CEA Taxation & Legal Considerations 5 — Questions and Answers
Question 1: A decedent's estate includes farmland worth $3 million at its highest-and-best-use value but only $1.5 million as a working farm. Under IRC § 2032A, the executor may elect to value the farmland at:
- Its highest-and-best-use value of $3 million
- Its special-use value of $1.5 million, subject to statutory limits (Correct answer)
- Zero, because agricultural property is exempt
- The average of both values, $2.25 million
Correct answer: Its special-use value of $1.5 million, subject to statutory limits
IRC § 2032A allows qualifying real property used in farming or a closely-held business to be valued at its special-use value, reducing the gross estate, subject to a maximum reduction limit.
Question 2: A decedent's will leaves 'all residuary assets to charity.' What marital or charitable deduction applies to reduce the taxable estate?
- Marital deduction, unlimited in amount
- Charitable deduction, unlimited in amount for qualifying organizations (Correct answer)
- Charitable deduction, capped at 50% of the adjusted gross estate
- No deduction; residuary bequests do not qualify
Correct answer: Charitable deduction, unlimited in amount for qualifying organizations
IRC § 2055 allows an unlimited estate tax charitable deduction for bequests to qualifying § 501(c)(3) organizations.
Question 3: Which installment payment election under IRC § 6166 allows an estate to defer and pay estate taxes attributable to a closely-held business interest over an extended period?
- Up to 5 years deferral then 5 annual installments
- Up to 5 years deferral then 10 annual installments (Correct answer)
- Immediate payment only; no deferral is permitted
- Unlimited deferral with no interest charged
Correct answer: Up to 5 years deferral then 10 annual installments
IRC § 6166 allows an estate to defer paying the portion of estate tax attributable to a qualifying closely-held business for up to 5 years (interest only), then pay in up to 10 annual installments.
Question 4: For state estate or inheritance tax planning, which statement is most accurate?
- All 50 states impose an estate tax mirroring the federal structure
- No state imposes a separate estate or inheritance tax
- Some states have lower exemption thresholds than the federal exemption, requiring separate state-level planning (Correct answer)
- State estate taxes are fully deductible from federal taxable income dollar-for-dollar
Correct answer: Some states have lower exemption thresholds than the federal exemption, requiring separate state-level planning
A number of states have their own estate or inheritance taxes with exemptions well below the federal threshold, making state-specific planning essential.
Question 5: An irrevocable trust distributes $20,000 of ordinary income to a beneficiary. The trust's distributable net income (DNI) is $15,000. How much income is the beneficiary required to include in gross income?
- $20,000, the full distribution amount
- $15,000, limited to the trust's DNI (Correct answer)
- $5,000, only the amount in excess of DNI
- $0, trust distributions are never taxable to beneficiaries
Correct answer: $15,000, limited to the trust's DNI
Under the conduit rules, a beneficiary's inclusion is limited to the lesser of the distribution or DNI; here DNI of $15,000 caps the taxable amount.
Question 6: A couple with combined wealth of $30 million wants to use a credit shelter (bypass) trust to preserve both spouses' exemptions. After the first spouse dies, the bypass trust is funded with assets up to the first spouse's exemption amount. The primary benefit of this structure is that:
- It avoids probate entirely for all estate assets
- Assets in the bypass trust, plus any appreciation, pass to heirs free of estate tax at the second spouse's death (Correct answer)
- It eliminates income tax on trust earnings during the surviving spouse's lifetime
- It qualifies for the unlimited marital deduction
Correct answer: Assets in the bypass trust, plus any appreciation, pass to heirs free of estate tax at the second spouse's death
Assets placed in a bypass trust at the first death are exempt from estate tax at the second death, including all post-death appreciation, effectively doubling the couple's estate-tax-free transfer.
Question 7: A client gifts a closely-held business interest worth $500,000 to a child but claims a combined 35% valuation discount, reporting a taxable gift of $325,000. The IRS may challenge this discount under which doctrine?
- Substance-over-form doctrine (Correct answer)
- Economic substance doctrine
- Adequate disclosure doctrine
- Step-transaction doctrine
Correct answer: Substance-over-form doctrine
The IRS frequently invokes the substance-over-form doctrine (and related rules) to collapse artificially structured FLP or LLC transfers that lack business purpose beyond tax savings.
CEA Taxation & Legal Considerations 5
A decedent's estate includes farmland worth $3 million at its highest-and-best-use value but only $1.5 million as a working farm.
Under IRC § 2032A, the executor may elect to value the farmland at: