 Hello and welcome to this session. This is Professor Farhad and this session we would look at taxable estate and specifically we're gonna be looking at expenses, losses and deductions. This topic is covered in a corporate income tax course, the CPA exam regulation section, enrolled agent exam. As always, I would like to remind you to connect with me on LinkedIn if you haven't done so. YouTube is where you would need to subscribe. I have 1,600 plus accounting, auditing, tax and finance lectures. If you like my lectures, please like them. It doesn't cost you anything to share them. Put them in playlist. If they benefit you, it means that they may benefit other people, so share the wealth and please connect with me on Instagram. On my website, you will find additional resources such as multiple choice, true, false, CPA questions, CPA exercises that are quasi-CPA simulations. So if you're studying for your CPA exam or you want additional resources, I strongly suggest you check out my website. Let's start by reviewing the estate tax formula, which starts with the fair market value of gross estate. And this is what we talked about in the prior session. You can check the description, which is what we call the slime one. Then we deduct from line one, we're gonna call line two and it's not really one line, it's multiple lines, but on these lines, we're gonna have expenses, losses and deductions. And in this session, we're gonna be focusing on this line, line two, the deductions, the losses, the expenses. Then line one minus line two will give us line three, which is the taxable estate. Then we add any taxable gift, which we already talked about, gifts and taxable gift. You could also look in the prior session, equal to the estate tax basis. Now we're gonna figure out what's our tax liability, deduct any taxes that we paid prior and prior years, post-1976 tax, deduct the unified tax credit, deduct any other tax credit, then if the answer is still positive, we have a tax due on estate tax. And basically, eventually we're gonna work all this formula, all this formula, but the two most important line are line one and line two and the rest are computation. And you will see later when we work and exercise that once you figure out line one and line two, the rest kind of they fill in from prior knowledge or from other sources. Or you need to know how to compute the tax liability, which we'll talk about this. Now when it comes to deductions, we're gonna focus a little bit more on the marital deductions, but the first we wanna look at losses and expenses. What are some of expenses, losses and charity that can be deducted after the person passes away? This is what we're gonna be looking at. So it's a list of things, a list of laundry list. So for example, for your exam at the university, you would need to know what that list is, what's included, what's not. For the CPA exam, the same exact concept, you wanna know what's included, what's not. Maybe you're better off knowing what's not included in those expenses because it's a list of you wanna know, because usually they ask you what's not. For example, funeral expenses, generally speaking, are included. Expenses incurred in administering the property. Once you pass away, that's included as an expense. Claims against the estate, like any unpaid mortgage, well, you can't deduct this. Expenses incurred in administrating community property. Community property means you and the other individual own it, only deductible to the portion of the deceased's spouse interest in the community. That include what? That include commissions to the executor, the person that's gonna be in charge of the estate, attorney fees, accountant fees, court costs, certain selling expenses. When you wanna sell the property, you're gonna incur expenses. Those are deductible. Deductible. Also, property taxes accrued before the decedents that, so if you owe any property before you passed away, then that's gonna be deductible. Unpaid income taxes on income received by the decedent before they passed away. Same concept. Unpaid gift taxes, so simply put, if you owe taxes before you passed away, you can deduct those taxes. The decedent's unpaid pledge or subscription in favor of public, charitable, religious, or educational organization is deductible to the extended. It would have constituted in allowable deduction had it been made a bequest. So simply put, if the individual that passed away made a pledge, then that pledge is deductible as long as it would have been deductible if the person deductible under taxes of the person basically either was alive or they passed away. Also, if there's any casualty or theft incurred during the period when the estate is being settled. Now here, we're talking about casualty and theft losses, but remember, the rules are a little bit different. What does that mean? It means we don't have the floor or the $100 deduction. So it's just so that casualty and theft losses are deductible if those happen during the settlement when the estate being settled. Charity, shareable contribution if designated in the decedent's will. If the decedents in their will said, I would like to contribute $5 million to a charity. As long as that's included in the will, that's deductible. Now of the executor who'd like, he or she would like to contribute this. That's not up to them. It's not deductible. They can, if they are allowed, but they cannot deduct it from gross estate. So simply put, what I just did showed you what are some of the expenses and losses that are allowed from the gross estate. Okay, because the more you want to deduct, the better off you are because you'll pay less taxes. Now we need to talk about the marital deduction because that's an important deduction. So simply put, the marital deduction, the purpose of it, the Congress says when someone passed away, if they're married, we really don't want to get involved between the husband and the wife. What's gonna happen is we're gonna allow what's called the marital deduction. So this way, the assets goes from the husband to the wife or from the wife to the husband with no tax consequences, with no tax consequences. So the marital deduction allows spouses to arrange their financial affair without federal gift or state gift consequences. So when you transfer assets, money, whatever you have left in your gross estate to your spouse, there's no, really, there's no effect on your federal gift tax or estate tax, okay? So asset can pass between them without any immediate gift or estate tax liability. And that's the purpose, to make the life of the person that passed away a little bit more easier, whether deduction allowed to offset otherwise a taxable gift or an estate. So what you do is you will include it, then you will deduct it. What's called, it's called the marital deduction. Obviously, if you pass away, your asset goes from you to your spouse. Well, it's gonna be included in your gross estate in line one, then in line two, you will deduct it. So it will be offset. So let's take a look at an example. At the time of his death in the current year, T owed an insurance owned an insurance policy on his own life. The face amount is half a million with Ella, his wife as a designated beneficiary. So if something happened to him, the half a million goes to his wife. T and Ella also owned real estate worth 600,000, as standard by entirety. It means when one of them passes away, the other individual gets the property. T had furnished all the purchase price. It doesn't matter if they are married, it's 50-50. As to these transfer, 500, the insurance proceeds, as well as the half of the asset, the insurance proceeds, as well as half of the asset is included in the gross estate of T. So if this is T, if this is Teo, the, let me just kind of write here this way we can see what's going on. If this is, we're gonna assume this is Teo, let me change the color so you can see. This is Teo and this is Ella. Okay, so the asset's gonna go 800,000. Why 800,000? The insurance policy and half of his real estate, okay? Goes to Ella and basically it's gonna be included in line one that then deducted in line two. So 800,000 plus 800,000 minus. Now, marital deduction when the property interest passing to the surviving staff is subject to a mortgage when there's a mortgage against that property. So the asset is passed, but there's a mortgage. We're gonna only count the net value of the interest after reduction by the amount of the debt qualified for the marital deduction. Simply put, if you transfer an asset and it has a loan, what's really transferred is the net value of this asset. In his will, Jacob leaves real estate for the fair market value of half a million to Rachel, his wife, if the real estate, the subject to a mortgage of half of 100,000, upon which Jacob is responsible, the marital deduction is limited to 400,000. So why 400,000? The fair market value of the property minus the loan. The 100,000 mortgage is deductible as an obligation of the decedent. So the 100 remember, if you owed any money, remember you can deduct that as well. That it's not a marital deduction, what really transfer is the net. Then we have something called Q-TIP or Qualified Turnable Interest Property. And we just wanna kind of know what Q-TIP is. When you think of Q-TIP, think of this individual. It doesn't mean think of this individual. This is Mr. Hafner, if you don't know who he is, he's the founder of the Playboy and he had multiple wives. So basically what happened is this. I'm not saying that he used the Q-TIP, I'm just saying when you have more than one marriage, what happened is this. Let's assume you married your first wife and you had two kids from your first wife or three kids. Then you got divorced, you married a second time. Now, over the second marriage, your new spouse maybe she has two, three kids. Now, when you pass away, what you want to do is you want to keep some assets to your kids from the previous marriage. Now, if you leave the asset to your kids from the previous marriage, they're not subject to the marital deduction because then go to your spouse, they went to your kids. So you can do, individuals can set up a Q-TIP, which is a trust. And what they would do, they would allow the recent spouse, the second spouse, to enjoy the asset, to enjoy the asset in a sense be able to use the asset. But once they pass away, the asset goes to your kids. So simply put, if you pass it, so you have picture, I'm just gonna try to do this real quick. So you have this individual, that's their first spouse. Okay, that's their first spouse and they have three kids. Now they get divorced, now he's married to a second spouse. Really lousy. Okay, now this is his second spouse. Now, what you would do is, you would pass the asset to your second spouse on the condition that once she passes away, the asset goes to the three kids from the first spouse. So this way, rather than paying the taxes now, you would defer the taxes for later. And this way, you also protect your second spouse that she can live off the asset, but there's nothing she can do with it or he can do with it until they passes away, then it goes to what you wanted to do. So basically, it's kind of deferring the tax until the, in a sense, second spouse. It doesn't have to be a second spouse situation. The reason I'm trying to explain this in a second spouse situation to make it easy for you to understand. And that's why I use Mr. Hafner as an example because he is a well-known figure and his divorce case lasted several years. And I don't know if it's done or not, but that's the whole point of it. So property that passes from one spouse to another by gift or at death and for which the transferee spouse has a qualifying income interest for life. So basically the asset goes from Mr. Hafner to his second spouse, let's assume that's the case, and the spouse has a qualifying interest income for life. So if they have stocks and bonds, the spouse can get the stocks, can get the interest, can get the dividend and live off that, okay? So the person is entitled for life to all the income from the property, payable at an annual or more frequent interval, whatever the arrangement is. No person has the power to appoint any part of the property to any person other than the surviving spouse during his or her life. So basically that's the deal. No person has the power to appoint the property other than the spouse. Once you make this election as a revocable, if the election is made, okay, a transfer tax is imposed on the Q-tip, on the trust when the surviving spouse dispose of it by gift. So let's assume the second spouse decided to give it a gift to the designated transferee today, to the kids from the first marriage or upon death, okay? And under those circumstances, if the later transfer occurred during the survivor, spouse's life, which is a gift, a gift tax apply, measure that fair market value, and if the spouse kept the asset until she passes away, it's part of her estate, part of her estate. So this is basically what's a Q-tip, qualified, turnable interest property, okay? An example with Clyde dies and provides in his will that certain asset fair market value of 2.1 million are to be transferred to a trust under which Lily, his wife, to receive income of the trust for her life. What the remainder passes to her, to their children upon Lily's death. So what's happening here, Clyde doesn't want to transfer the asset to the kids now because it will have to be included in his estate. That's one thing. And maybe he also wants to protect his wife in a sense that he wants the property to be under her control until she passes away. Presuming that all the preceding requirements are satisfied and Clyde's executor so-elects the estate, receive a marital deduction of 2.1 million. So Lily dies when the trust assets are worth 6.4, the amount is included in her gross estate, then it goes to the kids as Clyde wished before he died. So basically there's like a two, what you do is you're deferring, the deferring the taxes for later. And let's take a look at a marital deduction, kind of a good example, work an example to kind of illustrate the concept. Hank and Wendy are married. Hank purchased survivor annuity. Wendy is a beneficiary, the fair market value is half a million. Hank and Wendy jointly own property with a fair market value of 600,000, jointly means 50, 50. Hank owns a property by himself for 100,000. Hank owns a life insurance on his life and Wendy is the beneficiary, the face value is 400,000. Hank dies. Let's assume Hank passes his solely owned property to his children, which is only the 100,000. And let's assume he passes everything to Wendy, passes his solely property to Wendy. So let's see how it works, how the marital deduction works. So here we go. What's included in the gross estate of Hank? Well, the annuity he purchased himself, that's his, that gets included. Then the jointly owned property, the 600,000, what's gonna happen with that? It's gonna be split, 50, 50. It's a joint property, 300,000 and 300,000. The 100,000 will be included in the gross estate of Hank and the life insurance, it's because it's his life insurance, Wendy's the beneficiary, but it's his, therefore it's included in his estate. So his gross estate is 1.3 million. Now what's gonna happen is he's gonna transfer things to his wife, to his spouse. So less the marital deduction. The annuity, 500,000, it's included here. Then it's deducted and transferred to Wendy. The 300,000 is included in the gross estate, then it's transferred to Wendy. It's deducted and transferred to Wendy. This asset he owned solely, he wants to keep for his kids directly. That's not marital deduction. It's gonna be included in his gross estate and the life insurance, the same thing. It's included, then deducted and it goes to Wendy. What's gonna happen is the taxable estate for Hank is only 100,000, which is nothing. It's that don't have to worry about anything. Now, the total gross estate for Wendy after this transfer is 1.5, one point, what's transferred to her, in total, now it's under her estate, 1.5 million. Now let's assume B, Hank transferred his solely property to Wendy, then his estate will be zero and Wendy will have 1.6 million, 1.6 million. We'll work another example when I do the CPA simulations, but this is basically an illustration of the marital deduction. Also what we can include deduct is estate taxes at debt. Now, certain states and certain counties, they impose a debt tax, basically, if you're passing not all states. That's why it's, I have Astrid because it's not all of them. These taxes can be assessed at a marginal of almost 20%. So if you pay the taxes, what can you do? You are allowed a deduction, a deduction against your taxable estate and inheritance taxes. So you pay them for the state or for the county, then you'll get a deduction. So the deduction is not to pay taxes twice, basically deduction for taxes paid to the estate at the debt mitigate the effect of subjecting property to multiple taxes, payable at debt. So you pay the taxes for the state, you will get a deduction. So that's another deduction. So basically, this is the formula that we started with. At this point, at this point, we've covered line one in the prior session. You could look at the description. In this session, we look at line two. Then the remainder of this is basically, it's a computation and we'll work a CPA simulation in the next session illustrating this concept. So in the next session, I'll work a few exercises, kind of CPA simulation to illustrate what we learned and reinforce and understand. Again, this topic often time is not properly taught in college or if it's taught in college, students don't pay attention. Then when they get to the CPA exam, well, you suffer and this is why I can help you. So what I suggest you do, if you like my videos, please like them. If you wanna visit my website for additional resources, don't hesitate to do so. You study for your CPA once, you wanna use all your resources to succeed. This is 20 to 30 year investment. Do it properly, get the CPA behind you. I'm here to help you and study hard.