Study Unit 20

1
STUDY UNIT TWENTY

ESTATES AND TRUSTS
20.1 Income Taxation . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1

20.2 Beneficiary’s Taxable Income . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 6
20.3 Gift Tax . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 7
20.4 Estate Tax . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 9
20.5 Generation-Skipping Transfer Tax (GSTT) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 12
This study unit addresses two different kinds of tax: income taxes and transfer taxes. Estates and
trusts are legal entities defined by the assets they hold. These assets produce income. The entities
are subject to tax on that income. This is referred to as fiduciary income taxation. The formula for
computing this fiduciary tax is the individual income tax formula presented in Study Unit 11, modified for
the distribution deduction and other special rules. Furthermore, the beneficiaries of these fiduciary
entities, rather than the fiduciary, are personally subject to income tax on certain fiduciary income.
In contrast, the gift and estate taxes (Subunits 3 and 4) are not income taxes. They are taxes on
the transfer of assets from one person to another. Relatively few exclusions and deductions apply, and
unified transfer tax rates and an applicable credit amount, or ACA, (formerly referred to as the unified
credit) apply against all transfers. The donor or estate, not the recipient, must generally pay the tax.
Finally, the generation-skipping transfer tax (Subunit 5) limits avoidance of gift and estate taxes.
20.1 INCOME TAXATION

Tax is imposed on taxable income of a trust or estate at the following rates for 2006.
Fiduciary Taxable Income Brackets Applicable Rate

$ 0 - $2,150 15%
> 2,150 - 5,000 25% (+ $ 322.50)
> 5,000 - 7,650 28% (+ $1,035.00)
> 7,650 - 10,450 33% (+ $1,777.00)
> 10,450 35% (+ $2,701)
1. Fundamentals. Following are some basic definitions and a discussion of filing

requirements.
a. A simple trust is formed under an instrument having the following characteristics:
1) Requires current distribution of all its income
2) Requires no distribution of the res (i.e., principal)
3) Provides for no charitable contributions by the trust
b. A complex trust is any trust other than a simple trust. A complex trust can accumulate
income, provide for charitable contributions, and distribute amounts other than
income.
c. A grantor trust is any trust to the extent the grantor is the effective beneficiary. Income
attributable to the portion of a trust principal treated as owned by the grantor is taxed
to the grantor. The trust is disregarded.
1) A trust is considered a grantor trust when the grantor has greater than 5%
reversionary interest.
2) Under Sec. 677(a), a grantor is treated as the owner of a trust in which the
income may be distributed or accumulated for the grantor’s spouse (without the
approval or consent of an adverse party).
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2 SU 20: Estates and Trusts
3) The grantor is also taxed on income from a trust in which the income may be
applied for the benefit of the grantor [Sec. 677(a)]. Use of income for the
support of a dependent is considered the application of income for the benefit of
the grantor. Under Sec. 677(b), however, the income that may be applied for
the support of a dependent is not taxable to the grantor if it is not actually used.
d. The rules for classifying trusts are applied on a year-to-year basis.
e. An estate with GI greater than or equal to $600 is required to file a tax return. A trust
is required to file a return if it has either any taxable income or more than $600 of
gross income.
1) The trustee, executor, or administrator must file the return no later than the 15th
day of the fourth month after the close of the entity’s tax year.
2) Form 1041, U.S. Fiduciary Income Tax Return, must be used with its own tax
rate schedule.
3) If a domestic estate has a beneficiary who is a nonresident alien, the
representative must file a return regardless of income.
4) Estate GI includes the gain from the sale of property (not gross proceeds).
2. Principal vs. income. Tax is imposed on taxable income (TI) of trusts and estates, not on
items treated as fiduciary principal.
a. State law defines what is principal and what is income of a trust or estate for federal
income tax purposes. Many states have adopted the Revised Uniform Principal and
Income Act, some with modifications. The act and state laws provide that trust
instrument designations of fiduciary principal and interest components control. They
also provide default designations.
b. Generally, principal is property held eventually to be delivered to the remainderman.
Change in form of principal is not taxable income. Income is return on, or for use of,
the principal. It is held for or distributed to the income beneficiary.
1) Principal is also referred to as the corpus or res.
Allocation of Fiduciary Receipts and Disbursements

Principal Income
Receipts
Consideration for property, e.g., Business income
Gain on sale Insurance proceeds for lost profits
Replacement property Interest
Nontaxable stock dividends Rents
Stock splits Dividends (taxable)
Stock rights Extraordinary dividends
Liquidating dividends Taxable stock dividends
Royalties (27 1/2%) Royalties (72 1/2%)
Disbursements
Principal payments on debt Business (ord. & nec.) expenses, e.g.,
Capital expenditures Interest expense
Major repairs Production of income expenses, e.g.,
Modifications Maintenance/repair
Fiduciary fees Insurance
Tax on principal items, e.g., Rent collection fee
Capital gains Tax on fiduciary income
Depreciation
SU 20: Estates and Trusts 3
3. Income tax formula. TI of a trust or an estate is computed similarly to that of an individual.

a. Gross income is computed as for individuals. Capital gain is charged to principal.
b. Life insurance proceeds are generally includible in the value of the gross estate but
are not considered income of the estate.
c. Income in respect of a decedent is also taxed as income if it is received by the estate.
d. Capital gains are taxed to the estate; then the gain must be added to the principal of
the estate.
e. AGI does apply to fiduciaries for purposes of computing deduction limits.
1) The standard deduction is not allowed.
f. Deductions. They generally follow those allowable to an individual. Trustee fees, or
administrator fees, and tax return preparation fees are deductible in full.
1) Administration expenses are deductible in full, if not deducted on the estate tax
return. The amount of trustee fees deductible is not limited to the excess over
2% of AGI.
2) Depreciation. In default of a trust instrument designation, the act charges
depreciation to income.
a) Nevertheless, absent provisions in the estate instrument apportioning the
deduction, the allowable amount must be allocated between the estate
and each beneficiary in proportion to the amount of fiduciary income
taxable to each party.
b) Trusts. The trust may deduct depreciation only to the extent a reserve is
required or permitted under the trust instrument or local law, and income
is set aside for the reserve and actually remains in the trust.
i)Any part of the deduction in excess of the trust income set aside for
the reserve is then allocated between the parties according to the
trust instrument. If the instrument is silent, allocation of the excess
between the trust and each beneficiary is in proportion to the
amount of fiduciary income taxable to each.
3) Fiduciary NOLs are computed without regard to charitable contributions or
distribution deductions. Carryover by the fiduciary is permitted.
a) Pass-through for deduction on personal returns of beneficiaries is allowed
only in the year the fiduciary terminates.
b) Pass-through NOLs and capital loss carryovers are used to calculate the
beneficiary’s AGI and taxable income.
c) Estates can claim a deduction for a NOL. The NOL is calculated in the
same manner as an individual taxpayer’s deduction, except that an estate
cannot deduct any distributions to beneficiaries or charitable contributions
in arriving at the NOL or NOL carryover.
d) An unused NOL in the final year of the estate may carry over to the
beneficiaries succeeding to the property of the estate.
4) A fiduciary may deduct a capital loss to the extent of capital gains plus $3,000.
Carryover is permitted for individuals and estates; however, no carryover is
allowed from a decedent’s final return to his/her estate or beneficiary.
5) Miscellaneous itemized deductions are subject to the 2%-of-AGI floor.
6) Charitable contributions are deductible only if the governing instrument
authorizes them. Deduction is not subject to limits based on AGI.
7) Expenses attributable to tax-exempt income are not deductible.

8) Personal exemption. A deduction is allowable but not for the year the trust or
estate terminates. The amount is $600 for an estate, $300 for a simple trust,
and $100 for a complex trust.
g. Credits. Gross regular tax of a fiduciary is offset by most of the same credits available
to individuals. Certain “personal” credits are unavailable. A fiduciary, for example,
has no dependents.
h. Losses from a passive activity owned by the estate or trust cannot be used to offset
portfolio (interest, dividends, royalties, annuities, etc.) income of the estate or trust in
determining taxable income.
4. Distribution deduction. The deduction for distributions allocates taxable income of a trust
or estate (gross of distributions) between the fiduciary and its beneficiaries.
a. Simple trust. The deduction is the lesser of the amount of the distributions (required)
or distributable net income (DNI) (computed without including exempt income).
1) Generally, DNI is current net accounting income of the fiduciary reduced by any
amounts allocated to principal.
b. Estates and complex trusts. The deduction is the lesser of DNI or distributions.
1) The amount distributed is the lesser of the FMV of the property or the basis of
the property in the hands of the beneficiary.
2) The trustee(s) of a complex trust may elect to treat distributions made during the
first 65 days of the (trust’s) tax year as if they were made on the last day of the
preceding tax year.
3) Specific bequests distributed or credited to a beneficiary in no more than three
installments are not included as amounts distributed.
4) The fiduciary recognizes no gain on distribution of property, unless an estate
executor so elects.
5) A beneficiary’s basis in distributed property is transferred, with adjustments for
any gain recognized to the fiduciary. Every $1 of value distributed is treated as
if (first) from any current DNI.
a) The instrument might allocate the $1 to current income, accumulated
income, or principal.
b) Principal (after DNI) is distributed tax-free.
5. Distributable net income (DNI) is the maximum deductible at the fiduciary level for
distributions and the maximum taxable at the beneficiary level. It is taxable income of the
fiduciary (trust or estate), adjusted by the following items:
Taxable Income (TI) of fiduciary (before the distribution deduction)
+ Personal exemption deduction ($600 estate,
$300 simple trust, $100 complex trust)
+ Tax-exempt interest minus any related expenses
+ Capital losses allocated to principal
– Capital gains allocated to principal
– Taxable stock dividends allocated to principal
– Extraordinary dividends allocated to principal
= Distributable net income
a. No adjustment to fiduciary TI is made for the following:

1) Dividends, other than as above
2) NOL deductions
3) Depreciation, if a reserve is established and all income is not distributable
4) Certain expenditures charged to principal, such as trustee fees. They do reduce
income taxable to the beneficiary.
6. Income in Respect of a Decedent (IRD). IRD is all amounts to which a decedent was
entitled as gross income but which were not includible in computing taxable income on the
final return. The decedent had a right to receive it prior to death; e.g., salary was earned or
sale contract was entered into.
a. Not includible on the final income tax return of a cash-method (CM) taxpayer are
amounts not received. Not includible on the final income tax return of an accrual-
method (AM) taxpayer are amounts not properly accrued. Examples follow:
Not IRD IRD
Salary earned and accrued by AM Salary earned prior to but not received
taxpayer before death of a CM taxpayer
Collection of A/R by AM taxpayer Collection of A/R by CM taxpayer
Gain on sale of property received Gain on sale of property by CM taxpayer,
before death not received before death
Rent received before death Rent accrued but not received by CM
taxpayer before death
Interest on installment debt accrued Interest on installment debt accrued by
after death CM taxpayer before death
Installment contract income Installment income recognized after death
recognized before death on contract entered into before death
b. IRD is reported by the person receiving the income.
1) The cash method applies to income once designated IRD.
2) IRD received by a trust or estate is fiduciary income.
c. A right to receive IRD has a transferred basis. The basis is not stepped-up to FMV on
the date of death, as is generally the case for property acquired from a decedent.
1) EXAMPLE: Mrs. Hart had earned 2 weeks’ salary of $2,000 that had not been
paid when she died. As a cash-method taxpayer, her basis in the right to
receive the $2,000 was $0. When her estate received the income, it had
$2,000 of ordinary income because its basis in the right to receive it was also
$0. Note that the $2,000 is not reported on Mrs. Hart’s final return.
d. IRD has the same character it would have had in the hands of the decedent.
e. IRD is taxable as income to the recipient and is includible in the gross estate. Double
taxation is mitigated by deductions.
1) Deductions in respect of a decedent. Expenses accrued before death, but not
deductible on the final return because the decedent used the cash method, are
deductible when paid if otherwise deductible.
a) They are deductible on a fiduciary income tax return.
b) They are also deductible on the estate tax return.
2) Deduction for estate tax. Estate taxes attributable to IRD included in the gross
estate are deductible on the fiduciary income tax return.
a) Administrative expenses and debts of a decedent are deductible on the
estate tax return (Form 706). Some of them may also be deductible on
the estate’s income tax return (Form 1041).
i) Double deductions are disallowed.
ii)The right to deduct the expenses on Form 706 must be waived in
order to claim them on Form 1041.
b) Deduction is allowed for any excess of the federal estate tax over the
amount of the federal estate tax if the IRD had been excluded from the
gross estate.
7. An estate may adopt any tax year ending within 12 months after death. Most trusts must
adopt a calendar tax year. Tax-exempt and wholly charitable trusts may qualify to use a
fiscal tax year.
a. A beneficiary includes his/her share of trust income in his/her return for his/her tax
year in which the trust’s tax year ends, without regard to when distributions are
made.
8. Any permissible accounting method may be adopted.
9. The alternative minimum tax applies to trusts and estates. It is determined in the same
manner as for individuals.
10. Trusts and estates are required to remit payments of estimated tax. The required amount
and due dates of installments are determined in the same manner as for individuals.
a. An estate is not required to pay estimated tax for its first 2 tax years.
b. A trustee may elect to treat any portion of an estimated tax payment by the estate as
made by the beneficiary. The amount would also be treated as paid or credited to the
beneficiary on the last day of the tax year.
20.2 BENEFICIARY’S TAXABLE INCOME

1. Simple trust. A beneficiary of a simple trust is taxed on the lower of the two amounts listed
below.
a. Trust income required to be distributed (even if not distributed)
b. The beneficiary’s proportionate share of the trust’s DNI
2. Estates and complex trusts. A beneficiary of a complex trust is taxed on amounts of
fiduciary income required to be distributed plus additional amounts distributed to the
beneficiary. However, the taxable amount is limited to the beneficiary’s share of DNI.
3. Character. The character of the income in the hands of the beneficiary is the same as in
the hands of the trust or estate.
a. EXAMPLE: A simple trust distributes all its $10,000 income to its sole beneficiary. Its
DNI is also $10,000. Included in the trust income was $1,000 of tax-exempt income.
The beneficiary treats $1,000 of the income from the trust as tax-exempt interest and
excludes it from his/her personal gross income.
4. Schedule K-1 (Form 1041) is used to report the beneficiary’s share of income deductions
and credits from a trust or an estate.
20.3 GIFT TAX

The gift tax is a tax of the transfer, imposed on the donor. The table below presents the basic tax
formula, modified for the gift tax.
GIFT AMOUNT
FMV on date of gift, for
All gifts in the calendar year
– Exclusions
Annual exclusion
$12,000 per donee
Gift-splitting between spouses
Paid on behalf of another for
Medical care
Education tuition
– Deductions
Marital
Charitable
= TAXABLE GIFTS FOR CURRENT YEAR
+ Taxable gifts for prior years
= TAXABLE GIFTS TO DATE
× Tax Rate
= TENTATIVE GIFT TAX
– [Prior year’s gifts × current tax rates]
– Applicable credit amount
= GIFT TAX LIABILITY
1. Amount of gift. Any excess of FMV of transferred property over the FMV of consideration
for it is a gift. In other words, the amount of a gift is the FMV of what was given.
a. A gift is complete when the giver has given over dominion and control such that (s)he
is without legal power to change its disposition.
1) EXAMPLE: R opens a joint bank account with A, I, and H, with R the only
depositor to the account. R, A, I, and H may each withdraw money. A gift is
complete only when A, I, or H withdraws money.
b. Gifts completed when the donor is alive (inter vivos gifts) are the only ones subject to
gift tax. Transfers made in trust are included.
1) Property passing by will or inheritance is not included.
c. To the extent credit is extended with less than sufficient stated interest, the Code
imputes that interest is charged. If the parties are related, the lender is treated as
having made a gift of the imputed interest to the borrower.
1) Gift loans are excluded if the aggregate outstanding principal is not more than
$10,000.
d. Basis in a gift is basis in the hands of the donor plus gift tax attributable to
appreciation.
2. Annual exclusion. The first $12,000 of gifts of present interest to each donee is excluded
from taxable gift amounts. The annual exclusion is indexed to reflect inflation.
a. The $12,000 exclusion applies only to gifts of present interests.
b. A present interest in property includes an unrestricted right to the immediate
possession or enjoyment of property or the income from property (such as a life
estate or a term for years but not remainders or reversions).
3. Gift splitting. Each spouse may treat each gift made to any third person as made one-half
by the donor and one-half by the donor’s spouse.
a. They must be married at the time of the gift.
b. They must make a proper election and signify their consent on the gift tax return.
c. Each spouse may exclude $12,000 annually of gifts to each donee.
4. Medical or tuition costs. Excluded from taxable gifts are amounts paid on behalf of
another individual as tuition to an educational organization or for medical care.
a. The payment must be made directly to the third party, i.e., the medical provider or the
educational organization.
b. Amounts paid for room, board, and books are not excluded.
5. Transfers that represent support are not gifts.
6. Political contributions are not subject to gift tax.
7. Marital deduction. The amount of a gift transfer to a spouse is deducted in computing
taxable gifts. Donor and donee must be married at the time of the gift, and the donee must
be a U.S. citizen.
a. The deduction may not exceed the amount includible as taxable gifts.
b. Otherwise, the amount of the deduction is not limited.
1) EXAMPLE: Sid Smith gave his wife, Mary, a diamond ring valued at $20,000
and cash gifts of $30,000 during 2007. Sid is entitled to a $12,000 exclusion
with respect to the gifts to Mary. His marital deduction is $38,000, i.e., the
portion that would have constituted taxable gifts.
8. Charitable deduction. The FMV of property donated to a qualified charitable organization
is deductible. Like the marital deduction, the amount of the deduction is the amount of the
gift reduced by the $12,000 exclusion with respect to the donee.
9. Computing the gift tax. Tentative tax is the sum of taxable gifts to each person for the
current year and for each preceding year times the rate. Taxable gifts to a person is the
total of gift amounts (FMV) in excess of exclusions and the marital and charitable
deductions for a calendar year.
a. The unified transfer tax rates are used. Current-year applicable rates are applied to
both current and preceding years’ taxable gifts. The rate is 18% for taxable gifts up
to $10,000. The rates increase in small steps (e.g., 2%, 3%) over numerous
brackets. The maximum rate is 45% on cumulative gifts in excess of $1.5 million in
2007.
b. The tentative gift tax is reduced by the product of prior years’ taxable gifts and the
current-year rates.
c. Applicable credit amount (ACA). Tentative tax may also be reduced by any ACA. The
ACA is a base amount ($345,800 in 2007) reduced by amounts allowable as credits
for all preceding tax years.
d. Gift tax liability for a current year = Tentative tax – (Prior-year gifts × Current rates) – ACA.
10. Gift tax return. A donor is required to file a gift tax return, Form 709, for any gift(s), unless
all gifts are excluded under the annual $12,000 exclusion, the exclusion for medical or
tuition payments, or the deduction for qualified transfers to the donor’s spouse. Gift
splitting does not excuse the donor from the requirement to file.
a. A gift tax return is due on the 15th of April following the calendar year in which a gift
was made. But a gift tax return for a year of death is due no later than the estate tax
return due date.
b. A United States donee must report information on gifts from foreign persons if the
aggregate of such gifts from all foreign persons exceeds $12,000.
20.4 ESTATE TAX

The estate tax is an excise tax imposed on the transfer of the taxable estate of every decedent
who was a U.S. citizen or resident.
ESTATE TAX Formula

GROSS ESTATE
– Deductions
Expenses, claims, taxes
Casualty and theft losses
Charitable bequests
Marital deduction
= TAXABLE ESTATE
+ Taxable gifts made after 1976
= TOTAL TAXABLE TRANSFERS
× Tax rate
= TENTATIVE ESTATE TAX
– Gift taxes paid on post-1976 gifts
– Applicable credit amount
– Other credits
= ESTATE TAX LIABILITY
1. The Gross Estate (GE). A decedent’s gross estate includes the FMV of all property, real or
personal, tangible or intangible, wherever situated, to the extent the decedent owned a
beneficial interest at the time of death. Special tax avoidance rules are established for U.S.
citizens or residents who surrender their U.S. citizenship or long-term U.S. residency.
a. Included are items such as cash, personal residence and effects, securities, other
investments (e.g., real estate, collector items), other personal assets such as notes
and claims (e.g., dividends declared prior to death if the record date had passed),
and business interests (e.g., in a sole proprietorship, partnership interest).
b. Liabilities of the decedent generally do not affect the amount of the GE, unless the
estate actually pays them.
c. The GE includes the value of the surviving spouse’s interest in property as dower or
curtesy.
1) Dower and curtesy are common-law rights recognized in some states, usually in
modified form.
a)
Dower entitles a surviving wife to a portion of lands her husband owned
and possessed during their marriage.
b) Curtesy entitles a surviving husband to a life estate in all of his wife’s land
if they had children.
d. The GE includes the full value of property held as joint tenants with the right of
survivorship, except to the extent of any part shown to have originally belonged to the
other person and for which adequate and full consideration was not provided by the
decedent (i.e., the other tenant provided consideration).
1) The GE includes 50% of property held as joint tenants by spouses or as tenants
by the entirety regardless of the amount of consideration provided by each
spouse.
e. The value of property interests over which the decedent had a general power of
appointment (POA) are included in the GE. A POA is a power exercisable in favor of
the decedent, his/her estate, his/her creditors, or the creditors of his/her estate.
f. Bonds, notes, bills, and certificates of indebtedness of the federal, state, and local
governments are included in the GE, even if interest on them is exempt from income
tax.
g. The GE includes insurance proceeds on the decedent’s life if either 1) or 2) below
applies.
1) The insurance proceeds are payable to or for the estate (including if payable to
the executor).
2) The decedent had any incident of ownership in the policy at death, e.g.,
a) Right to change beneficiaries
b) Right to terminate the policy
3) Payment of premiums is not determinative.
4) No contemplation-of-death rule applies.
h. Annuities and survivor benefits including interest. The GE includes the value of any
annuity receivable by a beneficiary by reason of surviving the decedent if either of the
following statements applies:
1) The annuity was payable to the decedent.
2) The decedent had the right to receive the annuity or payment
a) Either alone or in conjunction with another
b) For his/her life or for any period not ascertainable without reference to
his/her death, or for any period that does not end before his/her death.
i. Medical insurance reimbursements due the decedent at death are treated as property
in which the decedent had an interest.
j. Gifts within 3 years of death. The gifts made prior to death are not included in the GE
of a decedent who died after 1981, except for certain transfers such as transfers of
life insurance and property in which a life estate was retained. However, the GE
does include gift taxes paid on gifts within 3 years before death.
k. Inter vivos transfers. The GE includes assets transferred during life in which the
decedent retained, at death, any of the following interests:
1) A life estate, an income interest, possession or enjoyment of assets, or the right
to designate who will enjoy the property
2) A 5% or greater reversionary interest if possession was conditioned on surviving
the decedent
3) The power to alter, amend, revoke, or terminate the transfer
4) An interest in a qualified terminable interest property (QTIP) trust
2. Valuing the gross estate. Value is the FMV of the property unless a special valuation rule
is used. Real property is usually valued at its highest and best use. A transfer of interests
in a corporation or partnership to a family member is subject to estate tax-freeze rules.
Generally, the retained interest is valued at zero.
a. The executor may elect to value the estate at either the date of death or the alternate
valuation date. An alternate valuation date election is irrevocable.
1) The election can be made only if it results in a reduction in both the value of the
gross estate and the sum of the federal estate tax and the generation-skipping
transfer tax (reduced by allowable credits).
b. The alternate valuation date is 6 months after the decedent’s death.

1) Assets sold or distributed before then are valued on the date of sale or
distribution.
2) Assets, the value of which is affected by mere lapse of time, are valued as of the
date of the decedent’s death, but adjustment is made for value change from
other than mere lapse of time.
a) Examples of such assets are patents, life estates, reversions, and
remainders.
b) The value of such assets is based on years.
c) Changes due to time value of money are treated as from more than mere
lapse of time.
3. Deductions from the gross estate. Deductions from the GE in computing the taxable
estate (TE) include ones with respect to expenses, claims, and taxes.
NOTE: A deductible amount is allowed against gross income on the decedent’s final income
tax return only if the right to deduct them from the GE is waived.
a. Expenses for selling property of an estate are deductible if the sale is necessary to pay
the decedent’s debts, expenses of administration, or taxes; to preserve the estate; or
to effect distribution.
b. Administration (Sec. 2053) and funeral expenses are deductible.
c. Claims against the estate (including debts of the decedent) are deductible.
1) Medical expenses paid within 1 year of death may be deducted on either the
estate tax return or the final income tax return (not both).
d. Unpaid mortgages on property are deductible if the value of the decedent’s interest is
included in the GE.
e. A limited amount of state death taxes is deductible. Federal estate taxes and income
tax paid on income earned and received after the decedent’s death are not
deductible.
f. Casualty or theft losses incurred during the settlement of the estate are deductible, if
not deducted in the estate’s income tax return.
g. Charitable contributions. Bequests to qualified charitable organizations are
deductible. The entire interest of the decedent in the underlying property must
generally be donated. Trust interests may enable deductible transfer of partial
interests in underlying property. An inter vivos contribution (vs. a bequest) may result
in exclusion from the GE and a current deduction for regular taxable income.
h. Marital transfers. Outright transfers to a surviving spouse are deductible from the GE,
to the extent the interest is included in the gross estate. The surviving spouse must
be a U.S. citizen when the estate tax return is filed. A marital deduction is allowed for
transfers of qualified terminable interest property (QTIP). These transfers allow a
marital deduction where the recipient spouse is not entitled to designate which parties
will eventually receive the property. QTIP is defined as property that passes from the
decedent in which the surviving spouse has a qualifying income interest for life and to
which an election applies. A spouse has a qualifying income interest for life if he or
she is entitled to all the income from the property that is paid at least annually, and no
person has a power to appoint any portion of the property to anyone other than the
surviving spouse unless the power cannot be exercised during the spouse’s lifetime.
4. Computing the estate tax and credits. The estate tax is imposed on the sum of the TE
plus gifts subject to the gift tax. However, it is reduced by gift taxes payable on those gifts
and by the ACA.
a. TE is the GE reduced by deductions.
b. Tentative tax is the product of total taxable transfers and the applicable rate.
c. Total taxable transfers are the sum of the TE plus taxable gifts after 1976 (valued at
FMV on the date of the gifts).
d. Applicable rates are the unified transfer tax rates. Current-year applicable rates are
applied to both current and preceding years’ taxable gifts. The rate is 18% for
taxable gifts up to $10,000. The rates increase in small steps (e.g., 2%, 3%) over
numerous brackets. The maximum rate is 45% on cumulative gifts in excess of
$1.5 million in 2007.
e. The tentative estate tax is reduced by the credit for gift taxes payable on post-1976
gifts, based on current rates.
f. Tentative estate tax reduced by gift taxes paid, the ACA, and other credit is the net
estate tax.
g. ACA. The ACA is a base amount ($780,800 in 2007), not reduced by amounts
allowable as credits for gift tax for all preceding tax years.
1) The ACA offsets the estate tax liability that would be imposed on a taxable
estate of up to $2,000,000 computed at current rates.
h. Credit is allowable for death taxes paid to foreign governments.
i. Credit is allowable on gift tax paid on gifts included in the gross estate.
j. Prior transfers. Credit is allowed for taxes paid on transfers by or from a person who
died within 10 years before, or 2 years after, the decedent’s death.
1) Amounts creditable are the lesser of the following:
a) Estate tax paid by the (prior) transferor
b) Amount by which the assets increase the estate tax
2) Adjustment is made to the credit for transfers more than 2 years prior to the
decedent’s death.
5. Estate tax return. The executor is required to file Form 706, United States Estate Tax
Return, if the gross estate at the decedent’s death exceeds $2,000,000. Adjusted taxable
gifts made by the decedent during his/her lifetime reduce the threshold.
a. The estate tax return is due within 9 months after the date of the decedent’s death. An
extension of up to 6 months may be granted. It should be sent to the IRS Center in
the state where the decedent was domiciled at the time of death. A death certificate
must be attached.
b. Time for payment may be extended up to 1 year past the due date. For reasonable
cause, the time for payment may be extended up to 10 years.
c. Estate tax is charged to estate property. If the tax on part of the estate distributed is
paid out of other estate property, equitable contribution from the distributee
beneficiary is recoverable. The executor is ultimately liable for payment of the taxes.
If there is more than one executor, each must verify and sign the return.
d. An estate that includes a substantial interest in a closely held business may be
allowed to delay payment of part of the estate tax, if that interest exceeds 35% of the
gross estate.
1) A closely held business includes the following, if carrying on a trade or business:
a) A corporation, if it has 45 or fewer shareholders or if 20% or more in value
of the voting stock is included in the gross estate
b) A partnership, if it has 45 or fewer partners or if 20% or more of the capital
interests in the partnership is included in the gross estate
20.5 GENERATION-SKIPPING TRANSFER TAX (GSTT)

The GSTT is imposed separately and in addition to gift and estate taxes on transfers directly or in
trust for the sole benefit of a person at least two generations younger than the transferor. GSTT is
generally imposed on each generation-skipping transfer (GST). A GST is a direct skip, a taxable
distribution, or a taxable termination.
1. A direct skip is a transfer of an interest in property, subject to estate tax or gift tax, to a skip
person. The transferor is liable for the tax.
a. A skip person is either a natural person assigned to a generation that is two or more
generations below the transferor or a trust, all interests of which are held by skip
persons.
1) In the case of related persons, a skip person is identified by reference to the
family tree.
a) EXAMPLE: A grandchild is two generations below the grandparent.
2) In the case of nonrelated persons, a skip person is identified by reference to age
differences.
a) EXAMPLE: An individual born between 37 1/2 years and 62 1/2 years
after the transferor is two generations below the transferor.
2. A taxable distribution is a distribution from a trust to a skip person of income or principal,
other than a distribution that is a direct skip or taxable termination. The transferee is liable
for the tax.
3. A taxable termination is a termination of an interest in property held in trust. A taxable
termination has not occurred if, immediately after the termination, a nonskip person has an
interest in the property or if distributions are not permitted to be made to a skip person at
any time following the termination.
a. Termination may be by lapse of time, release of power, death, or otherwise.
b. The trustee is liable to pay the tax.
4. Amount. The GSTT approximates the maximum federal estate tax that would have applied
to the transfer on the date of the transfer.
NOTE: The Economic Growth and Tax Relief Act of 2001 provides for the eventual repeal
of the GSTT after 2009.
5. GST exemption. Each individual is allowed a $2,000,000 exemption in 2007 that (s)he, or
his/her executor, may allocate to GST property. The exemption is indexed for inflation.
a. Gift splitting applies to GSTTs. $4,000,000 is allocable.
6. Inter vivos gifts are exempt from the GSTT if they are not subject to gift tax due to the
$12,000 annual exclusion or the medical/tuition exclusion.

Study Unit 20

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STUDY UNIT TWENTY

20.1 Income Taxation . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1

20.1 INCOME TAXATION

Fiduciary Taxable Income Brackets Applicable Rate

1. Fundamentals. Following are some basic definitions and a discussion of filing

Allocation of Fiduciary Receipts and Disbursements

3. Income tax formula. TI of a trust or an estate is computed similarly to that of an individual.

7) Expenses attributable to tax-exempt income are not deductible.

a. No adjustment to fiduciary TI is made for the following:

20.2 BENEFICIARY’S TAXABLE INCOME

20.3 GIFT TAX

20.4 ESTATE TAX

ESTATE TAX Formula

b. The alternate valuation date is 6 months after the decedent’s death.

20.5 GENERATION-SKIPPING TRANSFER TAX (GSTT)

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