 Hello and welcome to the session. This is Professor Farhad and this session we would look at the estate tax, a topic that's covered in a corporate income tax course as well as the CPA regulation section and the EA 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. Click on the like button. It doesn't cost you anything. Share them, put them in playlist. If they benefit you, it means they might benefit other people and please connect with me on Instagram. My website, you'll find additional resources on farhadlectures.com where you can supplement your education, your CPA preparation with exercises through false multiple choice. And if you are studying for the CPA exam, 2000 plus CPA questions. So I'm gonna start this session by going over the overall picture about the transfer tax which is composed of the estate tax and the gift tax. They're kind of connected in one way or another and we're gonna see how later the estate tax is imposed on the decedents entire estate. And this is the tax on the right to pass property at death basically after you died. That's when this is when the estate tax kicks in. The gift tax is called an inter vivos or lifetime transfer for less than full consideration. Basically you are giving gift and you are not expecting anything in return and you expect to pay taxes on those gift. And we looked at the gift tax in the prior session. So that's done. Now we're gonna talk about the estate tax. Matter of fact, I'll put the description for the link for the gift tax because somehow they're gonna be, not somehow they're gonna be related. Okay, so it's very important to understand the gift tax. I'm gonna start by going over some terms with the estate tax. You may or may not see them before but they're very important for this session. For example, the decedent is the person who dies. Beneficiary is the person who receives the decedents property. So if you are the beneficiary of your decedent uncle, your uncle passed away, they left some property for you, that's good. Gross estate is the older property owned by an individual and we're gonna focus this session specifically on the gross estate, how we compute this. Where is a will? A will is a document that details how an estate is to be distributed, disseminated. And bequeath is the transfer of property after that. So you'll be happy when you were bequeathed something. So somebody gave you something because they passed away. And I'm gonna start this session by looking at the estate tax formula because it's very important to look at the overall picture. Then we're gonna start to drill within each line in the formula. So the first thing we do is we compute the fair market value of the gross estate. And I'm gonna call it here line one and I'm gonna be referring to this as line one. So this is line one. The fair market value of the gross estate, then we're gonna deduct the expenses, losses and deductions, which is line two. I will have line two for a separate session. So I'm gonna focus on this line for now. Line one minus line two will give you the taxable estate. Then we're gonna add to the taxable estate. Any taxable gift, this is one gonna consider line four. And we already learned about the taxable gift. If not go to the tax gift, that's why they are connected. That's equal to estate tax basis. Then we're gonna compute our tentative tax liability. Then we're gonna deduct any taxes paid on gift post 1976 gift. Then we're gonna take the unified tax credit, which as we talked about in the gift tax, then we might take other credits if any available. Then we're gonna get to the estate tax too. So this is the complete formula. Obviously eventually we'll work a complete example illustrating this formula, but we're gonna be focusing on line one. So let's take a look at line one. What is the gross estate? Basically the gross estate is everything that you own at that. A hat, a boat, your investments, your car, your clothes, your vehicle, your jewelry, your furniture, all of these is part of your estate. So we're gonna look at the fair market value of all property owned by the decedent, the decedent at the date of that or an alternative valuation date. I will talk about this alternative valuation date later on at the end of the session. That include personal effects, jewelry, furniture, stocks, bonds, investments, right to receive dividends or interest if they accrued at the date of that. So as long as they accrued at the date of that, especially interest, then you are entitled. For the dividend, there is no accrual. As long as they are declared, then you're not you, the person will be gone, the estate of that individual. The value of business owned by the decedent, you could be a partner and an LLC, LLP, you could have your own business, the value of that business, the proportionate value of any asset owned by a decedent and any other person of both parties pays. So if you are a co-owner with someone, for example, if you're the decedent jointly owned a boat with his son, both parties paid one half. So therefore one half of the value of that boat will go into your estate because you paid half of it and you own it, okay? Now, we have something called revocable trust. What are revocable trust? Remember what we talked when we talked about gift. If you gifted something, if you gifted something, it means you're transferred without any adequate consideration and it's gone, it's no longer part of your estate. However, we have something called revocable trust. Maybe you would create a trust but you still control that trust. Those are called incomplete transfer. So if you have a complete transfer, you don't have to worry about it. If it's a complete transfer, then it's part of your gift when you were alive. But if you made an incomplete transfer, that's gonna be included in your gross estate, okay? What could be an incomplete transfer? A revocable transfer. If you put something in an estate for someone, but you maintain the power of changing the beneficiary to terminate this trust, to change it, to revoke it, to terminate it. If you have any power over the trust, it's called a revocable trust. If it's a revocable trust, you did not really transfer it to that individual. Therefore, it's gonna be part of your estate. So if it says revocable trust, it's gonna be included in your estate, okay? What happened if the decedent releases the revocation? You change your mind. Well, if you do so, here are the rules. You have to do it three years before you die. Now, how would you know? You never know. But as long as you revoked it and you lived an additional three years, then the revocation is complete. Otherwise, if you died within three years, then the trust will go into your estate. So it's very interesting. And the same concept would apply if you retain life estate. So if you put an asset away and you kept using it, it's for your own use, well, same thing, unless you release the retention. If the retention should be released, again, three years before the death. So if it's not a complete transfer, it's gonna go on your gross estate. Let's take a look at a few examples, just to see how this whole thing worked. In 2000, Rita created an unrevocable trust, a revocable trust, but security is worth 900,000. But here's what happened. It's irrevocable. However, Rita retained a life estate. So what does that mean? What is retained a life estate? Because we mentioned this term here. Retained life estate, it means she can use it as long as she is alive. As long as she's alive. But once she passes away, the remainder goes to her children. So it's irrevocable. Simply put, it's irrevocable. So he said, if it's irrevocable, it should be out of her, out of her estate. Well, she retained a life estate. So she said, okay, I'm not gonna, I can't change anything, but as long as I'm living, I'm gonna use it, okay? Now here we go. In 2000, created a life estate. The Benny is herself. She's the beneficiary. Why? Because she's using the estate. It's a retained life estate. This is what it retained life estate. Retained life estate as incomplete transaction, incomplete transfer. Therefore there is no gift. Here she did not make any gift. What does that mean? There is no gift. If something happened to her, let's assume she passed away, it's gonna be included in her gross estate, okay? Now, two years later or 12 years later, Rita released the retention on her life estate when the trust asset now have 1.5 million in value. Now, it's irrevocable. We're ready to determine this. And it's irrevocable. And she released the retention of her life estate. Simply put, it's no longer mine. I'm not gonna be using this. Well, now there is a gift, okay? Rita releases the retention. The transaction was complete. Thus it's a gift to her children. Now there's a gift and the value of the gift is 1.5 million. So it was not gift in 2000 because she retained a life estate. As long as she's living, she can use it, then it's not a gift. Now it's a gift. Let's assume Rita dies in 2012 when the trust asset have a fair market value of 2 million. Where are Rita's transfer tax in 2014? Guess what? Because she released it and she died within three years. Remember, she released it in 2012. She dies in 2014. It's gonna go back and be included in her gross estate. Now that's no longer a gift. It's gonna be included in her gross estate because she releases the retention within three years. The fair market value of 2 million goes back in her gross estate. Let's assume she passed away in 2016. Now it's over three years since she over three years because 2016 is within outside the three year period. If that's the case, if that's the case, you remember she released it in 2012. She didn't die until 2016. Then in that case, it's not a problem. None of the 1.8 is included in her gross estate because she simply gifted them. She simply gifted them. So revocable trust is something that you have to be concerned about. Another issue that comes up is life insurance. Well, you have to know that the life insurance, the gross estate includes the life insurance. And usually that's a large chunk for a lot of people because that's what they do. They buy life insurance. That's how they maintain their wealth and protect the wealth of their loved ones. Now, if the individual transferred the policy three years before this, it's included in the gross estate. So if you tried to get rid of it three years before, before you die, it's included. So life insurance, if you buy life insurance on the life of another person, so notice here what's happening. You buy the insurance on the life of another person. So life insurance of another owned by a descendant at the time of that is included in the gross estate as the asset owned by the decedent, okay? Now the amount, it's not gonna be the full amount because it did not mature. The amount includeable is the replacement value. Let's take a look at an example because it did not mature. So let's take a look at an example. At the time of his death, Luigi owned a life insurance policy on the life of Benito. So if something happened to Benito, somebody's gonna be paid and it's gonna be paid half a million. The replacement value is 50,000 and Sophia is gonna be paid. So if something happened to Benito, Sophia will be paid half a million dollar. Right now the value of the policy, the replacement value, which is the cash value is 50,000. So if they cancel it today, it's only 50,000 because the policy has not matured at Luigi's death. So Luigi died. What's gonna happen? Only the 50,000, which is the replacement policy will be included in Luigi's gross estate. So notice he bought the policy. He's the buyer, but on the life of Benito and Sophia is gonna get the money if something happened to Benito. So under those circumstances, Luigi died. It did not mature. We only put the replacement policy. I see this question on the CPA exam, just you know the policy. So you're the owner, but you're not the beneficiary. It's interesting. If the owner retain any incident of ownership. So if incident of ownership in the policy exists, the policy is included in the estate in the estate of the decedent. So if you have a policy, but you control that policy, okay? As long as you have some control of the policy, it's included, okay? At the time of the death, B was the insured under a policy of a million dollar owned by Gregory, with Demi as a designated beneficiary. Now B was the insured, took out the policy five years ago, he took out the policy and immediately transferred it as a gift to Gregory. So he bought it and he transferred it to gift. Under the assignment, B transfer all the rights of the policy except the right to change the beneficiary. What happened here is he did not really give up everything because he kept this right to change the beneficiary. B died without having exercised this right. It doesn't matter whether he exercised the right or not, the policy proceeds are paid to Demi. Okay, he died, the policy proceeds are paid to Demi. B, retention of the incident of ownership of that policy will be included, causes the one million dollar to be included in his gross estate, even though he never exercised that right. So because he kept the right to change the beneficiary when it paid out, it goes to his estate. So one million dollar is assumed and it's under his control, causes the one million to be included in his estate. So if you don't want it, just make sure you don't have any incidents of ownership. Otherwise, the value will be included in your estate. Also, under certain conditions, the death of the insured may constitute a gift to the Benny of all the proceeds. Let's take a look and example to see how this worked. This occurred when the owner of the policy is not the insured person. So let's take a look at this. Randolph owned an insurance policy on the life of Frank. So he owns the policy and the life of Frank and Tracy is the designated beneficiary. Up until the time of Frank's death, Randolph retained the right to change the beneficiary of the policy. The proceeds paid to Tracy by the insurance company. Now here's what happened. Let me just kind of, so we have Randolph and he bought the policy against Frank. But the payout will go to Tracy, the T. So when the payout happened, it's considered a gift from R to T. It's a gift from R to T. So the proceeds paid to Tracy by the insurance company by reason of Frank's death, Frank's die, but Rodolf owns the insurance policy. Basically, it's a gift from, it's considered a gift from Randolph to Tracy. Now, what does that mean? Randolph will have to include that in his tax gift. Let's take a look at joint interest. Joint interest is when you own a piece of property with someone else. Now you could own that piece of property with your spouse or you could own it with your friends, with your brother, with your body, with anyone. There are different rules or different terminology that you need to be familiar with. Whether you own the property with a non-spouse, with somebody other than your spouse or whether you own it with you. It's a spousal joint property. So under non-spousal, we have two categories. You could own something as a joint tenancy. And here, how do you know it's a joint tenancy? Well, when you bought this asset, your lawyer and their lawyer and your friend agreed to be joint tenancy. But what does that mean? It means that the receiving interest automatically transferred to the surviving owner. So if you own a property that joint tenancy guess what? You die, the property goes to your friend, to your brother, whoever owns it. Well, you have no control over that. So it's included in the decedent's gross estate during the inclusion formula, using the inclusion formula. What's the inclusion formula? We're gonna look at the inclusion formula in a moment. But it goes to the other person. So you have no control. If the ownership is tenants in common, not joint tenancy. Now we're talking about tenants in common. That's different. Now the decedent can pass the property to whoever they want to, because let's assume they own 25%. Well, it doesn't go automatically to your brother or to your body or to your friend. You decide. So it's includeable in the decedent's gross estate using the percentage. If 25% of the fair market value goes to your gross estate. Now here you have control. It doesn't go automatically to the other person. You decide where does this property go? Now ownership with your spousal is a little bit different. It's called tenant by entirety. And basically what does that mean? It means half of the property fair market value included in the gross estate of the first spouse to die. So you and your spouse, one of you passes away. The property goes to the other, to the surviving spouse. So the decedent interest also automatically, you have no choice, transfer to the surviving spouse using the marital deductions. What's gonna happen at transferred, then through the marital deduction, you will see later it will be deducted. An example of a joint tenancy or joint interest or joint ownership is an annuity. And what is an annuity? It's a stream of payment extended over a period of time. What is an annuity and how is it used? It's basically used, once people get closer to retirement, what they do, they sell older asset and they buy a policy to pay them money. Basically this is what an annuity is. A policy to pay you money, basically what they do is, they will sell everything and they would say, I want to be paid for the next 120 month or 240 month, for example, agreement of $5,000 every month. So that's the agreement. So you buy a policy, you pay an amount here, you sell all your asset and you, let's assume you pay a million dollar, just make it up. And you have the right to receive that money. So it's an investment. So this is what an annuity is. We have two type of annuities. One is called straight life. And this one is pretty straightforward. Basically once you die, once that's it, it stops. So nothing to worry about here because if it stops, we don't have to worry about your gross estate. Then we have a survivorship annuity and this is different. This survivorship annuity either starts after you die or keeps going after that depending on the agreement. But the point is we have to know what's gonna happen. What amount do we need to include in the decedents? Here we have to use what's called the inclusion formula to determine how much to include in the decedent estate. So how much to include in the decedent estate. Now the decedents formula is something like this. It's the decedent contribution. How much did they contributed? How much they contributed? I'm pretty sure we covered this basic formula in the past divided by the cost. So what is your ownership level? How much did you contributed? Okay, let's assume you contributed $100 and the total cost was 1,000. Well, you contributed 10%. So this is what we're saying here. Then we multiply this percentage by the fair market value of that annuity and that's the amount that you would include. That's as simple as that. Not as simple, but that's how you do it. So let's take a look at an example to see how it works when it comes to an annuity, okay? So in 1990, Allen and his longtime girlfriend, Kate, purchased a commercial single premium annuity. So they purchased an annuity. The total cost was 100,000. Allen paid 60,000 and Kate paid 40. So the ownership is 60, 40. Under the terms of the policy, Allen and Kate are to receive 50,000 annually for life starting in 2010. So that's the payout, okay? So every year they'll pay them 50,000 until they die. When one person died, the survivor is to receive 25,000 annually for life. So the benefit will transfer to the other person, 25,000 for life. In 2000, Allen married Kate. Now they're married in 2016, Allen dies first. So six years later Allen died. At time of his death, the survivorship feature of the annuity is worth 400,000. So it's valued at 400,000. How did we know this? It's given, they're telling us the value of the annuity is 400,000. Basically the present value of the future cash flow. So the first question is how much was Allen's gift to Kate in 2000? Because in 2000 they got married. And remember Allen owns 60% initially and Kate owns 40%. What happened is when they get married, they have ownership of 50, 50. What does that mean? It means Allen gave up 10,000 or 10% and gave it to Kate. So that's a gift, okay? So Allen initially owned 60% and Kate 40%. In 2000, Allen and Kate are married. The ownership becomes 50, 50. As the gift was made when they married in 2000. So what's the amount of the gift? Again, 60,000 minus 50. Allen's gift to Kate is 10,000, okay? In 2016, how much is included in Allen's gross estate? What happened in 2016? In 2016, he passed away. So how much is included in his gross estate? Now we have to go back and compute the formula using this formula up here. Okay, remember the value was 400,000. We are giving the value when he passed away. The value is 400,000. So we're gonna take the amount that Allen contributed 60,000 divided by 10 times 400,000. And that amount is 240,000. Now the question is how much he would include in his estate? Well, he's gonna include 240,000. And what's gonna happen? We're gonna turn around and deduct 240 for marital deduction because she's gonna get it, okay? So the 240 is automatically passed to Kate, okay? So simply put, we're gonna say it's 240,000 included. Then we're gonna learn in the next session about marital deduction. Then with the deduct 240, therefore the taxable estate is nothing. The net amount is nothing because you're gonna include 240, then it's gonna go to his wife. Remember what we talked about when it comes to your wife. You don't have an option. It automatically goes to the wife. You will include it in the gross estate. Then you will deduct it. Basically the net is zero. The net amount is zero. Let's take a look at another joint ownership situation. We have Keith and Steve, father and son acquired a track of land with ownership listed as a joint tenancy. Let's go back to joint tenancy. This is not husband and wife. This is father and son joint tenancy. What does that mean? It's one person die, right here. One person die, it goes to the other person. So you know what it is before we proceed. Keith, the father furnished 400,000. Keith furnished 400,000. And Steve furnished 200,000 to purchase it. Of the 200 that Steve furnished, 100 has been received as a gift from his father. So technically his father paid 500,000. The property was worth 900,000. Keith died. The father died. Because only 1,000 of Steve's contribution can be counted. Steve has furnished only 1,600, which is 100,000. The son furnished 100,000, 1,600 of the cost. What's gonna happen? Now we have to include 5,600 of the cost, which is 900 times 5,600 in the father's estate. And this result presumed that Steve can prove that he did in fact made the 100,000 contribution in the absence of such proof. The full value is included in his father's estate. So as long as he can ensure that, yeah, I made this 100,000, I saved it over the years. And when I bought this land, here's my bank account, and here's my check, that's the case. The, what we need to look at too is the valuation date. When do we value the asset? Well, the valuation date is determined at the date of death or an alternative valuation date, AVD. What is that alternative valuation date? Six months after death or the date of the disposition within six months. So if you sold something within six months, well, we know when we cash something, we know the value. Okay? So to collect, to not collect, to choose the alternative valuation date, that date must reduce the gross estate and the estate tax liability. So simply put, what you're hoping is, it's kind of counterintuitive, is when you pass away, when a person passes away, and if they choose the alternative valuation date, it means they are hoping that the value of the asset goes down, the value of the asset goes down. Why? Because if the value of the asset goes down, they will choose that six months later. Let's assume we're talking about stocks and bonds. You want the stocks and bonds to go down in value. Why? Because when you value the estate, if it's lower, then you pay less taxes. It's kind of counterintuitive. Yes, but that's how it is. Let's take a look at a quick example to see how it works. Robert Gross Estates consists of the following land. We have the value at the date of death and the value six months later. 14 million 800, six months later, 14 million 840 stocks in Brown Company, 900,000. The value is lower at six months later. And stock in Green Corporation, the value is lower as well. So here's the total, 16.2 million, six months later, 16 million. Now, if Robert's executor elects the alternative valuation date, the estate must value at 16 million. It's not permissible to value the land at the date of death, which is lower, and choose the alternative valuation date. It's either for all, unless you sold those assets, one of those assets during the year. Now, this is basically, I looked at the gross estate. What's included in the gross estate and basically going back to what we started with, that is line one. That's why I went over line one. In the next session, I will work a quick example illustrating line one. Then I would go into line two, which is expenses, losses, and deduction, which include the marital deduction. As always, I would like to remind you, if you like this recording, please click on the like button, subscribe, share it with others. Also, if you are interested, if you are studying for your CPA exam and interested in supplementary material, visit my website. You study for your CPA once for 20, 30 years, make it worth it, pass, move on. That's what you need to do. Study hard, good luck. And usually this topic is not taught very well in colleges and universities. So hopefully I did help you clarify this topic. Good luck and study hard.