limited partnership was purchased with money he earned during the marriage. David and Jill own two cars in joint names, with a total value of $50,000. Jill owns $20,000 in municipal bonds in her own name that she received as a gift from her parents. If David were to die soon after the Rooneys move, what would be the total value of the property considered quasi-community property in California? A. $250,000 B. $270,000 C. $290,000 D. $350,000 E. $370,000 APPLICATION QUESTIONS 2. If Jill Rooney (in the previous question) sells the mutual funds for $25,000 and the common stock for $120,000 after David s death, what is the amount of capital gain that she should report? A. $0 B. $5,000 C. $12,500 D. $25,000 E. $45, Roger Allen, who lives with his wife Jean in New York, inherited a vacation home in Maine from his uncle. Roger would like to arrange for the title to the vacation home to pass to his wife at his death to avoid the expense of probate. Roger also wants to avoid any title arrangement that might allow his wife to sell or transfer the property before his death. Which of the following forms of titling the vacation home would be most appropriate? A. Tenancy in common B. Joint tenancy WROS C. Tenancy by the entirety D. Sole ownership E. Quasi-community property 2017 Keir Educational Resources

16 Estate Planning Application Questions Topic Which of the following transfers to an irrevocable trust conveys a present interest to the beneficiary? E. (1) The beneficiary will receive income from the trust for 10 years, and then the trust assets will be paid to the grantor. F. (2) The trust allows the grantor s spouse to live in the home for life, and at the spouse s death, it will pass to the beneficiary. G. (3) The trust provides for income to be accumulated in the trust, and both income and principal are payable to the beneficiary (a minor) at age 21. H. (4) The trust provides for the beneficiary to receive income for life, and at the beneficiary s death, any remaining trust assets will be paid to the Red Cross. A. (1) and (2) only B. (1) and (4) only C. (2) and (3) only D. (2) and (4) only E. (3) and (4) only 5. Jerry Freeman, age 65, and his wife Elizabeth, who is 55 years of age, own a shopping center property as joint tenants WROS. Jerry would like to use the property to fund a trust for his son and daughter, but Elizabeth wants the property to pass outright to their son. If no agreement can be reached, which of the following statements would be appropriate advice to give Jerry? A. Jerry can sever the joint tenancy and put one-half of the property in trust for the two children. B. Jerry can convert ownership to a tenancy in common and place onehalf in trust for the daughter and give one-half outright to the son. C. Jerry will have to wait until he outlives Elizabeth to take any action. D. Jerry cannot sever the joint tenancy, but he can buy Elizabeth s share and then leave the property in trust. E. If Jerry paid all of the purchase price for the property, he can convert it to sole ownership at any time Keir Educational Resources

17 Estate Planning Application Questions Topic 63 For practice answering case questions related to Topic 63, please answer the following questions in the cases included in the Appendix at the back of this textbook. Case Questions Bartlett 1 Marshall 1, 2, and 3 Webster Unser Tingey Lytle Beals Mocsin Young Borelli 1 Cunningham 1 Fred and Mary Ferris Keir Educational Resources

18 Estate Planning Application Questions Topic 63 ANSWERS AND EXPLANATIONS 1. E is the answer. Quasi-community property is property acquired in a common-law state that would have been treated as community property if the couple had lived in a community-property state at the time of acquisition. The couple moved from Oregon, a common-law state, to California, a community-property state that also has the concept of quasi-community property. In California, only the municipal bonds received by Jill as a gift and the mutual funds purchased by David before the marriage will be treated as separate property. The home ($200,000), the brokerage account ($100,000), the cars ($50,000), and the 1/5 interest in the limited partnership ($20,000) are all considered quasi-community property and will be treated as community property. 2. D is the answer. The quasi-community property is treated as community property, and it will receive a full step-up in basis to the date-of-death value. The common stock in the brokerage account is quasi-community property and will also receive a full step-up in basis. The mutual funds were David s separate property and, therefore, will receive a full step-up in basis, too. The date-of-death value for the stock is $100,000, so Jill s gain on this stock is $20,000. The date-ofdeath value for the mutual funds is $20,000, so Jill s gain on these funds is $5, C is the answer. Tenancy by the entirety will enable Roger to include his wife in the title to the vacation home and still require her to obtain his consent before making any transfer or disposition of the property. Tenancy in common will not prevent Roger s wife from selling her interest. Joint tenancy WROS will also not prevent Roger s wife from selling her interest in the property because the joint tenancy could be severed and turned into a tenancy in common, allowing the wife s separate interest to be sold or transferred. Sole ownership in Roger s name will not avoid probate. Quasi-community property is not available in Maine. 4. B is the answer. The beneficiary who receives income from the trust for 10 years begins to enjoy the income immediately and is given a present interest to the income. There is no delay in the start of this income interest. By contrast, the beneficiary who must wait until the death of the grantor s spouse cannot make immediate use of the home and has a future interest. The beneficiary who must wait until age 21 to receive income and principal also has only a future interest. Note that Code Section 2503(c) provides that gifts to such a trust shall not be treated as gifts of a future interest for purposes of the annual exclusion. The beneficiary who has an income interest for life has an immediate life estate and a present interest. 5. A is the answer. Jerry can sever the joint tenancy, and then as a tenant in common, he can dispose of his one-half interest as he wishes. He can leave the one-half interest in trust for both children or set the trust up entirely for the daughter. He will not be able to exercise control over the entire property by converting to a tenancy in common. He cannot convert it to sole ownership even if he paid the entire purchase price. Waiting to outlive Elizabeth does not make sense because he is older by 10 years. If the property were owned in tenancy by the entirety, Jerry could not sever the interests Keir Educational Resources xiv