STEP Taxation of Trusts and Estates 3 — Questions and Answers
Question 1: A grantor trust is taxed to the grantor under Subchapter J. Which of the following powers would cause a trust to be treated as a grantor trust?
- The trustee's power to accumulate income for minor beneficiaries
- The grantor's power to substitute trust assets for assets of equivalent value (Correct answer)
- A spendthrift clause restricting beneficiary alienation
- The power of an independent trustee to make discretionary distributions
Correct answer: The grantor's power to substitute trust assets for assets of equivalent value
Under IRC Section 675(4), a grantor's power to reacquire trust assets by substituting other property of equivalent value causes grantor trust status.
Question 2: The GST (Generation-Skipping Transfer) tax exemption for 2024 is indexed for inflation. What is the primary purpose of the GST tax?
- To tax transfers that skip one or more generations, preventing indefinite wealth transfer without transfer tax (Correct answer)
- To impose an additional income tax on trust distributions to grandchildren
- To replace the estate tax for transfers to lineal descendants
- To limit the marital deduction for transfers to non-citizen spouses
Correct answer: To tax transfers that skip one or more generations, preventing indefinite wealth transfer without transfer tax
The GST tax prevents wealthy families from avoiding estate and gift taxes by transferring wealth directly to grandchildren or later generations, skipping the intervening taxable transfer.
Question 3: An irrevocable life insurance trust (ILIT) is designed to keep life insurance proceeds out of the insured's taxable estate. For the ILIT to exclude proceeds from the estate, the insured must NOT:
- Name the ILIT as the policy beneficiary
- Transfer an existing policy to the ILIT more than three years before death
- Allow the trust to pay premiums using Crummey powers
- Retain any incidents of ownership in the policy (Correct answer)
Correct answer: Retain any incidents of ownership in the policy
The insured must not retain any incidents of ownership, and if an existing policy is transferred within three years of death, the proceeds revert to the gross estate under IRC Section 2035.
Question 4: Which type of trust receives a $300 personal exemption for federal income tax purposes rather than the standard $100?
- Complex trust
- Simple trust (Correct answer)
- Qualified disability trust
- Foreign grantor trust
Correct answer: Simple trust
A simple trust—one that is required to distribute all income currently and makes no charitable contributions—receives a $300 personal exemption under IRC Section 642(b).
Question 5: For estate tax valuation, the 'willing buyer/willing seller' standard requires valuation as of the date of death. An alternate valuation date under IRC Section 2032 may be elected if:
- It reduces the gross estate or the estate tax liability (Correct answer)
- The estate consists primarily of real property
- The estate has no estate tax liability due to the unified credit
- The executor files a request within 6 months of the return due date
Correct answer: It reduces the gross estate or the estate tax liability
The alternate valuation date election under IRC Section 2032 is only available if its use decreases both the value of the gross estate and the estate tax liability.
Question 6: A Qualified Personal Residence Trust (QPRT) removes a residence from the grantor's taxable estate. If the grantor dies during the trust term, what is the estate tax consequence?
- Only the present value of the remainder interest is included in the estate
- The full fair market value of the residence is included in the gross estate (Correct answer)
- No portion of the residence is included because the trust was irrevocable
- The residence is included at the value on the date the QPRT was created
Correct answer: The full fair market value of the residence is included in the gross estate
If the grantor dies during the QPRT term, the entire value of the residence at the date of death is pulled back into the gross estate, negating the estate planning strategy.
Question 7: A Grantor Retained Annuity Trust (GRAT) transfers appreciation to heirs gift-tax free if the trust earns more than the IRC Section 7520 rate. The Section 7520 rate is based on:
- The federal short-term rate plus 3%
- 120% of the applicable federal mid-term rate (Correct answer)
- The prime lending rate published by the Federal Reserve
- The 10-year Treasury note yield
Correct answer: 120% of the applicable federal mid-term rate
The IRC Section 7520 rate, used to value annuities and life estates, equals 120% of the applicable federal mid-term rate for the month of the transaction.
STEP Taxation of Trusts and Estates 3
A grantor trust is taxed to the grantor under Subchapter J.
Which of the following powers would cause a trust to be treated as a grantor trust?