Indiana Bar Corp, Est, Gift Taxes

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Pass-Through Business Entities

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RULE: the pass-through business entity pays no tax at the entity level.

RULE: Individual SHs/partners will report tax on their distributive share of income from the corp/PS regardless of whether they receive it.

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Examples of Pass-Through Business Entities

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General Partnerships
Limited Partnerships
LLCs
Subchapter S Corporations

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Partnership tax liability

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RULE: each partner must report his distributive share of PS income, regardless of whether he has received it.

RULE: formation of a PS is generally not a taxable event.

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Subchapter S Corporation

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RULE: corporations may elect to be treated as S-corporations for tax purposes.

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S Corporation eligibility

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(1) < 100 SHs

(2) SHs must be individuals

(3) Only one class of stock

(4) All SHs must consent to the election

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Corporate Tax

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RULE: corporate tax is a DOUBLE tax regime - corps pay income tax upon their profits AND SHs pay tax upon dividends received from the corp.

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Corp tax on formation - to the corp

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RULE: there is no gain to a corp upon the receipt of money or property upon formation/incorporation.

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Corp tax on formation - to the SHs

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RULE: these is no gain or loss to the SHs upon forming/incorporating a corp where:

(1) The SHs contribute property
(2) The SHs receive stock in return for the exchange
(3) AND the SHs are in control (SHs have 80% of the outstanding corp stock) immediately after the exchange

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Corp tax on formation - basis rules for corp

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RULE: When a corp receives a contribution of property from its SHs, the corp's basis is the same basis that the SHs had in the property, PLUS any gain the SH was required to recognize on the transaction.

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Corp tax on formation - basis rules for SHs

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RULE: the SH's basis in stock received from the corp upon formation is the same basis they had in the property they contributed (substituted basis)

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Corporate Distributions - taxable to SHs?

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RULE: SHs are taxable on the dividends they receive.

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Dividend

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A corp distribution made out of the corp's earnings and profits.

NOTE: most paid by domestic corps are eligible for preferential capital gains rates.

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Distributions NOT made out of corp's earnings or profits

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RULE: treated as a fax-free recovery of the SH's basis in her stock.

BUT, if it exceeds the SH's basis in her stock, it is treated as gain from sale of a capital asset.

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Corporate Distributions - taxable to corp?

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RULE: taxable upon distributions of appreciated property to its SHs.

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Liquidation

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RULE: when a corp distributes property to its SHs in COMPLETE LIQUIDATION of the corp or in COMPLETE TERMINATION of an individual SH's interest, the SH is treated as having sold her stock to the corp.

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Redemption

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RULE: for purposes of the corp redemption and liquidation rules, stock owned by one SH may be viewed as CONSTRUCTIVELY owned, i.e., is DEEMED to be owned, by a "related" SH. (spouses, parents, children)

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Purchase of Corporate business

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Can be structured as either:

(1) Asset sale

OR

(2) Stock Acquisition

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Asset Sale

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Results in 2 levels of tax that are generally IMMEDIATE:

(1) A corp level tax on the asset sale itself
(2) AND a SH level tax upon subsequent distribution of proceeds

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Stock Acquisition

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Results in only 1 immediate tax - to the SHs on the sale of their stock.

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Basic Taxation Principle of Trusts, Estates, and Beneficiaries

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Trusts and estate are taxable entities, which are liable to pay federal income tax.

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Income taxation of trusts

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RULE: Subject to fed income taxation on amounts distributed to them from the trust. The trust is entitled to deduct distributions made to beneficiaries. The practical outcome is that there is no tax to the trust on distributed income.

RULE: trust subject to fed income tax on accumulated income

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Income taxation of estates

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RULE: an estate will be subject to fed income tax on any income generated by property held during the administration of the estate.

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Income in Respect of Decedent (IRD)

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RULE: Payments that were owed to a cash basis decedent, but not yet paid at the time of death, are taxable to the estate, assuming that the estate is entitled to receive the payment.

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Grantor Trust

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RULE: if a grantor transfers property to a trust, retaining certain strings attached, the grantor will still be regarded as the owner of the property for income tax purposes. Income generated in the property will be taxed to the grantor, not the trust.

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Examples of Grantor Trusts

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revocable trust

trust with a life estate retained by the grantor

trust with a reversionary interest of more than 5%

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Basic wealth tax transfer principles

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(1) The estate and gift taxes are taxes imposed on the donor upon the transfer of wealth to another. These tax regimes are distinct from the fed income tax.

(2) The estate and gift taxes apply a unified rate structure and generally adopt similar tax principles and definitions.

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Current state of estate tax

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Was repealed altogether on 12/31/2009. Unless Cong votes to make the repeal permanent, the estate tax reappears and reverts to its pre-2001 rules and rates on 1/1/2011.

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State Gift Tax

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IN does NOT impose its own separate state-level gift tax

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Federal Gift Tax

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RULE: a gift tax is imposed on any completed or irrevocable transfer by gift.

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Def of gift

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A transfer for less than full and adequate consideration.

YES:
-bargain sale of property to a family member
-interest-free loan to a family member
-purchase or ownership of property with joint title

NO
-divorce property settlements

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Powers of Appointment

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RULE: a transfer of property pursuant to a general power of appointment may be subject to gift tax.

UNLESS:
(1) It is limited to conditions related to health, education, support, or maintenance.
(2) If can only be exercised with grantor's consent.
(3) OR it can only be exercised with consent of another with an adverse interest.

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Annual Exclusion

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RULE: each taxpayer may exclude the first $13k in gift transfers per year per donee.

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Annual Exclusion Restriction

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RULE: the annual exclusion generally cannot be used for a gift of a future interest.

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Exceptions to the Future Interest Restriction

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(1) Transfer for the benefit of a minor

(2) Crummey Trust

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Transfer for the benefit of a minor

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RULE: the transferor can still use the annual exception for the gift of a future interest in property IF:

(1) the property and income from the property must be used for the benefit of the donee before the age of 21

(2) Any property and income not used for the minor's benefit passes to the minor at the age of 21

(3) AND in the event of the minor's death, the property and income is payable to the minor's estate.

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Crummey Trust

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The transferor can still use the annual exclusion for the gift of a future interest in property if the trust instrument gives the beneficiary the power to demand immediate withdrawal of amounts contributed to the trust.

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Gift-splitting by spouses

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RULE: spouses can effectively "double" the annual exclusion by electing to treat the gift as a "split gift" (each spouse has own $13k per year per donee)

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Exclusion for tuition and medical expenses

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RULE: amounts paid for tuition and medical expenses on behalf of another are excluded from taxable gifts.

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Charitable contributions deduction

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RULE: gifts to qualified charities are deductible for gift tax purposes. A gift of services to a charity is not considered a taxable gift.

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Marital deduction

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RULE: a gift transfer from one spouse to another is eligible for an UNLIMITED MARITAL DEDUCTION

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Terminable Interest Exception

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RULE: unless the taxpayer makes a qualified terminable interest election (Q-Tip election), no marital deduction is allowed for transfer to a spouse if the transferor's property or interest may ultimately be received by someone other than the spouse.

(applies on estate and gift transfers)

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Exemption

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RULE: for 2009, taxpayers are entitled to a $3.5m exemption for estate tax purposes. (NO estate tax for 2010)

BUT amount will be reduced to the extent taxpayer has used the LIFETIME GIFT EXEMPTION (limited to $1m)

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Gift Tax exemptions/exclusions

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(1) certain powers of appointment

(2) Annual exclusion ($13k per donee per year)

(3) Tuition and medical expenses of another

(4) Charitable deduction

(5) Unlimited marital deduction

(6) $1m lifetime gifts limit

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Estate Tax Return

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RULE: must be filed for decedents who were residents of the US and whose gross estate exceeds $3.5m (for 2009)

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Who files the estate tax return?

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Executor is responsible for filing the estate tax return within 9m of decedent's death.

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Gross Estate

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RULE: is defined and governed by the INTERNAL REVENUE CODE and includes the value of all assets beneficially owned at the time of the decedent's death as well as certain lifetime transfers.

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Probate Estate

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RULE: is defined by IN state law.

-tends to be narrower that Gross Estate (i.e., does not include life insurance proceeds)

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Gross Interest in TIC

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Decedent's estate simply includes the proportionate share of any property held by TIC at time of death.

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Gross Interest for Joint Interests of Spouses

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The estate of the first spouse to die will include 1/2 of the value of a qualified joint interest, including those held TBE or JT with right of survivorship.

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Gross Interest for Joint Interests of Non-Spouses

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The decedent must include the entire value of property held as JTs with a right of survivorship or as TBE

UNLESS the executor can show that the property belonged to, or was contributed by the surviving owner

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Life Estates and Future Interests

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RULE: since death terminates the decedent's life estate interest, the value of a life estate measured by the decedent's own life generally is not included in the gross estate.

EXCEPTION: decedent himself created the life estate.

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Lifetime Transfers

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RULE: even though the decedent transferred title to assets during lifetime, certain lifetime transfers will be included (SWEPT BACK IN) to the gross estate.

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What kinds of Lifetime Transfers will be swept back in?

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(1) Retained Life Estate: strings attached - if decedent transferred intervivos, but retained substantial strings attached, it will be swept back in to the gross estate.

(2) Retained right to possession or enjoyment

(3) Right to alter or revoke: any discretionary power to alter or revoke, BUT is based on an ascertainable discernible standard then not swept back in (i.e., changes can be made if a beneficiary becomes severely disabled)

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Life Insurance policies owned at death

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RULE: proceeds of a life insurance policy on the decedent's own life are included in the gross estate if either:

(1) the proceeds are receivable by the executor

(2) OR the decedent possessed any incidents of ownership at the time of death

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Receivable by the executor

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beneficiary pre-deceases executor

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Incidents of ownership

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(1) right to change a beneficiary

(2) right to cancel or revoke the policy

(3) policy with a cash surrender value

(4) right to pledge or borrow against the policy

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Life Insurance Policies transferred within 3y of death

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RULE: a life insurance policy that wold have been included in the decedent's gross estate if he had retained it, will be swept back into the gross estate if the decedent transferred the policy within 3y prior to death.

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Estate tax exclusions and deductions

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(1) Estate Tax Exemption ($3.5m for 2009)

(2) Marital Deduction

(3) State death taxes

(4) Funeral and administrative expenses

(5) Debts owed by the decedent at death

(6) Charitable contributions

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Estate Tax Marital Deduction

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RULE: the portion of the estate passing to the surviving spouse is entitled to an UNLIMITED marital deduction.

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Estate Tax Terminable Interest Exemption

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Unless the executor makes a Q-Tip election, no marital deduction is allowed for transfers to a surviving spouse if the decedent spouse's property or interest may ultimately be received by someone other than the spouse.

(same rule as gift tax)

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Q-Tip (Qualified Terminable Interest Property)

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RULE: if the executor makes an election with respect to qualified terminable interest property, the decedent's estate will be eligible for the 100% marital deduction with respect to the terminable interest.

RULE: once made, a Q-TIP election is irrevocable.

RULE: the interest with respect to which a valid Q-Tip election is made will be included in the surviving gross estate.

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Requirements for a Q-TIP election

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(1) Property must "pass" from the decedent to the surviving spouse.

(2) Surviving spouse must be entitled to all of the income from the property for life, payable annually or more frequently.

(3) No persona can have a power to appoint any party of the property to anyone other than the surviving spouse.

(4) The executor must make a Q-TIP election on or before the date for filling the decedent's fed estate tax return 9m after death.

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Valuation of assets for estate tax

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RULE: generally, the gross estate's assets will be valued at their FMV at the time of the decedent's death.

EXCEPTION: current farm or business use - certain realty used in farming or in a closely held business may be eligible for valuation at its current farm or business use rather than its general use.

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Indiana Taxes

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(1) Income tax

(2) Real and personal property tax

(3) Sales and Use Tax

(4) Indiana Death Taxes

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IN Income Tax

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IN imposes its own AGI tax (AGIT) on individual IN residents.

Non-residents are also subject to IN income tax, but only upon income derived from sources in IN.

Piggy-backs on fed regime (same income and deductions)

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IN income tax v. Fed income tax

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IN does not permit a deduction for state and local taxes paid.

IN offers a homestead and renters' deduction.

IN authorizes credit for taxes paid in other states.

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IN AGI rate

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flat rate of 3.4%

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IN Real and Personal Property Tax

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IN imposes a property tax on tangible real and personal property.

Vehicles are subject to an annual vehicle excise tax.

NOTE: In 2008, Legis created "circuit breakers" that limit property taxes to a certain percentage of gross assessed value

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IN Sales and Use Tax

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7% sales tax on:

(1) retail sales within IN
(2) AND a similar use tax on transactions NOT in IN if the property is stored, used, or consumed within IN.

EXEMPT:
-services
-most food for consumption (other than restaurant and take-out)
-drugs

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IN Death Taxes

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Inheritance tax: imposed on heirs, but same practical outcome as estate taxes.

Parallels fed estate tax

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IN Death Taxes on resident decedent's estate

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Subject to inheritance tax on:

(1) real and tangible personal property located within IN

(2) all intangible property, regardless of location

NOTE: no IN inheritance tax on transfers of real property located outside of IN

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IN Death Taxes on non-resident decedent's estate

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Subject to IN inheritance tax on real and tangible personal property located in IN.

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IN Death Tax Exemptions and Rates

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Depend upon different classes of transferees:

CLASS A (lineal ancestors or descendants): a $100k exemption & rates ranging from 1-10%

CLASS B (brothers/sisters, decedents of brothers/sisters): a $500 exemption & rates ranging from 7-15%

CLASS C: a $100 exemption & rates ranging up to 20%

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IN Death Tax discount

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For inheritance taxes paid within 9m of the date of death