Estate Plan Scenario

Kathi and Darrin Background

Kathi and Darrin have been married for 50 years and are both in good health. Kathi and Darrin live in a community property state. They have the following children and grandchildren:

Elizabeth, an estate planning attorney, is married, healthy, and happy. Kathi and Darrin adore Elizabeth's husband, Scott, and their 4 children. 

James, a high net worth investment consultant, was recently divorced and his ex-wife, Catherine, has custody of their 3 children. Kathi and Darrin, never quite cared for Catherine, as she always seemed to be quite snooty. Especially since the divorce, the relationship between Kathi and Catherine has been very strained. Since his divorce, James has had somewhat of a mid-life crisis.  He recently rented a penthouse apartment and bought a new Jaguar. James has also been dating Natalie, a 21-year-old swimsuit model. While Kathi and Darrin are confident that this is only a phase, they are concerned about giving any gifts to James or his children outright.

Lynn, Kathi and Darrin's third child, was a bit of a wild child. Lynn died in a tragic motorcycle accident in her senior year of college while she was on her way home to tell her parents about a big secret she had been keeping. The summer before, Lynn had given birth to a baby girl named Marie. At the time, Lynn gave the baby to the baby's father, an older married man, although no official adoption was ever performed. Kathi and Darrin still do not know about Marie.

Kathi and Darrin own Fresh Veggies, a popular organic health food store. Scott, Elizabeth's husband, has worked at the store since he was a kid. Scott is now the store manager and handles most of the day-to-day functions, with very little input from Kathi and Darrin. Kathi and Darrin would like to reward Scott for all of his hard work by giving Scott and Elizabeth 3/4 of the business and giving the remaining 1/4 of the business to James. They do not want James to have any control over the business, just to have an income interest.

Elizabeth's youngest child, Andrew, was born with a serious physical disability. To provide additional support for Andrew, Darrin created an irrevocable trust with an $8,013,000 transfer of separate property 5 years ago. The trust meets the requirements of Section 2503(c).

Darrin and Kathi made the following additional lifetime transfers:

• Four years ago, Darrin gave Elizabeth, James, and their spouses $100,000 each (assume the annual exclusion was $11,000) of community property.
• Two years ago, Darrin gave Elizabeth, James, and their spouses $200,000 each of his separate property. Darrin paid gift tax of $347,760.

Kathi and Darrin have never elected to split gifts of separate property.

Darrin and Kathi estimate the following at each of their deaths:

• The last illness and funeral expenses are expected to be $100,000 per person.
• Estate administration expenses are estimated at $250,000 per person.

The Will

Kathi does not have a will. Darrin has an old, outdated will leaving most probate assets to Kathi.

Clauses from Darrin's Statutory Last Will and Testament

I, Darrin, being of sound mind and wishing to make proper disposition of my property in the event of my death, do declare this to be my Last Will and Testament. I revoke all of my prior wills and codicils. 

1. I have been married but once, and only to Kathi with whom I am presently living. Out of my marriage to Kathi, 3 children were born, namely Elizabeth, James and Lynn. I have adopted no one nor has anyone adopted me.

2. I leave my Vintage Mustang and House Boat to my son, James.

3. I leave the life insurance proceeds on my life to my daughter, Elizabeth.

4. I leave Vacation Home 1 to my daughter, Lynn.

5. I leave Auto 1 to the Methodist Church, a qualified charity.

6. I give the residual of my estate to Kathi, my wife.

7. In the event that Kathi predeceases me or fails to survive me for more than 6 months from the date of my death, I give any interest of my estate determined to be payable to her to my children, Elizabeth, James and Lynn, in equal and 1/3 shares.

8. In the event that any of the named legatees should predecease me, die within 6 months from the date of my death, disclaim, or otherwise fail to accept any property bequeathed to him or her, then such interest will pass to the said legatee's descendents, otherwise his or her share of all of my property of which I die possessed shall be paid equally among the surviving named legatees.

9. I name my best friend, Keith, to serve as the executor of my succession with full seizin and without bond.

10.  I direct that the expenses of my last illness, funeral, and the administration of my estate shall be paid by my executor as soon as practicable after my death and allocated against the residual estate.

11.  Since I have made numerous lifetime gifts to my children, all inheritance, estate, succession, transfer, and other taxes (including interest and penalties thereon) payable by reason of my death shall be allocated to the children's share, regardless of whether my spouse survives me.

Statement of Financial Position (Darrin & Kathi)

Notes to Financial Statements:

1. Assets are stated at fair market value (rounded to even dollars).

2. Liabilities are stated at principal only (rounded to even dollars).

3. The adjusted basis of the personal residence is $600,000.

4. Kathi received vacation home 2 from her grandmother, Lois. Kathi and Lois were always very close and Lois gave her the home when Elizabeth was first born so Kathi could enjoy motherhood as much as Lois had. Lois purchased the vacation home for $30,000 and the FMV of the home at the date of transfer was $200,000. The FMV when Lois died was $250,000.

5. The life insurance policy has Kathi listed as the designated beneficiary. The Investment account is a Transfer on Death account with Elizabeth and James as the listed beneficiaries of both Darrin and Kathi's shares.

6. The Yacht was purchased by Darrin after his House Boat was destroyed by a Hurricane.

7. Property Ownership:

CP - Community Property.
H - Husband separate.
W - Wife separate.

8. Insurance face value and cash value of $1,000,000 are the same.

Estate Plan

Answer the following questions. Assume the facts given in the fact pattern and that the 2012 estate and gift tax rates and annual exclusion apply to all transfers in the current and previous years. (Numbers are rounded for convenience.)

1. Which of the following transfer mechanisms would be appropriate for the transfer of Fresh Veggies to James and Elizabeth assuming Kathi and Darrin did not want to make an outright gift of the company to them?

1. Private Annuity.

2. SCIN.

3. Family Limited Partnership.

4. QPRT.

(a) 1 only.
(b) 3 only.
(c) 1 and 2.
(d) 1, 2, 3 and 4.

2. If Darrin died today, which of the following statements is true regarding the transfers made in his will?

(a) Kathi will receive Darrin's interest in the Investment Portfolio.
(b) Elizabeth will receive the proceeds of the life insurance policy.
(c) James will receive the yacht in place of the house boat.
(d) Marie may potentially receive Vacation Home 1 as Lynn's rightful heir.

3. Assuming Darrin died today, calculate his gross estate.

(a) $5,525,000.
(b) $7,525,000.
(c) $8,025,000.
(d) $8,372,760.

4. Assuming Darrin died today, calculate his probate estate.

(a) $5,525,000.
(b) $7,525,000.
(c) $8,025,000.
(d) $8,380,320.

5. Assuming Darrin died today, calculate the marital deduction available for transfers to Kathi (remember this is a net amount).

(a) $4,425,000.
(b) $4,539,500.
(c) $5,425,500.
(d) $6,375,000.

6. Assume that Darrin died today and the estate tax due was $702,591 and Keith is appointed executor. Unfortunately, Keith forgot to file an Estate Tax Return (Form 706) and pay the estate tax due until 45 days after the return's due date. How much is the failure-to-file penalty?

(a) $7,026.
(b) $63,233.
(c) $70,259.
(d) $77,285.

7. Assume Kathi and Darrin wanted to establish college funds for each of the grandchildren. Which of the following statements would be true?

(a) An irrevocable trust would be a completed gift for gift tax and estate tax purposes.
(b) The transfers would not be subject to GSTT, regardless of to whom the money is paid, because the payments were made for education.
(c) If Darrin and Kathi found out about Marie and wanted to establish a fund for her as well, then the transfer to Marie would be subject to GSTT.
(d) An appropriate planning technique for both Elizabeth and James' family would be to place the assets into 2 family trusts, 1 for Elizabeth's children (with Elizabeth and Scott as joint trustees) and 1 for James' children (with Catherine as the trustee).

8. Which of the following statements regarding the transfer to Andrew 5 years ago is correct?

(a) Andrew is a skip person because he is more than 37½ years younger than Darrin, thus the transfer results in a taxable termination.
(b) The transfer will qualify for the GSTT annual exclusion.
(c) Assuming 2011 rates apply to this transfer, the GSTT will be 35% of $8,000,000.
(d) The only tax consequence for this transfer will be GSTT due.

9. Assuming Kathi died today, which of the following statements is true?

(a) Kathi's assets would avoid probate.
(b) State intestacy law would dictate who received Kathi's assets.
(c) All of Kathi's community property assets would transfer to Darrin because of the implied right of survivorship.
(d) Kathi's gross estate would include the life insurance policy on Darrin.

10. Assuming Darrin died today, which of the following statements regarding a valid disclaimer is correct?

(a) Assume Darrin left Elizabeth his interest in the Yacht. If Elizabeth disclaims her property then the transfer will be subject to GSTT.
(b) If James disclaimed his property, the property would transfer to Kathi.
(c) If Kathi wanted to disclaim a portion of the property, she must do so by the due date of the estate tax return plus extensions.
(d) In order for the disclaimer to be valid it must be in writing or witnessed by 3 nonrelated individuals if the disclaimer is oral.

11. Assume Kathi died today and left Vacation Home 2 to Elizabeth. What would Elizabeth's adjusted basis be in Vacation Home 2?

(a) $30,000.
(b) $200,000.
(c) $250,000.
(d) $500,000.

12. Assume Kathi died today and left her share of the personal residence to Darrin. What would Darrin's adjusted basis be in the personal residence?

(a) $300,000.
(b) $600,000.
(c) $1,050,000.
(d) $1,500,000.

13. Kathi and Darrin are considering making a charitable contribution to the Boys and Girls Club of America and want the grandchildren to receive income from the property for an extended period. Which of the following charitable devices may be appropriate to meet their objectives?

1. Charitable Remainder Annuity Trust.

2. Charitable Remainder Unitrust Trust.

3. Pooled Income Fund.

4. Charitable Lead Trust.

(a) 1 only.
(b) 1, 2, and 3.
(c) 2, 3, and 4.
(d) 1, 2, 3, and 4.

14. Which of the following types of clauses appear in Darrin's will?

1. Specific Bequests.

2. Survivorship Clause.

3. No-contest clause.

4. Simultaneous death clause.

(a) 1 only.
(b) 2 and 3.
(c) 1 and 2.
(d) 1, 2, 3, and 4.

15. Assume Darrin died today and Keith is appointed as executor. Of the following, which is not an available election Keith can make before he files Darrin's estate tax return?

(a) Electing the QTIP election on property passing to Kathi.
(b) Utilizing the annual exclusion against testamentary transfers.
(c) Selection of the income tax year end for Darrin.
(d) Deducting the expenses of administering Darrin's estate on the estate tax return (Form 706).

16. Assume Darrin died in 2011. Which filing status can Kathi use on her 2011 income tax return?

(a) Single.
(b) Head of Household.
(c) Married Filing Jointly.
(d) Qualifying Widow.

17. Assume Darrin died in 2011. Which filing status can Kathi use on her 2012 income tax return?

(a) Single.
(b) Head of Household.
(c) Married Filing Jointly.
(d) Qualifying Widow.

18. Assume Darrin died today, Keith is appointed executor, and the estate does not have sufficient cash to pay the required taxes or expenses. Of the following statements, which is not true regarding selling an estate's assets to generate cash?

(a) The estate may have income tax consequences.
(b) The assets may not be sold at full, realizable fair market value.
(c) Any losses on the sale of the assets are deductible as losses on the estate tax return.
(d) Any selling expenses are deductible on the estate tax return.

19. Assume Darrin dies today and Keith is appointed executor. Keith is considering electing the alternate valuation date. Which of the following statements does not correctly reflect the rules applicable to the alternate valuation date?

(a) The general rule is the election covers all assets included in the gross estate and cannot be applied to only a portion of the property.
(b) Assets disposed of within 6 months of decedent's death must be valued on the date of disposition.
(c) The election can be made even though an estate tax return does not have to be filed.
(d) The election must decrease the value of the gross estate and decrease the estate tax liability.

20. Assume Darrin transfers ownership of the life insurance policy on his life to an Irrevocable Life Insurance Trust (ILIT) and retains the right to borrow against the policy. Assume Darrin dies 5 years later. Which of the following is correct regarding the treatment of the proceeds of the life insurance policy?

(a) The proceeds will be included in Darrin's federal gross estate if he has any outstanding loans against the life insurance policy.
(b) The proceeds will be included in Darrin's federal gross estate if Darrin continued paying the policy premiums after the life insurance policy was transferred to the ILIT.
(c) The proceeds will never be included in Darrin's federal gross estate.
(d) The proceeds will always be included in Darrin's federal gross estate.