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ABSTRACT

A COMPUTER SIMULATION OF
SEVEN ESTATE PLANNING TECHNIQUES

BY

Edward J. Schnee

The purpose of this study was to test seven general

"rules-of-thumb" used by practitioners and educators. The

seven were :

1. Marital Deduction

2. Gifts "in Contemplation of Death"
3. Inter Vivos Trusts

B. Post—Mortem
1. First Income Tax Year

2. Deduction of Administration Expenses
3. Alternate Valuation Date
4

. Waiver of Executor's Commission

A simulation model was constructed for each of the

general "rules-of-thumb". The models generated the data

which was used to test whether or not the rules provided

Optimal decisions .

The rule of thumb for marital deduction is to trans-

fer exactly 50% to the surviving spouse. It was found

that this Procedure does not give Optimal decisions.

the data. new rules were develOped in terms of the after—

Edward J. Schnee

From

tax rates 0f return and surviving spouse's remaining life.

33885 on the rates of return they are:

1.

In terms

1.

Make no qualifying transfer if the spouse's
rate of return is less than or equal to the
other beneficiaries' and his/her estate is

less than or equal to the decedent's;

Transfer between 0% and 40% to the spouse if
his/her rate of return is less than the bene—
ficiaries' and his/her estate is less than

the decedent's. Transfer between 0% and 50%
if the spouse's rates of return equals the
other beneficiaries' and his/her estate is
less than the decedent's. In most of these
cases zero will still be Optimal.

The amount of the transfer must be determined
individually for each case in which the spouse's

rate of return is greater than the other bene-
ficiar ies ' .

of the spouse's remaining life they are:

Transfer zero to the Spouse unless he/she out—
lives the decedent by more than six months;

Transfer 0% if the spouse's remaining life is
sixteen years or more and his/her rate of
return is less than the other beneficiaries';

Transfer 100% if the spouse's remaining life
is sixteen years or more and his/her rate of
return is greater than the other beneficiaries.

The model also reveals that it is. on the average, better

to under-qualify the marital deduction than over-qualify

it and that the credit for prior taxed transfers does not

 

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completely eliminate double taxation.

The general rule-of—thumb concerning gifts in contem—
plation 0f death is that they will reduce the total amount

of tax paid because the amount of the gift tax is not in-

cluded in the estate. The majority of the cases verified

this rule. The only time this rule does not hold is when

the decedent‘s estate is relatively small and sizeable

gifts have already been made. The model also pointed out

that the additional tax cost of having a gift ruled in

contemplation of death is small in relation to the size

of decedent ' s estate.

Inter vivos trusts are thought to provide both mone-

tary and nonmonetary advantages. This study supports

the opinion that trusts are advantageous for solely mone-

tary reasons. The only time that trusts do not provide

a monetary advantage is in those cases in which the bene-
ficiary's income tax bracket exceeds that of the planner.
Several practitioners have suggested that if the

first income tax year is a short one. a benefit will be

derived from the additional personal exemption and possible

lower tax rates. The model indicated that no simple rule

could be formulated. It also indicated that the final

year was one of the most important variables. The effect

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Edward J. Schnee
of either the distribution of the final year! income or a
carryover of excess deductions to the beneficiary must be
considered.

The general rule-of-thumb concerning administration
expenses is that they should be deducted on the tax return
with the highest marginal tax rate. This will not always
provide the optimal solution. The rule should be restated
as:

Deduct the administration expenses on the tax

returns so that the effective tax rates are

equal.

The effective income tax rate is either the estate's or
tmneficiary's marginal tax rate. The effective estate tax
rate equals the marginal rate only if the maximum marital
deduction is not claimed. If it is claimed, the effective
rate equals one-half the marginal rate.

The general rule-of-thumb concerning the alternate
valuation date is that this alternate should be selected
hlthose cases in which the assets have increased in
value, but only if at the same time the increased estate
tax*will be less than the reduction in the income tax.

The model indicated that the rule should be restated

Insed on type of asset and marital deduction as follows:

Edward J. Schnee

1. If the assets are capital assets and no marital
deduction is claimed, do not use the alternate
value.

2. If the assets are capital and a fifty percent
marital deduction is claimed, use the alter-
nate value when the beneficiary's income tax
rate is 60% or more. Do not use it if his/her
tax rate is 20% or less. If the rate is 40%,
a table has been developed to indicate whether
or not to use the alternate value.

3. If the assets are not capital and no marital
deduction is claimed, use the alternate value
when the beneficiary's tax rate is 70%. If
his/her rate is either 40% or 60%, use the
tables provided in Chapter 7. If the rate is
20% or less. use date of death values.

4. If the assets are not capital and the marital
deduction is 50%. use the alternate value when
the beneficiary's tax rate is 40% or more.

Use the table provided if the rate is 20%.
Do not use the alternate value if the bene-
ficiary's rate is 0%.

The general rule—of-thumb concerning the executor's
commission is that he should waive it and take under the
will if he is entitled to part of the residual estate.
This is not always optimal. If the executor's share is
50% or less or his tax rate is 20% or less, he should take
his commission. If his share is 75% or 100%, tables have
been provided in Chapter 8 to assist in the decision.

The tables use the size of the estate, the estate's

income and the executor's income tax bracket.

A COMPUTER SIMULATION OF

SEVEN ESTATE PLANNING TECHNIQUES

BY

Edward J. Schnee

A THESIS

Submitted to
Michigan State University
in partial fulfillment of the requirements
for the degree of

DOCTOR OF PHILOSOPHY

Department of Accounting and Financial Administration

1973

ACKNGN LED GMENT

The author is indebted to several peOple for their
help with this study. The author would like to thank Pro-
fessor Charles Gaa of the Department of Accounting and
Financial Administration of Michigan State university,
whose comments consistently helped and improved this study.

Two other faculty members at Michigan State Univer-
sity aided this study. They are Professor James Lampe,
also of the Department of Accounting, and Professor M. B.
Ifickerson of the Department of Business Law. Professor
Iempe assisted in the formulation of the simulation
nmdel and the computer programs. Professor Dickerson
assisted with the legal aspects.

In addition, the author would like to thank the
Cbmmittee on Estate Planning of the AICPA who sponsored
this research and especially Mr. Arthur F. M. Harris who
suggested the tOpic and made very valuable comments at
the beginning of the research.

Finally, the author would like to thank his wife,
Rosemary, without whose encouragement, proofreading and
typing, this study might never have been completed.

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TABLE OF CONTENTS

ACKNOWLEDGMENT. . . . . . . . . . . . . .

LIST OF TABLES. . . . . . . . . . . . . .

LIST OF CHARTS. . . . . . . . . . . . . .

Chapter

1

3

INTRODUCTION . . . . . . . . .

Definition . . . . . . . . . .
Role of Taxes. . . . . . . . .
Need for Study . . . . . . . .
Scope. . . . . . . . . . . . .
Methodology. .
Limitations. . . . . . . . . .

MARITAL DEDUCTION. . . . . . . .

The Laws Relating to Marital
Deduction . . . . . . . . . .
Uses of Marital Deduction an
Estate Planning . . . . . . .
The Simulation Model . . . . .
Results. . . . . . . . . . . .
Summary. . . . . . . . . . . .

GIFTS IN CONTEMPLATION OF DEATH.

Laws Relating to Gifts in
Contemplation of Death. . . .
Uses and Estate Planning . . .
The Simulation Model . . . . .
Results. . . . . . . . . . . .
Summary. . . . . . . . . . . .

iii

Page

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14

21
26
34
50

52

53
58
62
69
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4 TRANSFERS TO AN IRREVOCABLE, SIMPLE
TRUS T O O C C O O O O O O O O I O O O O o 7 8

Laws Relating to Taxation of Trusts,

Grantor, and Beneficiaries. . . . . . . 79
Estate Planning with Trusts. . . . . . . 86
The Simulation Model . . . . . . . . . . 92
Results. . . . . . . . . . . . . . . . . 99

Summary. . . . . . . . . . . . . . . . . 101
5 SELECTION OF ESTATE'S TAX YEAR . . . . . . 105

The Law Related to the Selection

of the Income Tax Year. . . . . . . . . 105
Estate Planning. . . . . . . . . . . . . 107
The Simulation Model . . . . . . . . . . 111
Results. . . . . . . . . . . . . . . . . 118
Summary. . . . . . . . ... . . . . . . . 131

6 DEDUCTION OF ADMINISTRATION EXPENSES . . . 132

The Laws Affecting Deductions. . . . . . 132
Uses in Estate Planning. . . . . . . . . 135
The Simulation Model . . . . . . . . . . 138
Results. . . . . . . . . . . . . . . . . 143
Summary and Conclusions. . . . . . . . . 146

7 ALTERNATE VALUATION DATE . . . . . . . . . 148

Law Relating to Valuation. . . . . . . . 148
Estate Planning. . . . . . . . . . . . . 151
The Simulation Model . . . . . . . . . . 152
Results. . . . . . . . . . . . . . . . . 159
Summary and Recommendation . . . . . . . 167

8 WAIVER OF EXECUTOR'S COMMISSION. . . . . . 169

Laws Relating to Executor's Commission . 170
Estate Planning. . . . . . . . . . . . . 172
The Simulation Model . . . . . . . . . . 173
Results. . . . . . . . . . . . . . . . . 178
Summary. . . . . . . . . . . . . . . . . 184

iv

Chapter

9 SUMMARY'AND CONCLUSIONS. . . . . . . .
A.1 Marital Deduction . . . . . . .
A.2 Gifts in Contemplation of Death
A.3 Inter vivos Trusts. . . . . . .
B.l First Income Tax Year . . . . .
B.2 Deduction of Administration
Expenses . . . . . . . . . . .
B.3 Alternate Valuation Date. . . .
B.4 Waiver of Executor's Commission

Overall Conclusions. . . . . . . . .
For the Future . . . . . . . . . . .

APPENDIX
A. Listings of Tax Computation Sub-
routines. . . . . . . . . . . . . . .
B. Computer Program Listings. . . . . . .
C. Flow Charts for Tax Computation
Subroutines . . . . . . . . . . . . .
D. Flow Charts for Computer Programs. . .

BIBLIOGRAPHY} .

Page

185
186
187
188
189
190
191
192

193
193

195

205

236

252

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LIST OF TABLES

Table Page
2-I Percentage Reduction in Credit for

Tax on Prior Transfers Based on Time

Between Deaths . . . . . . . . . . . . . . 21
2-II Total Cases Generated

Breakdown by Optimal Percentage of the
Decedent's Estate Transferred to the

Surviving Spouse . . . . . . . . . . . . . 36
2-III Optimal Decisions

Breakdown by Relative Estate Sizes and

Relative Rates of Return . . . . . . . . . 37

2-IIIA Optimal Decision Where Spouse's Rate of
Return is Greater than Beneficiaries'
Breakdown by Relative Estate Sizes for
those Cases in which Decedent's Estate
is Less than Spouse's. . . . . . . . . . . 39

2-IIIB Optimal Decision where Spouse's Rate of
Return Greater than Beneficiaries'
Breakdown by Relative Rates of Return
for those Cases in which Decedent's

Estate is Less than Spouse's . . . . . . . 42
Z-IV Optimal Decisions by Spouse's

Remaining Life . . . . . . . . . . . . . . 44
2-V Additional Tax Cost of Transferring

Either 45% or 55%.When the Optimal

was 5%. O O C C O O O O O O O O O O O O O 48
3-1 Breakdown of Cases by Type of Property

and Planning Result. . . . . . . . . . . . 70

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3—II Type 1 Gift (Non Income Producing)
that were Disadvantageous
Breakdown by Planner's Remaining Life
and Rate of Return . . . . . . . . . . . . 71

3-III Type 2 Gift (Income Producing) that
were Disadvantageous
Breakdown by Planner's Remaining Life
and Rate of Return . . . . . . . . . . . . 71

3-IV Additional Tax Cost as a Percent of the
Original Estate if Gift Considered
"In Contemplation of Death". . . . . . . . 76

4-1 Cases in which Trust Advantageous and
Disadvantageous
Breakdown by Rates of Return . . . . . . . 100

4-II Cases in which Trust is Disadvantageous
Breakdown by Relative Tax Rates and
Remaining Life
Rate of Return 8 5%. . . . . . . . . . . . 102

4-III Cases in which Trust is Disadvantageous
Breakdown by Relative Tax Rates and
Remaining Life
Rate of Return.- 6%. . . . . . . . . . . . 103

5-1 Optimal Decisions Regarding Length of
First Tax Year
Breakdown by Life of Estate and Length
of First Tax Year
No Reduction in Revenue due to Payment
of Tax . . . . . . . . . . . . . . . . . . 119

5—II Optimal Decisions Regarding Length of
First Tax Year
Breakdown by Life of Estate and Length
of First Tax Year
Reduction in Revenue due to Payment
of Tax . . . . . . . . . . . . . . . . . . 120

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Optimal Decisions Regarding Length

of First Tax Year

Breakdown by Net Income, Life of

Estate and Length of First Tax Year. . . . 122

Cases in which Estate Income Negative

(Omitting Cases in which Beneficiary's

Tax Bracket was Zero)

Breakdown of Optimal Decisions by Life

of Estate and Length of First Tax Year . . 123

Cases in which Estate Income was Positive

and Beneficiary's Tax Rate was Either

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Breakdown of Optimal Decisions by Life

of Estate and Length of First Tax Year . . 124

Cases in which Estate Income was Positive

and Beneficiary's Tax Rate was Either

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Breakdown of Optimal Decisions by Life

of Estate and Length of First Tax Year . . 125

Optimal Decisions Regarding Length of

First Tax Year

Breakdown by Flow of Revenue and Expenses

Life of Estate - 14 Months . . . . . . . . 127

Optimal Decisions Regarding Length of

First Tax Year

Breakdown by Flow of Revenue and Expenses

Life of Estate - 18 Months . . . . . . . . 128

Optimal Decisions Regarding Length of

First Tax Year

Breakdown by Flow of Revenue and Expenses

Life of Estate - 24 Months . . . . . . . . 129

Advisability of Use of Alternate Date

Breakdown of Cases by Type of Asset,

Marital Deduction and Advantage of

Using Alternate Date . . . . . . . . . . . 160

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Table for Selection of Cases in which
Alternate Date is Advantageous
Capital Asset - Fifty Percent Marital
Deduction - Beneficiary's Tax Rate
is 40% . . . . . . . . . . . . . . . . . . 162

Table for Selection of Cases in which

Alternate Date is Advantageous

Not Capital Assets - Zero Marital

Deduction - Beneficiary's Tax Rate

is 40% . . . . . . . . . . . . . . . . . . 164

Table for Selection of cases in which

Alternate Date is Advantageous

Not Capital Assets - Zero Marital

Deduction - Beneficiary's Tax Rate

is 60% . . . . . . . . . . . . . . . . . . 165

Table for Selection of Cases in which

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Not Capital Asset - Fifty Percent Marital
Deduction - Beneficiary's Tax Rate

is 20% . . . . . . . . . . . . . . . . . . 166

Cases Regarding‘Waiver of Commission
Breakdown by Size of Estate and
Estate Income 0 O O O O O O O O O O O O O O 179

Cases in which Commission Should be Waived
Breakdown by Size of Estate and
Estate Income. . . . . . . . . . . . . . . 180

Decision Table for Waiver of Commission

by Estate's Size and Income

Executor's Share - 75% of Residual Estate
Executor's Tax Rate - 60%. . . . . . . . . 182

Decision Table for Waiver of Commission

by Estate's Size, Estate's Income and

Executor's Tax Rate

Executor's Share - 100% of Residual Estate 183

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Flow Chart

Flow Chart
of Death .

Flow Chart
Trusts . .

Flow Chart

Flow Chart

LIST OF CHARTS

for

for Gifts in Contemplation

for

for

Marital Deduction . .

Simple Irrevocable

Tax Year 0 O O O O O O

Deduction of Adminis—

tration Expenses Against Income Tax
or Estate Tax.

Flow Chart for Use of Alternate

Valuation.

Flow Chart for waiver of Commission.

 

Page

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67

96

115

141

156

176

 

 

 

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CHAPTER 1
INTRODUCTION

Definition

If the term estate planning is presented to a group
of peOple, their immediate reaction probably is to think
of death and taxes. These are only two small parts of a
very large field as the following definition illustrates:

Estate planning is planning for coordinated

production of income, accumulation and preser-

vation of wealth, and utilization of the in—

come and wealth to create, maximize, maintain,

and improve the personal happiness and comfort

and financial security of the planner's family

during and after his lifetime.

This definition indicates two things. First, suc-
cessful estate planning must start long before death.
There must be a deliberate action by the planner to pro-
duce and accumulate wealth before any thought can be

given to its disposition. Second, the planner's per-

sonal desires are of paramount importance. An estate

1Charles J. Gaa, "Some Important Considerations in
Estate Planning," Aspects of Contemporary Accounting.
Inuversity of Florida, 1966, p. 45.

 

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gflan'Which limits itself to monetary considerations and
ignores the planner's total goals does him and his family
a great disservice. The monetary aspect must be made to
conform to the planner's desires and not the other way

around.

Role of Taxes

The previous statements are not intended to imply
that the monetary aspect is unimportant. Once the
planner's goals are stated, the estate plan should con—
sider how to best reach these objectives financially. At
this point, tax considerations enter the estate planning.
Unless there has been a deliberate attempt to prevent
them, taxes will represent some of the most prohibitive
barriers to attaining the planner's objectives. Income
taxes inhibit the production and accumulation of wealth.
Gift, estate, and inheritance taxes inhibit the disposi-
tion of it by reducing the amount of wealth available for
distribution to the beneficiaries. The failure to allow
for these taxes could reduce or nullify the planner's

other actions.

Need for Study
There are several reasons why this study has been

undertaken. One reason is that the results to be obtained

 

 

 

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are of potential benefit to the practitioners and educators
who work in this field every day. At the present time,
both of these groups are forced to rely on unverified
"rules-of-thumb" such as: transfer exactly one half of
the decedent's estate to the surviving spouse but no more;
select the alternate valuation date if a step up in basis
will be beneficial; etc. Since these "rules" have not
been adequately tested, there is no Objective evidence
to indicate the cases in which they do not apply. There—
fore, the practitioner is not certain if the application
of any of these "rules“ will be of maximum benefit to his
client. By testing and perhaps improving existing "rules-
of—thumb", this study will provide the practitioner with
the knowledge to do a better jdb for his client.

The practitioner's need for such a study has in-
creased. There are a large number of pe0p1e who are
involved in this field (accountants, attorneys, bankers,
trust officers, investment counselors, insurance agents,
etc.) and the breadth of knowledge they must have is
quite extensive. It is becoming very difficult to
acquire the basic knowledge of all the directly related
disciplines needed in this field and almost impossible
to stay abreast of the changes and the effect they will

lmvecxxclients. It is imperative that some basic rules

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be established, subject to modification when the laws
cmange, so that the practitioner is not lost in a quag-
ndre of conflicting Options.

In a relevant article, Carl Paffendorf, a practi-
tioner, hinted at another reason for making this type of
study when he said, "The time required to deve10p and
maintain estate planning proficiency, to analyze and plan
an estate thoroughly, and to implement the plan often is
not commensurate with the fees clients are willing to
pay."2 The result is not that it is unprofitable to go
into the field of estate planning, but rather that true
estate planning will be denied all individuals but those
with large estates because of the cost involved. Unless
decision rules are deve10ped and tested, the practitioner
will be forced to rely on unverified "rules-of-thumb".

A recent change in the tax laws points out another
reason for this study. The time for filing the federal
estate tax return has been reduced from fifteen months
after death to nine months. This adds a time factor on

top of the cost pressure. Within those nine months, the

executor or administrator must, among other duties,

 

2Carl G. Paffendorf, "The Computer in Estate
Planning-Use of Electronic Systems and Equipment,"
mats and Estates, September 1966, p. 855.

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gamer the assets, value them, determine the liabilities,
«Kennine the Options, and provide the necessary liquidity.
lflthough this list is not complete, it illustrates the
rmed for a fast method of highlighting and selecting those
cmtions which will minimize the tax bill while fulfilling
Hm planner's Objectives.

The educator will benefit from this study by having
tested decision rules for use in the classroom. This will
permit him to indicate the effect of using one estate
pdanning tool over another. It will also allow an analysis
cfi'the effect of the relationship between different vari—
ables by illustrating the effect of changing one variable
wmile holding the others constant. Finally, when changes
in the law are pr0posed, he can evaluate the effect on the
public by simply modifying the tested rules and applying
them to sample cases by the use of the models constructed
in this study. All of this will also produce flow-through

benefits to the public.

ScoEe

The scope of this study will be limited to the exam-
ination of only certain aspects of federal gift and estate
'taxation. The limitation is for purely practical reasons.

It.is not feasible to study all aspects of federal estate

 

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mm gift taxation, let alone including income taxation in
astudy of this size. The areas selected were ones which
cpuld'be tested without many unrealistic limitations and
assumptions .

Although several insurance companies and CPA firms
are using the computer in estate planning, this study is
still needed. Most firms have restricted the use of the
cmmputer to the computation of specific items such as the
estate tax, the estate income tax, the estate's cash
rmeds, etc. This study goes beyond this point by attempt-
ing to provide improved decision rules based on the con-
sideration of many variables rather than just one or two
as is now being done.

The tapics, "rules-of—thumb", and relevant variables
are:

A. Predeath Planning

1. Marital deduction (Chapter 2) - give exactly
one half of the decedent's estate to the
surviving spouse.

a) size of decedent's estate

b) size of surviving spouse's estate

c) remaining life of the spouse

d) after-tax rate of return of spouse

e) after-tax rate of return of other
beneficiaries

f) amounts transferred to surviving

spouse

2. Gifts "in contemplation of death" (Chapter 3)
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of death because the amount of the gift
tax paid is not added back into the
estate although an estate tax credit is
allowed for the gift tax paid.

a) type of prOperty

b) rate of return

c) size of planner's estate
d) value of current gift

e) value of cumulative gifts
f) life of planner after gift

Inter vivos trusts (Chapter 4) - irrevocable
inter vivos trusts save taxes by spreading
the income over several parties.

a) rate of return

b) size of planner's estate

c) value of cumulative gifts

d) value of transfer in trust

e) remaining life of planner

f) income tax bracket of planner -
effective tax rate

g) income tax bracket of beneficiaries -
effective tax rate

B. Post-Mortem Planning

1.

First income tax year (Chapter 5) — there is
an advantage to having a short first tax
year because of the extra $600 exemption and
the lower tax rates if income is spread over
more years.

a) size of income of the estate

b) expenses of the estate

c) income tax bracket of the beneficiary

d) life of the estate

e) pattern of receipts of income and
disbursements for expenses.

f) length of first income tax year

Deduction of administrative expenses
(Chapter 6) - deduct expenses either on the
income tax return or the estate tax return
whichever has the higher tax bracket.

 

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a) marital deduction

1)) size of estate

c) income of estate

6) amount of administrative expenses

.Alternate valuation date (Chapter 7 ) - if
the beneficiary's tax rate is larger than
the estate tax rate, use the alternate

value date if the assets have increased
in value.

a) type of asset

b) marital deduction

c) value of estate at death

d) value of estate on alternate date
e) beneficiary's tax bracket

f) date of subsequent sale

Waiver of executor's commission (Chapter 8) -
the executor should waive his commission if
his income tax bracket is high and he will
take under the will.

a) size of the estate

b) income tax bracket of the executor

c) income tax bracket of the estate

d) per cent of residual estate that
executor is entitled to

Because of the interrelationships between estate,
gift, and income taxation, the latter two will be included
when it is evident that they have a direct effect on the
estate planning decision rules. The actual consideration
of these areas will be limited to the reductive effect
they have on the estate and its distribution. No con-
sideration will be given to their effect on the accumula-

tion of the estate.

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Methodology

The study*will be performed using a computer simula—
tion technique on each individual tOpic. The computer
will calculate the total amount to be received by the
beneficiaries for the many thousands of cases formed by
every possible combination of the discrete relevant vari-
ables functioning within wide pre—defined ranges. This
data will be analyzed to determine the Optimal decision
for each case. This Optimum will then be compared to the
general "rule-of-thu " to see if it agrees with it. If
it does not, then the Optimal decisions will be reviewed
to determine if patterns exist from which general rules
can be derived.

The criterion used to select the optimal decision is
that of maximizing the sum value of the transfers to be
received by the surviving spouse, the children and other
residual beneficiaries. For this study, sum value is
defined as the total of all distributions received by
the beneficiaries with accrued interest added up to the
date of the final transfer.

Sum value was selected as the Optimal decision
loecause it is reasonable to assume that the distributions
-tc>the beneficiaries will not occur at one point in time.

TQmerefore, a problem exists in evaluating and comparing

 

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current receipts with future receipts by the beneficiaries.
The theoretically correct methods of handling this situa-
tion are to use either discounted present value or the
sum value of all the receipts. Both methods will yield
similar comparisons. The major difference is that the
numbers under the sum value method are larger because
interest has been added on to the principle amounts,
whereas the interest will be subtracted from receipts in
future periods under the present value method. The sum
value method was selected because it required fewer calcu-
lations and yields identical decision patterns in most
cases. This is because the sum value of the estates had
to be calculated anyway in order to determine the exact
amount of the estate tax that would be due on future
estates.

When an interest rate is included in the calculation
of the sum value of receipts, it is necessary to state the
rate to be used. The literature of accounting and
finance is not definite but seems to indicate that market

or opportunity rate should be used.3 The most apprOpriate

 

3For example, Sprouse and Moonitz state that receiv—
akfles should be discounted at the market rate in force at
tkm date acquired. RObert T. Sprouse and Maurice Moonitz,
'2A.Tentative Set of Broad Accounting Principles for Busi-
Imess Enterprises", Accounting Research Study*#3, American
Inistitute of Certified Public Accountants, 1962, p. 24.

 

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rate probably would be the one which each beneficiary
could earn on the money. However, it would be impossible
to calculate because it would vary depending on the indi-
vidual beneficiary's financial education, time spent
managing the funds, and risk preference, as well as
other items.

To avoid this problem, it was decided to use the
average rate which a competent trustee would earn. This
rate was selected because in the case of trusts, this
would be the actual rate earned; and as an estimate for
the beneficiaries' individual rates of return, it would
be both reasonable and conservative. Unless otherwise
stated, the rate of interest used in this study will be
6%. This rate was used because it is the average rate

that a corporate fiduciary could earn on trust funds.

Limitations

Within the restricted area of this study, two other
limitations have been imposed. No consideration will be
given to the prOblem of distributions where one bene-
ficiary is entitled to a life interest and another the
remainder. The reason for this is that the life tenant
wvill receive many payments which could differ in amount

and timing. In order to prOperly compare these

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distributions with others from the planner's estate, they
would have to be discounted back to a set date. This
would involve a prohibitive amount of work and the dollar
amount may not even be significant if the interest rate
is high or the length of time reasonably long. It is
preferable to consider the life interest problem as a
separate entity. This is an attempt to keep each question
independent of the others and therefore, allow more accu—
rate conclusions concerning each individual question.

The other major limitation is that no adjustment will
be made for the non—monetary matters that a planner has to
consider. For example, some men would be willing to pay
additional tax and transfer their entire estate to their
wives, rather than give half to their children, so that
they will not be financially independent of their mother.
It would be impossible to imagine all the circumstances
and reasons for consciously deviating from the Optimum and
to attach a monetary value to them. Therefore, by ignoring
them in determining the decision rules, the planner can
easily calculate the dollar effect of not Optimizing by
comparing the results of his non-monetary decision with
tlm results he would obtain by following the Optimal deci-
ssion. It is, then, the planner's decision whether or not

time nonmonetary reasons justify the cost.

CHAPTER 2

MARITAL DEDUCTION

The estate planner has many decisions to make during
his lifetime. One of the most basic decisions is pre-
cisely how much money and what property he wants to leave
to each beneficiary. This choice is a very personal one.
From a tax standpoint, this decision is important because
the estate tax will be affected by the amount that is left
to the surviving spouse. The general rule-of-thumb is
that the estate tax will be minimized by a transfer of 50%
of the estate to the spouse unless his (her) estate is
large. It is the purpose of this chapter to study this
rule—of-thumb in depth.

The discussion of the marital deduction (as well as
the other rules-of-thumb in subsequent chapters) will pro—
ceed as follows. First a discussion of the laws relating
to the marital deduction will be presented. This will be
.followed by a discussion of the use of the marital deduc—
tiion in practice. The simulation model constructed to
teast the appropriateness of the marital deduction in many

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14
different situations will be discussed. This will be

followed by an analysis of the results and a summary.

The Laws Relating to the Marital Deduction
Definition of Estate

The Federal Estate Tax is an excise tax on the
transfer of property. It has a progressive rate starting
at 3%.and ending at 77%. The 3% rate is applied to tax-
able estates less than $5,000; the 77% rate to ones
greater than $10,000,000.1

The taxable estate is defined in section 2051 of the
Internal Revenue Code as being the gross estate minus the
exemption and deductions specified in sections 2052 to
2056. Section 2031(a) defines the gross estate as:

The value of the gross estate of the decedent

shall be determined by including to the extent

provided for in this part, the value at the

time of his death of all property real or per-

sonal, tangible or intangible, wherever situated.
The remainder of that part of the Code deals with specific

valuation prOblems such as annuities, powers of appoint-

nent, proceeds of life insurance, etc.

Sfecific Deductions and Exemptions

Section 2052 provides for an exemption of $60,000 for

each and every estate. Section 2053 allows for deductions

 

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15

from the gross estate for the dollar amount of funeral ex-
penses, administration expenses, claims against the estate
and indebtedness associated with prOperty included in the

estate. Section 2054 allows for a deduction for casualty

and theft losses "when such losses are not compensated for
by insurance or otherwise." A deduction for transfers to

charity is provided in Section 2055. This section also

covers transfers for public and religious uses.

section 2056 - Marital Deduction

Section 2056 (a) states:

For purposes of the tax imposed by Section 2001,
the value of the taxable estate shall, except
as limited by subsections (b), (c), and (d), be
determined by deducting from the value of any
interest in prOperty which passes from the
decedent to his surviving spouse, but only to
the extent that such interest is included in
determining the value of the gross estate.

This section provides a marital deduction——a deduction for
transfers to a surviving spouse. There is the general
limitation that, to qualify, the prOperty transferred

must be included in the decedent's gross estate. The regu-
lations state that any transfer of prOperty for which a
«deduction is allowed under Section 2053 will not be con-

2

sidered as included in the estate. Therefore, any debts

 

2Estate Tax Regulation §20.2056(a)—2(b)(2)

 

 

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16
of the decedent or executor's commission paid to the
surviving spouse will not give rise to a double deduction.
Subsection (b) denies a marital deduction for trans-
fers "where, on the lapse of time, on the occurrence of an
event or contingency, or the failure of an event or con—
tingency to occur, an interest passing to the surviving

3 Those transfers are

Spouse will terminate or fail...."
known as terminable interests and include life estates,
annuities, patents and COpyrights.4

There are two very important exceptions to the
terminable interest rule. The deduction will not be
denied if the surviving spouse's interest is contingent

upon either —

l - his (her) out-living the deceased by at least
six months, or

2 - his (her) not dying from a common disaster.5
Therefore, the property will be included in the spouse's
estate and a marital deduction claimed only if either or
both of these conditions are met. This prevents the

prOperty from being taxed in two estates within a very

 

3IRC 52056 (b) (1)

4Estate Tax Regulation §20.2056(b)(l)

5IRC 52056(b)(3)(A) For a discussion of the advis-
mfiJity of using a six-month condition see page 26.

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17
short period of time.

A deduction will also be denied for property where
the surviving spouse has disclaimed his/her interest and
it passes to another party.6 On the other hand, a timely
disclaimer by a third party such that the surviving spouse
receives the prOperty will qualify the prOperty for the
marital deduction.7

The most frequently referred to limitation on the
amount of prOperty which will qualify for the marital
deduction, given in subsection (c), states that the
marital deduction is limited to fifty percent of the
adjusted gross estate.8 The adjusted gross estate is
determined by subtracting the expenses, debts, taxes and
casualty losses, deductible in determining the taxable

9,10

estate, from the gross estate. It is interesting and

 

6IRC §2056(d)(l)

7IRC §2056(d)(2)

8IRc §2056(c)(1)
9IRc §2056(c)(2)(A)

10To determine the adjusted gross estate, there is
also a deduction for community prOperty. This was
inserted because only 1/2 the value of such property is
included in the gross estate. Therefore, 1/2 the com-
munity prOperty is transferred to the surviving spouse
free of tax automaticallyu

18
important to note that the adjusted gross estate used as
a basis for qualifying the marital deduction is not limited
by either the $60,000 exemption or any transfers to chari—
table or religious organizations deductible under section

2055 from the gross estate.

Revenue Procedure 64-19 - Formula Clauses

When discussing the tax law associated with the use
of the marital deduction in estate planning, there are
two more points that should be considered. The first is
the effect of formula clauses on qualifying for the marital
deduction. This is covered by Revenue Procedure 64-19.11

This Procedure states that if the will requires the
executor to distribute assets in kind to the surviving
spouse, and if they are to be valued at the values used
for Federal Estate Tax purposes, and these assets might
fluctuate in value, there is a question whether or not
the amount of the transfer is fixed at date of decedent's
death. If it is not fixed, then the marital deduction
will be denied.

Certain bequests are automatically excluded from

question. They are:

 

111964-1 Cumulative Bulletin 682.

19
(1) the surviving spouse is to receive a frac-
tional share of the estate and any changes
in value will be prOportionally included,
(2) it is to be settled with specific assets,

(3) it is to be settled solely in cash, or

(4) the assets distributed are to be valued at
their date of distribution value.

If the bequest is one covered by this Procedure and it is
not automatically excluded, it will be considered undeter-
mined at death unless it specifically provides:
(1) the executor must use assets having a value
at the date of distribution at least equal
to the value at date of death, or
(2) the assets distributed must be fairly
representative of the change in value
of the entire estate.
As was stated before, the penalty for not complying with

this Procedure is complete disallowance of any marital

deduction.

Section 2013 - Credit for Prior Taxed Transfers

The second point which should be considered is that
a credit is allowed in certain cases where prOperty was
taxed in a prior estate. Section 2013(a) states that if
prOperty was taxed in a prior estate within ten years of
the date of the decedent's death, than a credit is
allowed against the current estate tax.

The actual credit is the lower of the following two

 

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20
computations. The first computation is the difference
between the tax due ignoring this credit (but subtracting
the credits for state, foreign or gift taxes) and the tax
that would be due if the prior taxed prOperty was excluded
from the current gross estate.12 The second computation
is the multiplication of the estate tax paid on the prior
estate by the ratio of the value of the prior taxed
prOperty included in the current estate to the prior tax—
able estate plus the amount of the exemption claimed under

Section 2052.13

(In most cases, the amount claimed under
2052 would be $60,000). The second computation can be

expressed mathematically as:

Credit 3 Prior tax paid (x) value of prior taxed property
prior taxable estate + $60,000

If the date of death of the decedent is more than two

years after the death of the prior decedent, the credit

1

which is determined as above must be reduced 4 by the per-

centages shown in the following table:

 

12IRC §2013(c)(1). There is also an adjustment if
the estate is claiming a deduction under 52055 or 52106

(a) (2) -

13IRC §2013(b)

141Rc 52013(a)

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PERCENTAGE REDUCTION IN CREDIT FOR TAX ON PRIOR TRANSFERS
BASED ON TIME BETWEEN DEATHS

 

 

 

Time Between Dates of Death Credit Reduction
At least (years) But less than (years) Percentage
2 5 20
5 7 40
7 9 6O
9 ll 80

 

This credit may come into play when there was a
transfer to a surviving spouse which either did not
qualify for the marital deduction or exceeded the amount

deductible because of the limitations.

Uses of Maritalflgeduction in Estate Planning

The use of the marital deduction is well known to
the practitioner in the field of estate planning. Many
advantages have been noted. A discussion of the most

important ones follows.

Minimizing Overall Estate Tax

Supposedly, the primary advantage is that it saves
current taxes. It permits the deceased to transfer more
assets currently to his beneficiaries. It may ultimately
reduce overall estate tax. If the spouse's estate is

smaller than the decedent's, then by using marital deduction.

 

 

 

 

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22

the transferred prOperty would be taxed at a lower rate
than before. This would reduce the total amount of estate
tax paid. Another advantage to reducing current tax,
whether or not it reduces the overall tax bill, is to
reduce the liquidity needs of the estate. It has been
pointed out that in the case of an estate whose major
asset is a closely held business, the current cash savings
from the marital deduction may be essential to minimize
the loss from having to sell either part or all of the

15 The question

firm rapidly in a disadvantageous market.
has become not whether to use the marital deduction or not

but rather how much to transfer to the surviving spouse.

Timing Factor

Several authors have indicated that there may be an
Optimal amount of prOperty to transfer qualifying for the
marital deduction. Several examples have been formulated
where the maximum use of the marital deduction gives rise
to a larger total tax bill even when the surviving

Spouse's estate is smaller than the decedent's.16'17

 

15Paul B. Sargent, "A.B.C. and D. of Marital Deduc—
tion," Tax Counselor's Quarterly, June 1963, p. 181.

16Harry Yohlin, "Deve10ping an Effective Gift Tax
Program to Save Taxes," The Practical Lawyer, May 1967,
p. 50.

17Robert A. Lewis, "The Marital Deduction, The (cont. p. 23)

3

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23
To illustrate: assume that the husband's estate is
$700,000 and his wife's estate is $500,000. If at his
death the full amount of the marital deduction is used
($350,000) the combined tax on both estates will be
$296,100. If, on the other hand, nothing is transferred
to his wife, the combined tax will be $293,200.

Neither Of the previously footnoted authors has in—
cluded an interest factor or determined an Optimal ratio.
The importance Of the interest factor has been recognized
in the literature. In fact, it has been suggested that
the interest that can be earned on the estate tax saved
by using the marital deduction may more than offset the
additional tax due even if the surviving spouse's estate

18 Therefore, the

is larger than the decedent's estate.
Optimal amount of marital deduction transfer is still

subject to investigation.

Formula Clauses
Assuming for the present that an Optimal percent of

decedent’s estate which will maximize the receipts of the

 

Credit for Tax on Prior Transfers and Their Interrelation-
ship—Post Death Action to Coordinate Their Use," Taxes-
The Tax Magazine, April 1964, pp. 225-226.

18Robert Brosterman, The Complete Estate Planning
glide For Business and Professional Men and Women and
'flmfix Advisors, New York, McGraw-Hill, 1964, p. 229.

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24
beneficiaries is determined, the question becomes how to
set up the bequest to the spouse so as not to over or
under qualify it. When the exact size of the estate is
known, the question is easily answered. Make the bequest
a specific dollar amount or a specific group of assets.
However, it would be rare to know in advance the exact
size Of the estate before death. Therefore, most advisors
would use some form of formula clause bequest.

There are two main types of formula clauses. The
first is a fractional share clause. Under this type, the
surviving spouse would get a constant fraction of the
residuary estate. In other words, he (she) would be
entitled to a part Of each asset that is included in the
residuary estate. The second is the pecuniary formula.
Under this type, the surviving spouse would get assets in
amounts equal to X% of the adjusted gross estate. In
other words, he (she) is entitled to a group of assets,
selected by the executor, whose value equals the number
arrived at by multiplying the adjusted gross estate by
the specified percentage. Both types of clauses have

their advantages and disadvantages. One point that must

be kept in mind is that Revenue Procedure 64-19 applies

tx>pecuniary clauses but not fractional share clauses.19

19See Page 18.

 

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25
Two other advantages of using the fractional share
clause are that the spouse will share in the appreciation
or depreciation Of the estate and that the assets do not
have to be revalued at the date of distribution.20 Two
of the advantages of the pecuniary clause are that it
allows more post-mortem planning and it allows timing of

21 It allows more post-mortem planning because the

income.
executor selects the assets to be distributed to the
spouse. Therefore, he can select assets which will be
consumed or decline in value and result in a lower estate
tax when the spouse dies. As for timing of income, Regu-
lation 91.663(a)-l(b)(1) states that a pecuniary bequest
is not a specific sum of money or a specific property.
Therefore, any distributions will come under 5663 of the
Code and be income to the beneficiary. By distributing
or not distributing assets, the executor dictates whether

the income will be taxed to the estate or the spouse and

in whose tax year it will be taxed.

 

20Mark B. Edwards, "Marital Deduction Formulae-A
Planner's Guide," The Tax Counselor's_Quarterly,
September 1967, p. 264.

2lAlan N. Polasky, "Marital Deduction Formula
Clauses in Estate Planning - Estate and Income Tax
Considerations," Michigan Law Review, March 1965,
pp. 879-880.

 

 

1

 

 

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26
The choice of which type of formula clause to use is
a decision which the decedent and his advisor should agree

to after considering the individual case.

Uses of Trusts

Another important consideration related to the marital
deduction concerns the transferring Of assets into a
trust. A discussion Of the advantages and disadvantages
of using a trust will be deferred until Chapter 4, because
this question is considered subordinate to the determina-

tion of the amount of transfer.

The Simulation Model

The general rule-of-thumb is to transfer exactly
50% of the decedent's estate to the surviving spouse.
This portion Of the study tested whether this rule leads
to the Optimal solution. The model was designed to com-
pute and output the amount of estate received by bene-
ficiaries based on the varying combinations Of pre-
defined variables. The study was set up to determine
‘the Optimal percentage in those cases in which the general

Inile did not maximize the receipts by beneficiaries.

Variables

There are many factors which affect this decision.

TTMB following variables have been selected to be included

 

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27
in the model because either they have been cited in the

literature,22

or they were necessary to make the model
approximate the real world. The variables are: size of
decedent's estate, size of surviving spouse's estate,
after-tax rate of return of spouse, after—tax rate of
return of the other beneficiaries, remaining life of the
spouse and amount transferred to spouse.

Size of Decedent's Estate

The range of this variable was $200,000 to $2,000,000
by increments of $200,000. The $200,000 starting point
was selected to assure that all of the estates would be
taxable after deducting the exemption and the marital
deduction. The maximum size of nontaxable estates under
the Code is $120,000 if full use is made of the marital
deduction and $60,000 exemption.

The $2,000,000 ending point was used to permit rela-
tively large estates while still restricting the computa-
tion output Of this study to a workable size. It was felt
that any trends that occur in large estates would be
noticeable for estates of $2,000,000.

Size of Surviving Spouse's Estate

The range was $200,000 to $2,000,000 by increments of

 

22See discussion Of Uses of Marital Deduction in
Estate Planning, pp. 21-25.

 

 

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28
$200,000. The range was the same as for the decedent's
estate and was selected for the same reason. The size of
this estate was varied independently of the size Of the
decedent's estate. This was done so that all the possible
combinations were considered.

After-Tax Rate of Return of the Surviving Spouse
and Other Beneficiaries

It has already been pointed out (pages 23 & 24) that
potential interest earnings on the deferred estate tax
should be considered.23 Not only should interest on the
tax be considered, but also the potential earnings on the
distributions should be taken into account. Therefore,
two more variables included in the simulation model repre-
sent the after-tax rates of return that each of the sur-
viving spouses and the other beneficiaries would earn.
The after-tax rates of return were used to recognize
that the beneficiaries are prObably in different tax
’brackets without having to add additional variables which
could confuse the primary issue. These returns were
varied from 0% to 30% by steps of 6%. They were varied
independently to again consider every possible combina-
‘tionu .A zero rate was used as a start up point to recog-

lxize that some beneficiaries would either not know how

 

23See Footnote 18.

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29

or not want to invest their inheritance in income producing
assets. Thirty percent was set as a maximum to allow for
extraordinary knowledge on the part of the beneficiary or
extremely favorable Opportunities. It is highly unlikely
that anyone would earn that high a rate for any length of
time; its inclusion was more for informational and theo-
retical reasons than practical ones.

Remaining Life of Spouse

Whenever interest is included, a time variable must
be specified. In this case, it is the life of the spouse.
This dictates how long the other beneficiaries must wait
to receive the remainder of the decedent's estate (the
portion which qualified for the marital deduction by
transfer to the spouse). The spouse's remaining life was
varied from one year to 22 years by increments of three
years. A starting life of one was selected to cover the
case where both the deceased and spouse are elderly. The
three year increments provide information concerning the
effect of the credit for prior taxed transfers on the
optimal decision. A maximum of 22 years was used to
account for the spouse who lives to a very Old age as
‘well as the case where the decedent died at a very young
lage. This does not exhaust all possibilities, but it

does provide for a reasonably wide range of cases.

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30

Amount Transferred to Spouse

The final variable considered was the percent of
decedent's estate that was transferred to the surviving
spouse. The percents used were 0,20,40,50,60,80 and 100.
They were chosen to hit the extreme cases in which the
decedent transferred all or nothing as well as the sug-
gested Optimal of 50%. The other rates were selected to
help determine the Optimal percent if it is not one of

the extremes mentioned.

Methodology

The simulation model used to generate the data was
programmed in fortran on an IBM 360 computer. Chart 2-I
is a flow chart of this model. The simulation proceeded
as follows: The size of the decedent's estate (DE) was
set at $200,000. The spouse's estate (SE) was set at
$200,000. The rates of return for the spouse (SROR) and
other beneficiaries (BROR) was set at 0%. The surviving
spouse's life (SLIFE) was set at one year. The percent
<3f the decedent's estate transferred to the spouse (PER)
was then set at the initial point of zero. The dollar
amount of the transfer to the surviving Spouse was then
calculated (T1) . The estate tax (TAX) due on the

decedent's estate was then calculated. The other

   

 

31

CHART 2-1

FLOW CHART FOR MARITAL DEDUCTION

 

[Vary Size of Decedent's Estate (DE) 200,000-2,ooo,000
ii by 209,000

 

 

 

 

 

ii
Vary Size of Spouse's Estate (SE) 200,000-2,ooo,ooo T‘I,
by 200.000 I J‘

 

Elan Spouse's Rate of Return (SROR) [Ci-30 by 6 j

 

I

[Vary Bengficiaries'kates of Return (BROR) 0-30 by 6 j

 

 

 

 

 

 

 

 

 

 

 

 

 

i

[Vary Spouse's Remaining LifengLIFE)_l-22 byy3 __J‘--
1

[flag Percent Transferred (PER) 0,2(1,40L50,60,80L or 100]?)
i

[Amojunt Transferred to Spouse (T1) - PER*DE J
I

ESTATE TAX (TAX) ' TAX.RATE* (DE-MARITAL DEDUCTION

- 601000) a

L 1

[TRANSFER.T0 EEuEr. (12) - DE-TifTAXV» ‘J

 

 

L
[Sum va1ue ngTRANS T0 BENEF. (a) - I2,* (1+BRog)**SLIFfl
r1.

 

, l
Fum Value of Spouse's Estate at Death (NSE) -
1, SE + 11* (1+SROB)**SLIFE

 

 

 

 

 

 

T“
max - TA_x_ RATE* (NSE - 60,000) L 7
[Transfer from Spouse to Benef. (B) 8' NSE - TAX ‘1
[

 

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32
beneficiaries were assumed to have received an amount
equal to the decedent's estate minus the amount transferred
to the surviving spouse and the amount of tax due (T2).
Interest was then added to the amounts transferred to
all beneficiaries (A). The sum value of the Spouse's
estate at her death was calculated (NSE). The amount of
the estate tax due at the Spouse's death was then computed
(TAX). The difference between the estate and the tax was
then added to the amount originally transferred to the
other beneficiaries (C). (Interest has already been
added to this amount.) The total amount received by the
other beneficiaries was then printed out as the result.
The computer then increased the percentage transferred to
the surviving spouse, and then all the other computations
‘were redone. .After the percentage reached the maximum

of 100, the other variables were increased in turn.

Limitations on Methodology

There are several limitations in this model. First,
.a1J.of the variables are certain (tax rate for example)
and based only on current provisions in the tax law.
Although restrictive, it is the same assumption that all
tax advisors must make to specify an exact answer and

leaves no alternative .

 

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33

The next limitation is that the surviving spouse
only earns a rate of return on the amount received from
the decedent. It is assumed that none of the estate earn-
ings are left uninvested. The surviving spouse either
consumes or gives away the exact amount of the earnings
from his(her) original estate so that there is neither
an increase nor decrease in its size. This was included
to eliminate all the additional assumptions which would
be necessary concerning the spouse's standard of living,
earnings capacity, charitable donations, etc., if it
were not included.

The use of the after-tax rate of return rather than
the before-tax rate may be viewed as another limitation.
The alternative would have been to include four variables
(spouse's before-tax rate, spouse's tax rate, benefici—
ary's before-tax rate, and beneficiary's tax rate) for the
two used. This would have increased the number of situ-
ations without increasing the useful output because the
accumulation due to income would still be based on
after-tax rate of return.

The next limitation is that only one rate of return
is used for all beneficiaries besides the spouse. This
could either be because there is only one other bene-

ficiary or that all of them have the same rate. There

 

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34
are many cases where this limitation would be inappro-
priate. It was included to limit the number of different
situations which would be considered. This has the advan-
tage of providing information on the effect of transfers
tO each beneficiary individually. If there are several
‘beneficiaries, treat each one as a separate case. An
‘approximate answer for all the beneficiaries combined
can be determined by interpolating between the results
Obtained for each individual case.

The final limitation is that no consideration was
given to the use of trusts for either the benefit of the
surviving spouse or the other beneficiaries. This is not
restrictive, because if the trust qualified for the
nmrital deduction, it would have the same effect as an
mnmight bequest to the spouse. As for the use of trusts
for the other beneficiaries, it really is a question of
what form the bequest should take. To have included this
Option would simply confuse the issue and mask the actual

effect of the marital deduction.

Results
The discussion of the results will proceed as follows:

1. The overall results of the different percents
transferred to the Spouse;

2. The effect of the relationship of the sizes of

O‘I

 

 

 

 

 

35

the decedent's and spouse's estate;

3. The effect of the difference in the rates of

return earned by the spouse and the other
beneficiaries;

The effect of the spouse's remaining life; and

5. The cost of under or over qualifying the
marital deduction.

Summary Results

In total, 28,800 cases were generated. A breakdown
<3f the Optimal decisions24 by percent of decedent's
estate transferred to the surviving spouse is presented
in Table 2—II. It can be Observed that in only 2,876
cases, or about 10% of the time, did the model determine
it apprOpriate to give the surviving spouse the maximum
amount which will qualify for the marital deduction.:ZS
n116,050 cases (55%), the Optimal decision would have
been to transfer zero to the spouse; and in 5,966 cases

(21%), the Optimal transfer to the spouse would have

been 100%.

 

24The Optimal decision is judged by the transfer to
the spouse which will result in the maximum receipts by
other beneficiaries from the decedent and Spouse at the
time of the spouse's death.

25See the discussion on Page 47 regarding the cost

of under or over qualifying for an adjustment to the
results presented.

 

36

TABLE 2-II

TOTAL CASES GENERATED
BREAKDOWN BY OPTIMAL'PERCENTAGE OF THE DECEDENT'S
ESTATE TRANSFERRED TO THE SURVIVING SPOUSE

 

Percent of Decedent's

 

Estate Transferred Number of Cases Z

0 16,050 55.7

20 2,153 7.5

40 1,158 4.0

50 2,876* 10.0

60 340 1.2

80 257 9

100 M2 iii-.7.
3.29:2. ices

 

*In only 2,876 cases, or about 102 of the time, the Optimal
decision is to give the surviving Spouse the maximum amount
which would qualify for the marital deduction.

Emfects of Size of Estate

Table 2-III gives the Optimal decisions broken down
by the relative size Of the decedent's and Spouse's
estates and the relative size of the spouse's after-tax
rate of return and other beneficiaries' afterftax rates
Of return. An evaluation of this table highlights two
points. First, the general "rule Of thumb" as to the
relative sizes of the estates, does not provide a good
yardstick. The common rule would indicate transferring

50% to the spouse in most cases in which the decedent's

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38
estate is larger than the Spouse's. It turns out that
this is the Optimal decision in only 1,529 cases
(16 + 1,513) out of a total Of 12,960. These results are
very similar to the overall result which indicated that
about 10% of the time, a transfer of 50% would be Optimal.

Similar results were Obtained when the decedent's
estate was varied to be equal and then less than the
spouse's estate. For example, Table 2-III A shows a
‘breakdown by relative estate size of those cases in which
the decedent's estate was less than the spouse's estate,
While the spouse's rate of return was greater than the
other beneficiaries'. It can be seen that fifty percent
transfer is Optimal a little less than 20% of the time
(296 out of 1,320) when decedent's estate is more than
70% Of the spouse's estate. This is the same percentage
as for those cases between 30% and 70% (551 out Of 2,640)
and those cases less than 30% (226 out of 1,440).

Tables 2—III and 2-III A indicate that the relative
sizes of the estates is not one of the determining vari-
ables with respect to the Optimal amount that should be
transferred to the spouse so as to qualify for the marital

deduction.

 

39

TABLE 2-IIIA

OPTIMAL DECISION WHERE SPOUSE'S RATE OF RETURN
IS GREATER THAN BENEFICIARIES'
BREAKDOWN BY RELATIVE ESTATE SIZES FOR THOSE CASES
IN WHICH DECEDENT'S ESTATE IS LESS THAN SPOUSE'S

Decedent's Estate as 3 Percent of Spouse's Estate

 

 

 

 

Percent MOre than More than 30% but Less than or
Transfer 70% not more than 70% Equal to 301 Total
0 66 196 172 434
20 186 276 93 555
40 108 137 65 310
so 296 551 226 1,073
60 35 57 26 118
80 27 51 27 105
100 602 11:17.2. .__8_3_1_ 1.1.9.5.
Total 1,320 2,640 1,440 5,400

Effect of Rates of Return

The second point which can be Obtained from Table
2-III is that the relationship between the after-tax rates
Of return is a very important variable. In 11,817 cases
(5,400 + 1,200 + 5,217) out of a total of 12,000 cases in
which the spouse's after-tax rate Of return was less than
the other beneficiaries' rates of return, the Optimal

26

decision was to transfer nothing to the spouse. In no

 

26The reader should keep in mind that the Optimal
decision of a zero transfer does not mean that the sur-
viving spouse should receive nothing from the decedent's
estate. It means that any transfer to (continued p. 40)

 

 

 

 

 

 

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40
case would you want to transfer 50% to the spouse. In
3,786 cases (2,160 + 480 + 1,146) out of 4,800 where the
rates of return were equal, the Optimal decision was,
again, to transfer zero to the spouse. In fact, the only
tine zero was not the Optimal decision when the after-tax
rates of return were equal was in those 1,014 cases
(761 + 237 + 16) in which the decedent's estate was also
larger than the spouse's. To further emphasize the im-
POmtance of the rates of return, note that in nearly 50%
0f the cases (5,966 out of a total of 12,000) where the
Spouse's rate of return was larger, the Optimal decision
was to transfer 100% of the decedent's estate to the
Spouse. Of these, 2,805 were cases where the spouse's
emtate was already larger than the decedent's. In an
attempt to determine the exact effect that the difference
in rates of returns has, Table 2—III B was prepared.
Table 2-III B presents a breakdown of the Optimal deci-
sions by relative rates of return for those cases in
which the decedent's estate is less than the Spouse's

estate and the spouse's rate of return is greater than

the other beneficiaries'.

 

the spouse should be set up in a way that it does not
qualify for the marital deduction On the decedent's

estate tax return.

 

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41
A review of Table 2-III B indicates that the summary

results of Table 2-III are relatively consistent through-
out the range of cases. A closer analysis of the extremes
(Spouse's rate 24% or 30% greater than beneficiaries' and
decedent's estate less than 30% of spouse's) indicates a
Slight'bias toward larger transfers to the spouse. This
is evident when the number of cases where 50% is Optimal
is examined. The overall results (see pages 35 and 36)
indicate that 50% should be Optimal about 10% Of the time.
then the spouse's rate is extremely large, that result
occurs only about 5% (SB/1,080) of the time in Table 2-IIIB.
In those same cases in Table 2-III B, the Optimal decision
cm 100% transfer increases to almost 90% (931/1,080) of
the time. This is what one would expect because of the
abnormally large return that is earned on investments.

An analysis of Table 2-III B leaving out the extreme

cases in the right column indicates that a 50% transfer
would be optimal in 1,015 cases (595 + 420) out of a

total of 4,320 cases. This is about 23% of the time.

It is larger than the overall results, but it is still
small enough to repudiate the general rule-of—thumb that
50% is the Optimal transfer.

An analysis similar to the one in Table 2-III B for

those cases in which the estates are equal and the

 

42

TABLE 2-IIIB

OPTIMAL DECISION WHERE SPOUSE'S RATE OF RETURN
IS GREATER THAN BENEFICIARIES'
BREAKDOWN BY RELATIVE RATES OF RETURN FOR THOSE CASES
IN WHICH DECEDENT'S ESTATE IS LESS THAN SPOUSE'S

‘

 

 

 

Percent Spouse's Rate Greater than Beneficiaries' Rate by
Transfer 62 122 or 18% 24% or 30% Total
0 260 160 14 434
20 424 99 32 555
40 215 61 34 310
50 595 420 58 1,073
60 44 69 5 118
80 42 57 6 105
100 __2_22 1.9.5.6. 931 23.8.9;
Total L199 .2_a_5_29. 349.82 L299.

 

 

 

 

spouse's rate of return is greater than the beneficiaries'
rate yields results very similar to those in Table 2-III B.
Therefore, a detailed listing of the results is not
included.

Referring back to Table 2-III, it appears more accu-
rate to replace the existing rule—Of—thumb with three
more specific rules as follows:

1. If the spouse's rate of return is less than

or equal to the other beneficiaries' and

his(her) estate is greater than or equal to

43
the decedent's estate, no qualifying transfer
should be made to the spouse.

2. For those cases in which the decedent's
estate is larger, transfer between 0% and 40%
if the spouse's rate is less than the other
beneficiaries'; and transfer between 0% and
50% if the spouse's rate equals the other
beneficiaries'. In most cases, zero would
still be the optimal size Of the transfer.

3. If the spouse's rate is greater than the bene-
ficiaries', the Optimal has to be determined

independently for each case.

Effects of Spouse's Remaining Life

Table 2-IV gives a breakdown of the Optimal decisions
1Dythe surviving spouse's remaining life. One would ex-
Pmnzthat the Optimal decision would be to transfer a sub-
suuuial portion, if not all of the decedent's estate, to
the spouse if his (her) remaining life was ten years or
less, especially if it were only one year. This expecta-
thx1is based on the feeling that the credit on prior
taxed transfers would reduce all double taxation to zero.
Axeview of Table 2—IV indicates that the expectation is

mnzvalid. In only 52 (29 + 11 + 12) out Of 3,600 cases

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44

 

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Oman unmouom

 

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>HIN NHQ<H

45
where the remaining life was one year, would you transfer
more than 50%. An evaluation of these 52 cases indicates
that in all but 5 of them the Spouse's rate of return
exceeded the other beneficiaries' rates by either 24% or
30%. In the other 5 cases the difference was at least 12%.
It, therefore, appears that the credit on prior taxed
transfers does not completely reduce double taxation. In
fact, it takes an abnormally large difference in the rates
to Offset the additional tax which is due because the
transferred amounts are included in two gross estates.
The reason that the credit does not completely reduce
double taxation is that the actual credit is the lower
Of either the additional tax in the current estate or a
Portion of the tax of the prior estate. Therefore, only
a minimum credit is available for use. Also, considering
that in almost 2/3 of the cases where the remaining life
“as one year the Optimal decision was to transfer zero
to the spouse, most decedents should include in their
Mdlls a provision that their spouse must survive them by
atleast six months to qualify for any transfer. Six
mxmhs is suggested rather than one year so that in those
cases in which the surviving spouse's remaining life is
1cmg enough to justify a transfer, the transfer will not

bedisqualified from the marital deduction automatically.

....

 

 

 

46
(See the previous discussion of the law on page 16 for
further explanation.)

Another expectation is that as the spouse's remaining
life increases,the number of cases in which the transfer
exceeded 50% would decrease and the number of cases in
which the transfer was 50% or less would increase. This
expectation also is not valid. The reasons are that the
credit on prior taxed transfers does not reduce double
taxation as shown above, and that the earnings on the
amount transferred and the future estate taxes on those
earnings are more important than the credit.

In an attempt to develop a more accurate decision
rule, Table 2-IV was subdivided by relative sizes of the
estates and relative rates of returns within each life.
Analysis of lifes 16, 19, and 22 years pointed out an
interesting observation: the only times that transfers
of 20%, 40%, 50%, 60% and 80% were Optimal were in those
Cases in which the spouse's rate Of return equaled or
mmmeded the beneficiaries' rate of return by only 6%.

Therefore, it can be concluded:

1. Unless the rates of return are within the very

narrow range of 6%, transfer either zero or
one hundred percent to the surviving spouse.

2. Use a zero transfer if the beneficiaries' rate

47
of return exceeds the spouse's; and
3. Use one hundred percent when the spouse's

rate is larger.

Cost Of Under or Over Qualifying

Because of all the trouble which formula clauses have
caused in attempting not to over— or underfund the marital
transfer, further analyses were performed on the 2,876
cases where the optimal decision was to transfer 50% to
the surviving spouse. The computer program was rerun for
these cases with the modification that the amount to be
received by the other beneficiaries was calculated for
transfers of 45%, 50% and 55%.to the spouse. The amounts
received with transfers of 45% and 55% were then compared
with the result assuming a 50% transfer and the difference
in receipts was printed. The results are presented in
Table 2-V. The analysis indicates certain points. First,
Of the 2,876 cases tested, it turned out that in 241 of
them, the Optimal decision was either 45% or 55%——not
fifty. Because the percent transferred to the spouse
increased by relatively large fixed amounts (either 10%
cm 20%), any case in which the actual Optimal percent was
Immween two that were used was included as Optimal under

avmong percent. This is what happened on those 241 cases.

 

48

TABLE 2-V

ADDITIONAL TAX COST OF TRANSFERRING EITHER
45% OR 55% WHEN THE OPTIMAL WAS 50%

 

\

___ Cost ($) Under—Qualifying Over-Qualifying

Atleast Not more than Transfer of 45% Transfer Of 55%
1 2,000 415 265
2,001 4,000 305 320
4,001 6,000 213 220
6,001 8,000 170 170
8,001 10,000 141 130
10,001 12,000 98 104
12,001 14,000 114 85
14,001 16,000 89 77
16,001 18,000 86 82
18.001 20,000 76 65
20,001 22,000 72 56
22,001 24,000 55 48
24,001 26,000 62 51
26.001 28,000 45 35
28.001 30,000 44 31
30.001 32,000 49 38
32.001 34,000 35 37
34.001 36,000 20 35
36.001 38,000 35 30
38.001 40,000 39 27
40,001 42,000 29 42
42.001 44,000 23 18
44.001 46,000 29 20
46.001 48,000 26 34
48.001 50,000 21 26
50.001 and other _fl ___5_8_9
TOtals géggg £522;

 

. 4 fibril .al

 

49
Therefore, the results presented earlier in this chapter
cwerstate the number of cases where 50% would be the
(mmimal. This further invalidates the general "rule-of—
thumb" of giving 50% to the spouse.

The second point relates to the overall cost of
over- and under—qualifying. Although the additional tax
cost in some cases exceeded $210,000, in most cases, it
was much less. The median cost of under-qualification
turns out to be $13,000; the median cost of over-qualifi-
cation turns out to be $17,000. Therefore, in over l/2
the cases, the cost was under about $15,000. When this
is compared to the size of the decedent's and spouse's
estate, which ranged from $200,000 to $2 million, it
appears that the cost of under— or over-qualifying may
‘be less than the cost of avoiding them, especially if it
Hmans running the risk of having the whole transfer dis—
qualified for the marital deduction.

The final point concerns whether it is better to
Over— or under-qualify when you cannot transfer exactly
50%. The median tends to indicate that it is better to
\Hmer-qualify the marital transfer. This is reinforced
EW’comparing the means, which turn out to be $24,555.22

flu under-qualifying and $37,453.89 for over-qualifying.

lflthough each case should be evaluated independently, on

 
 

 

 

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50
the average, it is better to under—qualify than over—

qualify.

mummry

The general rule-of-thumb for determining the Optimal
transfer to the surviving spouse was to transfer exactly
50% except if the spouse's estate was large. The simula—
tion model disproves this general rule.

In place of the previous rule, a more accurate rule
can‘be stated either in terms of rates of return or the
spouse's remaining life after decedent's death. In terms
Of rates it is:

1. If the spouse's rate of return is less than

or equal to the other beneficiaries' and
his(her) estate is greater than or equal to
the decedent's estate, no qualifying transfer
should be made.

2. For those cases in which the decedent's estate
is larger, transfer between 0% and 40% if the
spouse's rate is less than and between 0% and
50% if the spouse's rate equals the other
beneficiaries'. In most cases zero will be

the Optimal size of the transfer.

3. If the spouse's rate is greater than the other
beneficiaries', the Optimal has to be deter-
mined independently for each case.

The individual decision can be determined by rerunning
the computer programs develOped for this study specifying
13m exact variables in the case.

In terms of the surviving spouse's remaining life

 

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51
the new rule is:

1. In most cases, the transfer should be zero,
unless the surviving spouse outlives the
decedent by more than 6 months.

2. If the remaining life is sixteen years or more:
a) transfer zero if the spouse's rate is less

than the other beneficiaries',
b) transfer 100% if the spouse's rate exceeds
the other beneficiaries' rates.

The model analyzed the cost of under- or over—
qualifying the marital deduction. In many cases, the
additional tax cost of under— or over-qualifying was less
than the cost of transferring the exact amount. In addi-
tion, if there is a choice between over“ or under-
qualifying it would appear that under—qualifying is better.

In addition to testing the general rule, this study

indicates that the credit for prior taxed transfers does

not completely reduce double taxation.

CHAPTER 3

GIFTS IN CONTEMPLATION OF DEATH

It has long been recognized that the making of gifts
could substantially increase the amount of the planner's
total estate which the beneficiaries would receive (through
bOth gifts and death transfers) because of the different
rate structures in the gift and estate taxes. It was for
this exact reason that the gifts in contemplation of death
Section was added to the law. The general rule-of-thumb
is that (1) gifts should be made so that they are not con—
sidered to have been made in contemplation of death when-
ever possible, and (2) in those cases in which the gift
Vfill be ruled to have been made in contemplation Of death,
there is a possible estate tax savings because the dollars
amended for the gift tax paid are not included in the
gross estate.

The discussion Of gifts in contemplation of death
Vfill proceed in the same general format as the previous
<nmpter. First, will be a discussion Of the law. This
Wtu.be followed by a discussion of the use of such gifts

52

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53
in practice. Next, a simulation model develOped to test
the general rule-Of-thumb will be discussed. This will

1m followed by an analysis and summary of the results.

1533 Relating To Gifts In Contemplation Of Death
Gift Tax

In conjunction with the estate tax there is a gift
tax on transfers made during one's life. Between the two
taxes, all transfers not made for full consideration will
be taxed unless they qualify for special exception. The
gift tax rates run from 2 1/4% to 57 3/4%.Of the taxable
gift.1 The 2 l/4%.rate is levied against taxable gifts
of $5,000 or less while the 57 3/4%.rate is levied
against taxable gifts over $10,000,000. An examination
of these rates reveals that they are exactly 3/4 of the
estate tax rates. One of the recent reforms in the gift
tax law is that this tax is now imposed on a quarterly
tfieis and a return must be filed for each quarter in
which there are taxable gifts.

Section 2503 defines taxable gifts as all gifts less
the deductions provided in sections 2521-2524. These

gifts are to be valued at their fair market value at the

\

lI.R.C. 52502

3
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54
date of the gift minus any consideration received for the
prOperty.2 Excluded from the taxable gifts is the first
$3,000 worth of prOperty transferred to a donee per year.3
'nua exclusion is per donee; therefore it could equal a
umximum of $3,000 times the number of donees who receive
spits during the calendar year. In the case of a husband
and wife, each could transfer prOperty to a donee and
(flaim the $3,000 exclusion. The law specifically provides
that if the husband and wife consent, they can treat all
gifts made during the calendar quarter as being made 1/2
by each one regardless of who actually transferred the
Property.4 Therefore a couple can exclude up to $6,000
per donee.

In addition to the $3,000 exclusion, taxable gifts
are reduced by a specific exemption. Every citizen and
resident is entitled to transfer $30,000 of prOperty free

5

0f tax during his/her lifetime. This exemption is used

UP only after the amounts of the gifts have been reduced

tWthe appropriate amounts of the annual $3,000 exclusion.

\-

2I.R.c. 52512

31.R.c. §2503(b)

41.12.0. §2503(a)

5I.R.C. 52521

 

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By electing to treat all gifts as made 1/2 by each
spouse, a couple gets an aggregate exemption of $60,000.
The second deduction that is provided for by statute

is for charitable gifts.6

All gifts to charity are
deductible in calculating taxable gifts.7 The organiza-
tions which qualify to receive these tax-free gifts are
13m same ones which qualify an estate to take a charitable
deduction.8

The final deduction permitted in calculating taxable
gifts is the marital deduction. Section 2523(a) provides
that the amount of taxable gifts can be reduced by 1/2
the value of prOperty transferred to the donor's spouse.
This is consistent with the fact that the estate tax
allows a deduction for prOperty transferred to the sur-
Viving spouse but it can not exceed 1/2 the adjusted
gross estate. Similar to the estate tax provision for
the marital deduction, there is no reduction for any

EEOperty where the spouse receives a terminable interest.9

 

 

6I.R.c. 52522

7This is for gift tax purposes only. It has nothing
F0 do with the limitation on charitable deduction for
Income tax purposes.

8These organizations appear to be the same ones

demufibed in 5170 which give rise to an income tax
deduction.

9I.R.c. §2523(b)

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56
inns rule prevents a deduction for prOperty which will
not*ultimately end up in the donee spouse's estate unless

the prOperty is considered a gift by the donee spouse to

a third party .

Section 2035 - Gifts in Contemplation Of Death

Section 2035 states:

The value of the gross estate shall in—
clude the value of all prOperty to the extent
of any interest therein of which the decedent
has at any time made a transfer (except in
case of a bona fide sale for an adequate and
full consideration in money or money's worth),

by trust or otherwise, in contemplation of his
death.10

Therefore, for estate tax purposes only, the prOperty must
be added into the decedent's estate. The section goes on
to state that all transfers during the last three years
Of the decedent's life will be deemed to have been in
Contemplation of death.11 The fact that the decedent
filed a gift tax return and paid the applicable tax will
not defeat this presumption.12

Although section 2035 states it will not apply in
Cases of transfers more than three years before death,

‘—

loI.R.C. 52035 (a)

1
1Ibid.

12Wells vs. U.S. 9 AFTR 1440

12:28:12 cases 'nf‘.

244.111. 9'3“: ‘8:

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57
there are cases where it will. They are associated with
revocable transfers. The law says that if the decedent
makes a transfer in which he retains a general power of
appointment or a right to revoke it and he/she retains
this right at death the value of the prOperty will be

included in the gross estate.13

If the decedent gives

up his right before death, the value Of the prOperty will
rmm.be included in the estate. However, if the revocation
(fifthe right occurs during the last three years of life,
it will be deemed in contemplation of death and the
Property will still be included in the gross estate.l4
Therefore, even if the prOperty was transferred before

the three year period it may come under the contemplation

of death provision.

Section 2012 - Credit for Gift Tax

When the value of the gift in contemplation of death
is included in the gross estate it becomes subject to two
tfixes-the gift tax and the estate tax. To prevent this
dmfifle taxation, section 2012 allows a credit against the

estate tax for the gift tax paid.15 This credit may not

‘K

131.R.c. §2038 and 52041

141.R.c. §2035(b)

l51.R.c. §2012(a)

" 44: e
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58

exceed the gift tax paid and is further limited to a per—
centage of the estate tax due, based on the relationship

Of the value of the gift property to the value of the

gross estate.

USes of Gifts in Estate Planning

Gifts can either be "normal" or "in contemplation of

death." The estate planner must first look at the

'Wmmmal" gifts, then at gifts "in contemplation Of death."

Advantages of Gifts

The question of whether or not gifts save money has

been asked many times before. Usually in answering this,

(1) the gift tax rates are compared with the estate tax
rates, and (2) it is stated that since the gift tax rates
are 3/4 of the estate rates, and since both are progres-

Sive, gifts will save money except when large in compari—

son with the remaining estate. This analysis ignores the

rate of return that can be earned by the donor on the

gifiztax paid. The full analysis was performed by Stone.16

Ifis analysis included the following parameters and

Variables:

h

_ 16Herbert L. Stone, "A Stochastic Dynamic Program-
ming Model for an Estate Planning Decision Process,"
Unmflflished doctoral dissertation at University Of
Southern California, August 1965.

 

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59
1. size of estate:
2. previous gifts of donor;
3. number of donees:
4. annual gift exclusions;
5. specific gift exemptions;

6. maximum proportion of capital to be
given away each year;

7. estate tax exemptions and deductions;
8. rate of earnings of donor and donee;
9. income taxes;

10. death taxes;

11. gift taxes;

12. provisions for gifts in contemplation of
death; and

13. marital status as it affects the above items.
The conclusion of the study was that in most cases a
series of lifetime gifts will produce an Optimal estate

Plan.

Gifts in Contemplation of Death

After considering gifts in general, the next ques-
thn1to be considered is whether a gift "in contemplation
of death" will be beneficial from an estate planning
Dunn of view. Two authors have discussed this point.

One mentioned that if a gift to charity is ruled in

60
contemplation of death it increases the estate tax marital
deduction without increasing the estate tax.17 The value
of the gift in this case would be added to the gross
estate, which would increase both the adjusted gross
estate, and the amount that can be transferred to the sur—
viving Spouse free of tax under the marital deduction. At
the same time, the taxable estate is reduced by the value
of the gift since it is to a charitable organization.
This will reduce the actual size Of the estate and the
tax due. This, of course, will only be beneficial if the
decedent has provided for a maximum marital deduction
transfer to a surviving spouse. For example, assume that
decedent's estate is $1,000,000 and he wills 1/2 of
adjusted gross estate to his Spouse. The estate would be
entitled to a marital deduction of $500,000 and have a
taxable estate of $440,000 ($500,000 - $60,000) . If, on
the other hand, he had made a $200,000 gift to charity
ruled in contemplation of death, the adjusted gross
Getate would be $1,200,000. This would entitle the
estate to a $600,000 marital deduction and a $200,000
Charitable deduction. The resulting taxable estate would

“

. ”Irving Evall, "'Hidden' Estate Tax-Saving Tech-
IncIues Can Be Found in Interplay of Tax Law," The Journal.
W, November 1963, p. 284.

 

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61
be $340,000. Note the gift to charity in contemplation
of death reduced the taxable estate by $100,000.

The second author suggested that, because of the
omission of the dollars spent for the gift tax paid from
the decedent's gross estate, there may be a tax saving.l8
By adding back to the estate the value of the gift, but
not the amount of the tax, the gift in fact has reduced
the size of the estate tax due. In addition, the gift
tax paid is allowed as a credit against the estate tax
due. These in combination account for the tax saving.

Although he indicates there may be an advantage to
gifts in contemplation of death, he does not try to
define in which cases it will appear. He also ignores
certain important variables such as possible rates of
return. When you include all the variables, the question
Of the benefit of gifts in contemplation of death has two
related parts. The first part is at what point does the
amount of the gift tax exceed the reduction in the estate
tax. The second part is at what point will the rate of
return that could be earned on the gift tax exceed the
amount of reduction in the estate tax. This current

study includes consideration Of both parts of the question

 

1802. cit., Yohlin, p. 47.

 

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62

in an attempt to determine the range of benefit of gifts

in contemplation of death.

The Simulation Model

 

From the previous discussion on uses of gifts in
contemplation of death, it appears that there is an
advantage in making them, because only the amount of the
gift is added into the gross estate, not the gift plus
tax paid. In this study a simulation model was constructed
which tested this rule over a wide variety of cases in an
attempt to determine more precisely the cases in which

these gifts are advantageous and to what extent.

Variables

In studying the question of whether or not to make
gifts that will be considered in contemplation of death,
many factors should be taken into consideration. The
following quantitative factors were considered the most
important and therefore were included:

1. type of prOperty;

2. rate of return;

3. size of decedent's estate:

4. past cumulative gifts by decedent;

5. current gifts in contemplation of death; and

6. remaining life of planner after gift.

'5': types 3:
me meter: 5

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63

Type of Pr0perty

Two types of property were considered. They were non-
income producing and income producing. The former, here—
after referred to as type 1 prOperty, does not earn a
rate of return. This group would include antiques, stamp
and coin collections, paintings, etc. Although these items
may increase in value, they do not provide the owner with
a set and separable income. The latter, hereafter referred
to as type 2 prOperty, does earn a set rate of return.

Rate of Return

Although type 2 gifts would yield the same before-
tax rate of return to the donor or donee, the after-tax
return would vary depending on the donor's and donee's
tax brackets. The donee's after—tax return was set at
6%. ,The donor's returns were 6%, 4%%, and 7%% to cover
those situations where his tax bracket equaled the
donee's, was twenty-five percent more and twenty-five
percent less.

For type 1 gifts, the only rate that had to be
Specified was the rate that the donor could have earned
(Mlthe amount of the gift tax paid. To provide the max—
hmmnamount of information, the model varied the rate

among 445%, 6%, and 78%.

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64

Size of Decedent's Estate

This was varied over the range of $200,000 to
$2,000,000 by increments of $100,000. This is the same
range as the one used for the marital deduction in
(flmpter 2. The only difference is that the increment is
$100,000 rather than $200,000. A smaller increment was
tmed to provide more information.

Past Cumulative Gifts

Past cumulative gifts were included because the gift
tax is a progressive cumulative tax with current gifts
being taxed at the highest rate applicable. The amount
of the cumulative gifts was varied over the range of $0
to $500,000 by increments of $50,000. This range was
selected to include individuals who were not in the
habit of making gifts as well as ones who were. There is
Cme additional assumption. In all cases, even those where
the cumulative gifts were zero, the $30,000 specific
eXemption has already been used up. In other words,
Fast cumulative gifts were past taxable cumulative gifts.
The assumption that the specific exemption has been used
1m>was included for simplicity only. It really does not
affect the results. To get the actual total amount of
Imst gifts, add $30,000 to the cumulative gifts as stated.

fiJbe even more accurate, add an additional $3,000 per

 
 

-.
~-

 

 

:-

 
 

‘vl

 

65

year per donee to this amount to account for the exclusion
allowed by statute.

Current gifts

The model includes current gifts only in the amount
that was transferred in contemplation of death. The range
MES from $50,000 to 80%,of decedent's estate before the
gift. The increment was by $50,000. Fifty thousand dollars
has selected as the starting point and incremental value
to allow the numbers to be significant without an exces-
sive number of cases. Eighty percent was selected as the
upper limit for two reasons. First, in most cases it
leaves the decedent with enough money to pay the gift tax
that is due. Second, it recognizes that most peOple will
not give away their entire estate while alive even if they
know they are dying. One additional limitation was placed
on the range. In no case could the sum of the gift and
the gift tax be larger than decedent's estate. This
eliminated the net gift circumstances (where the donee pays
the gift tax) and the additional computations it would
require without restricting the conclusions that can be
<hmwn from this study. The model assumes only one donee.

Remaining Life of Planner

This was included to compute the interest that could

}mve been earned on the amount of the gift tax paid. If

 

 

 

...!

 
 

 

 

66
the gift were not made, no tax would be due until after
the planner's death. Therefore, to determine if there is
a benefit in making gifts in contemplation of death, the
estate tax savings must be reduced by the interest fore—
gone. The range was one to three years, varied by one.
The range is dictated by statute since it says that no
gift made more than three years before death will be con—
sidered made in contemplation of death. One year incre-
ments were selected to simplify the interest calculation.
To have selected a shorter period would have required
additional assumptions, such as how often is the rate of

return compounded, how much is forfeited because the in-

vestment is not held to term, etc.

Methodology

The simulation model was programmed on an IBM 360
°°mputer in the Fortran language. Chart 3-I is an overall
flow chart of the program. The simulation proceeded as
follows: The property was set at type 1. The rate of
return was set at 6%. The size of decedent's estate was
Set at $200,000. Cumulative gifts were set at $0. The
size of the gift was set at $50,000. Decedent‘s life
after the gift was initially set at one year. The gift

tax that the decedent would have to pay was then

67

CHART 3-I

FLOW CHART FOR GIFTS IN CONTEMPLATION OF DEATH

 

Igary Type of Property type lgznon—incomej or type 2 (income)

 

Egry Rate of Return (ROR)

62, 782, 582 4]*———“—* '

 

Wary Size of Decedent's Estate TOE)

 

 

 

 

 

 

 

 

 

 

 

[igpx Past Cumulative Gifts (CCIFT) o-soo,ooo by 50,990 ]<+———T
fiflgy'Current Gift (GIFT) 50,000-801 x DE by 50,000 ]+-—
[yaryiDecedenth Remaining Life (LIFETV 1-3 by_lg r”
[Qalculate Gift Tax 4]
[gema1n1q5:§g;ace (DEl) - DE-GIFT—GIFT TAX ]
[Ealgulate Estate Tax on DE - GIFT TAX AJ

 

Type 1

 

Receipt by Benef. (SUM) - GIFT +l
DEl - ESTATE TAX

Decedent's Estate - No Gift (D82)
I - DE + (303 x GIFT TAX) I

[Calculate Estate Tax qgfiDEZ ##J

 

 

gr

Efceipt - No Gift (ALT) - 022 -]
ESTATE TAX

 

4T—
l§avings by GIFT - SUM T ALT I

 

”1k Type 2

200J 000-2 L900, 000 by 100,00Q*—"

 

 

 

]<——-—-———-

 

 

 

 

.ls\\\{::::::;//' ”‘1
lReceipt by Benef. (SUM) - [GIFT* (l + .06)*

LIFE1_+ DEl - ESTATE TAX

1

 

Decedent's Estate — No Gift (0E2) - DE +

[GIFT + GIFT Tiglttgpa
I

I

 

[Ealculate Estate Tax on DEZ

J

 

lReceipt - no GIFT (ALT) - DEZ - ESTATE TAX ]

 

LT

 

Savin s b GIFT - SUH - A
[l.l_JE;'5g'_,

‘RINT SAVINGS

 

 

 

/-..
N
\

ski

 

 

 

 

 

 

 

 

law 9

STOP

 
 

l‘.¥1

.E'

‘i-

 
 
 

68

calculated. The size of the remaining estate was calcu—
lated by subtracting the gift and gift tax paid. The
estate tax was calculated on the federal taxable estate.
The appropriate credit was allowed for the gift tax. The
remainder of the estate after paying the estate tax was
added to the value of the gift. The size of the estate,
if the gift was not made, was then computed by adding the
donor's after-tax return on the gift tax to the estate.
The estate tax was calculated for the size of the estate
just computed. The remainder of the estate after sub-
tracting the tax was compared to the amount that the
donee received if the gift was made. The difference
between those two amounts was printed. The remaining
life of the decedent was increased by one and then all
the calculations were redone. After the decedent's
remaining life equalled three, the other variables were
increased in turn. After this was completed, the prOperty

was set at type 2 and all the calculations were redone.

Limitations

There are three major limitations to this study.
The first one is that only gifts of prOperty are con-
sidered. This is not a very severe limitation because

most actual cases have to do with transfers of prOperty

    
 

- Q

0'.» I b. .\ y.I-“\ v

\:---€§ s-ufini hv‘Es
s

.‘ s
\ '* fifiwfl
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a
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. I
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.
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69
rather than powers of appointment.19

The second limitation is that only three possible
rates of return were considered in order to restrict the
number of different cases that were being studied.
Although it is unlikely that an actual case would have
the exact rates of return used, it is hOped that there
is a sufficient number of Observations to permit conclu-
sions on the effect of including a rate of return.

The final limitation is that only the gift and/or
the gift tax earns a rate of return. In other words,
the decedent consumes all, but no more than, the income
earned on the residual estate. This is the same limita—
tion as was included in the study on the marital deduc-

tion. The reasoning for its inclusion is the same.20

Results

In total, 33,462 cases were generated. One-half,
c>r'l6,731, concerned type 1 gifts, gifts that do not earn
arate of return while the other half concerned type 2

Sfifts. Table 3-I presents a breakdown of the cases by

19A power of appointment gives the recipient of the
FWWer the right to determine who shall receive the income
ahd/or prOperty subject to the power.

2OSee Chapter 2 pages 32—34.

2‘16 a" 226‘ ' e:

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70

type and whether or not the gift was a beneficial estate
planning device. In the large majority of cases, a
deliberate gift in contemplation of death was beneficial.
This was true for the gifts that earned a rate of return
as well as those which did not. Rather than analyze the
32,942 cases in which the gift was beneficial and list
all the situations in which they occurred, it was decided
to analyze just the 520 cases in which the gifts were not
beneficial to determine under what limited situations
gifts in contemplation of death should not be made.

TABLE 3-I

BREAKDOWN OF CASES BY TYPE OF PROPERTY
AND PLANNING RESULT

—__1

Number of Cases

 

 

3P" °f Gift Gift Not
Operty Advantageous Advantageous Total
1- Non Income Producing 16,372 359 16,731
2- Income Producing 16,570 161 16,731
Total 32!942 520 33,462

 

Table 3-II presents a breakdown by the planner's

remaining life and the planner's rate of return of the

359 cases of type 1 prOperty in which the gift was dis-

advantageous .

Table 3-III presents a breakdown by the

Planner's remaining life and the planner's rate of return

71

of the 161 cases of type 2 prOperty in which the gift was

disadvantageous.

TABLE 3-II

TYPE 1 GIFTS (NON INCOME PRODUCING) THAT WERE DISADVANTAGEOUS
BREAKDOWN BY PLANNER'S REMAINING LIFE AND RATE OF RETURN

 

 

 

 

 

 

 

Planner's Planner's Rate of Return
Remaining Life 62 782 48% Total
1 year 30 32 30 92
2 years 38 43 35 116
3 years 48 64 39 l§l_
Total 116 139 104 .352
TABLE 3-III
TYPE 2 GIFTS (INCOME PRODUCING) THAT WERE DISADVANTAGEOUS
BREAKDOWN BY PLANNER'S REMAINING LIFE AND RATE OF RETURN
Remaining Rate of Return
Life 61 732 482 Total
1 25 29 15 69
2 16 30 2 48
3 .12 2‘; _9_ _44
Total 51 93 17 161

 

A comparison of the two tables points out three
things. First, if the gift earns a rate of return, it is

more likely to be advantageous to give it away. Numeri-

oath“ there are less than one-half the number Of

It;

III
.II

 

'zv'.
.m,

 

 

 

 

I
“I
1

 

 

72

disadvantageous cases in Table 3-II as there are in Table
3-III. This can be explained by the fact that any accumu-
1ated income the gift earns will be exempt from the estate
tax even if it is ruled a gift in contemplation of death,
because only the value of the actual gift property is in—
cluded in the decedent's estate. The income earned between
date of gift and date of death is not included. Therefore,
the estate tax reduces the after-tax rate of return of the

decedent in relation to the beneficiary's rate of return.

Remaining Life

The second point has to do with the remaining life
of the decedent after the gift. Table 3-II indicates that
the longer the decedent lives, the more likely it is that
the gift will be disadvantageous. Table 3-III indicates
the opposite. Again, this can be explained by the tax
savings on the income earned on the gift prOperty. There—
fore, the decedent's remaining life expectancy should
dictate whether to give income or non-income producing
PrOperty away as the gift. In other words, if the
Planner's life expectancy is at least two years, he can
rEduce the chance that the gift will be disadvantageous

by giving away income producing prOperty.

73
Rate of Return

The third point that is indicated by both is that
the difference between the after-tax rate of return of the
decedent and the beneficiary is an important consideration.
In Tables 3-II and 3-III whan a 7%% rate was used, the
highest number of disadvantageous cases occurred. It is
reasonable to assume that rate of return would be more
important in the type 2 gift situations because the gift
as well as the gift tax has a rate of return. A compari—
son of the tables confirms the assumption.

A further review of Table 3—III indicates there are
more disadvantageous cases in the third year than in the
second year when the rate of return was 7%%. This is a
contradiction to the second observation about the remain-
ing life. The explanation is that the additional return
that the beneficiary receives offsets the additional
estate tax. The use of only three different rates of
return does not permit an exact statement as to how much
the rates have to differ before it is significant. It
does indicate that it is an important variable which can

offset some of the other benefits to gifts of property.

 

 

 

 

74
Size of Estate

Tables 3-II and 3—III do not provide the entire pic-
ture. To complete it, an analysis was made of the cases
in which a loss occurred due to the gifts. From this
analysis, several facts became apparent. First, in only
three cases was the decedent's estate as large as $400,000.
In all other cases the estate was either $200,000 or
$300,000. Those three cases occurred during the simula-
tion of type 1 gifts with a 7%% rate of return.

The next two points concern the sum of the past cumu-
lative gifts and current gifts. The first point is that,
the sum of the current and cumulative gifts is at least
$100,000. The other and more important point is that in
only three cases are the sums less than the remaining
estate. In four cases, the sum equals the remaining
estate, and in all others the sum is greater than the
remaining estate. It appears, therefore, that gifts in
contemplation of death will be advantageous in most cases.
In fact, the only time they will not be is if the original
estate is relatively small and the sum of all gifts has
reduced the original estate to a small fraction of what

it was.

75

Cost of Gift Ruled In Contemplation

A review of current tax cases indicates that there is
still substantial disagreement and confusion concerning
vmether a gift was in contemplation of death or not. Be-
cmuse of this, one more computer run was analyzed. The
run was designed to determine the additional tax liability
if a gift was considered in contemplation of death as
Imposed to the tax if it was not so considered. The
range of the decedent's estate, past cumulative gifts and
cmrrent gifts were the same as past runs. The estate tax
Ems computed with the value of the gift included and then
excluded from the taxable estate. The difference was then
Eminted. The additional tax ranged from $2,000 to $11,500.
The mean cost was $35,641.20 and the median cost was
$31,500. Next, the additional tax was measured as a per—
cent of the original estate. The original estate is
defined as the estate before the questioned gift and gift
tax is subtracted. From the results presented in Table
3“IV, a question arises whether the cost of a court suit
is justified by the tax savings. This is especially true
in those cases in which an acceptance of the presumption
"in contemplation of death" will be used to bargain for

another question to be settled in the taxpayer's favor.

76

TABLE 3—IV

ADDITIONAL TAX COST AS A PERCENT OF THE ORIGINAL ESTATE
IF GIFT CONSIDERED "IN CONTEMPLATION OF DEATH"

 

 

 

 

 

 

Percent of Original Z of
Estate at least But less than Number of Cases Total
0 1 156 8
1 2 337 18
2 3 378 20
3 4 516 28
4 5 369 20
5 6 87 5
6 7 16 __;L
Total 1L§59 100%
Summary

The original rule—of-thumb was that gifts in contem-
Plation of death would reduce the total tax paid. An
Overwhelming majority of the cases verified this rule-of-
thUmb. The only time this rule did not hold was when the
decedent's estate was relatively small and sizeable gifts
hhd'been made in the past.

The model also indicated that the possible earnings
OTithe gift and the relationship between the planner's
tax'bracket and the beneficiaries' tax brackets were very

iJrlportant. The income tax consequences of the gift can

'z'e::ide :‘e 95‘

 

. ‘ I
I b h
‘3'0‘2' e
_,....U. I "‘

o ‘ ' a -‘
.-.-~Aavafl ‘ . .
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|
I... ;. ‘ v
...e Senna- :

at; ::,:-.;fl"\a1 '
e... ‘ua..bv-A e ‘

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fray-b“ '

...“... S 85:31

 

.t J‘- ‘J’ “‘”
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77
override the estate tax benefits from making the gift.
Therefore, the income tax effect of the transfer must be
considered in addition to the estate tax effects.

The final point that the model illustrated is that
the additional tax cost of a gift being ruled in contem—
plation of death is small relative to the size of
decedent's estate. This raises the question of whether

the cost of fighting the presumption is justified by the

potential tax savings.

'u-I

CHAPTER 4

TRANSFERS TO AN IRREVOCABLE, SIMPLE TRUST

The final pre-death planning device which will be
considered is that of transfers to an irrevocable simple
trust. Many authors have discussed the advantages and
disadvantages of the use of trusts and the different
types of trusts. Although they mention the tax benefit,
quantification of the minimum size of the trust and how
the other variables affect the minimum size has been
(matted from the literature. This study will try to
determine more specific rules to guide when trusts should
he set up and when it would be more beneficial not to set
up trusts.

There are several terms which should be defined at
the outset. The following definitions will be used,
throughout the chapter:

Simple trust - a trust which is required to

distribute all of its income currently. In

addition it does not make charitable contri-
butions or distributions other than income.1

1Regu1ation §l.651(a)—l

78

 

”A”. §

VJuboex tr‘,
f:‘ S‘ft‘hg.o
“e -. .A- ..

makes a c

Other the

367°C ‘59 9
dissal"e

 

 

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.::EIOC32 -E

Cd!) CCt C

ash“;
'
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v
iriter .l'i'a'hc
'.~ :

c‘_°“—n

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Q
«esta:.eh ear!

 

C)

0
ll"

79

Complex trust — a trust which is not required to
distribute all of its income currently or
makes a charitable contribution or distribution
other than income.

Revocable trust - a trust which the grantor can
dissolve and therefore can reacquire the
property.

Irrevocable trust — a trust which the grantor
can not dissolve and therefore can not re-

acquire the prOperty.

Inter vivos trust - a trust set up during one's
lifetime.

Testamentary trust - a trust set up after one's
death.

Laws Relating to Taxations of Trusts,
Grantor and Beneficiaries
Income Taxation of Estates and Trusts

Section 641 imposes an income tax on both estates and
trusts.2 The income includes all items regardless of
whether the income is to be held or distributed. In
general, taxable income is computed in the same way for
the trust or estate as it is for an individual. There
are, however, several areas of difference.

Charitable Deduction

Individuals are allowed a charitable deduction for
items transferred during the tax year. The limit on the

ixmal amount of the deduction is based on the type of

¥

2I.R.c. §41(a)

'———1

"WIN trans :

 

"azsierrei.
‘ l
Zfififihers

135:5 and 55:5

   

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-: transfs

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I
l

 

t .... : *
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8O
prOperty transferred and the charity to which it is

transferred. In no case can it exceed fifty percent of

the taXpayer's adjusted gross income. Section 642 allows

trusts and estates to take an unlimited deduction for
prOperty transferred to charitable organizations.3 The
regulations define "transferred" as paid or permanently
set aside for the charitable purpose.4 The amount of
the deduction, however, must be adjusted for tax exempt
income which is included in the transfer. The dollar
amount of the deduction is reduced by the dollar amount
of the tax exempt income included. In determining the
amount of exempt income included, the governing instru-
ment will be followed if it dictates the source of the
transferred prOperty. If it is silent on this point,

the charitable transfer will be assumed to consist of a

percentage of each type of income included in the trust's

or estate's gross income. The percentage is determined

by the ratio of each individual item to the total gross

5

income. If the transfer included capital gains income

there is one further reduction in the deduction. The

3I.R.c. 9642(c)(1)

4Reg. §l.642(c)-1

SReg. §l.165(c)-2

81

deduction has to be reduced by the amount of the 50%
deduction allowed under section 1202.6 Therefore,
although the deduction starts out unlimited, there are
certain specific reductions which must be made.

Personal Exemption

For the tax year 1972, an individual is entitled to
a personal exemption in the amount of $750. He is also
entitled to additional $750 exemptions if he is blind
and/or over 65 years of age. Estates and trusts are only
entitled to one exemption. For an estate it is $600. For
a trust required to distribute all of its income cur-
rently, the deduction is $300. For all other trusts, the
deduction is $100.7 The regulations specifically state
that the $300 exemption is allowed to all trusts which
are required to distribute all income currently, even if
they make other distributions and therefore, do not
qualify as a simple trust.8

Standard Deduction

In computing his taxable income, an individual is

entitled to subtract the standard deduction rather than

 

6Reg. 51.642(c)-2

7I.R.c. 9642(b)

8Reg. §l.642(b)-l

 

a“.

 

 

u.-
0‘
ll-

 

82

his itemized deduction. For tax year 1972, the deduction
is 15%.of adjusted gross income, with a maximum of $2,000.
Estates and trusts are specifically prohibited from taking
the standard deduction.9

Deduction for Distributions

In calculating the taxable income of a trust or
estate, it is allowed a deduction which has no counter-
part on an individual's return. .Both trusts and estates
are considered conduits somewhat similar to partnerships.
In other words part of its income may be taxed to the
beneficiaries and the trust or estate will be allowed a
deduction for the amount of income thus taxed. For
simple trusts, the deduction is the lower of either the
amount of income required to be distributed currently
or the trust's distributable net income.10 Distributable
net income is defined as the trust's taxable income
adjusted as follows:

1. The deduction for personal exemption is
added back.

2. Capital gains are excluded, except if they
are allocated to income, distributed to
the beneficiaries, or used for a charitable
deduction. Capital losses are excluded.

 

gReg. §l.642(i)-l (a)

1°Reg. §l.651(b)-1

83
3. Tax exempt income is excluded after being
reduced for the proper prOportion of ex-
penses and for charitable contribution
which is deductible.

4. The full amount of dividends before the
$100 exclusion are included.11

For complex trusts (all trusts that are not simple trusts)
and estates, the deduction is the lower of either the
distributable net income or the amount of income required
to be distributed currently plus any other amounts actually
paid or disbursed.12 In all cases, the amount of the
deduction does not include any amount that has not been
included in the trust's income.13

Carryovers

Because trusts and estates are considered partial
conduits, a unique situation arises when the trust or
estate is terminated. If in the final year the trust's
or estate's income is positive, the prOblem is very
simple. When the assets are distributed, the full amount
of the distributable net income will also be distributed.

Therefore, the full income will be taxed to the bene-

ficiaries. A question arises if there is an unused net

 

11Reg. §l.643(a)-0-§1.643(a)-7

12Reg. §1.66l(a)-2

l3Reg. §l.651(b)-l and Reg. §1.66l(c)-l

84
Operating and/or capital loss. The question is whether
the beneficiaries can benefit from the losses. The Code
provides that these losses may be carried over to the
beneficiaries succeeding to the prOperty of the trust or

14

estate. The last question that must be asked is, "What

if, in the final yean.the trust or estate has an excess
of deductions over income rather than a net Operating or
capital loss?" If it were an individual, the loss could
not be carried over, and therefore would not produce a
tax'benefit. For trusts and estates, however, the loss
can be carried over on to the succeeding beneficiaries'

tax returns.15

The only restriction is that the loss
can not include the personal exemption or a charitable

deduction.

Income Taxation of Grantor

No discussion of the taxation of trust income would
In complete without at least mentioning the case in which
the income will be taxed to the grantor. The grantor will
he taxed on the income if he is considered the substantial

owner.16 The regulations point out several cases in

‘r

14I.R.c. 5642(h)
15Reg. §l.642(h)-2

16I.R.c. 5671

85

which he will be considered the owner. They are:

1.

If the grantor has a reversionary interest
and ex sets to take possession within ten
years. 7 The major exception to this rule
is if repossession will not take place until
after the death of the income recipient even
if the recipient's life expectancy is less
than ten years:

If the grantor or nonadverse party has
certain powers over the beneficial interest
under the trust such as: a limited power
to distribute corpus; the power to apply
income to support a dependent; the power

to determine the beneficial enjoyment of

a charitable beneficiary, etc.:18

If the grantor benefits from certain admin-
istrative powers such as the power to vote
the stocks held by the trust; 9

If the grantor has the right to revoke the
trust, except if it can not be exercised
for ten years;20 and,

If the grantor has the right to distribute
income to himself or for the benefit of
his spouse.21

Income Taxation of Beneficiaries

Since trusts and estates are conduits, the benefi-

cflaries will be taxed on at least some of the income.

 

17

Reg. §l.673(a)—l

18Reg. 51.674(b)-l

19Reg. §l.67S-l

2OReg. §l.676(b)-l

21Reg. §l.677(a)—l

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86

For simple trusts and estates, the amount of the income
that must be reported is the amount of the distribution.
In no case, however, can that amount exceed the distribu-
table net income of the trust or estate. Along with the
income, any deductions or expenses connected with it are
passed through to the beneficiaries and are deductible by
them. In all cases, the transfer of specific prOperty,
or of a specific sum of money, according to the governing
instrument, will be received tax free by the beneficiary.22
A.specific sum of money may not be payable in more than
three installments, if it is to be tax free.

Distributions from complex trusts are more complicated.

For these, the recipient must make unlimited throWbacks of
the income to the year earned. The actual computation of
the tax can be done either by the long method or the

short-cut (averaging) method. Because of the number of
additional variables which would be necessary to include

complex trusts in this study, they were omitted.

Eatate Planning with Trusts
Revocable Trusts
There are many advantages and disadvantages to using

revocable trusts. Rhoads provides the following partial

22 Reg. Sl.665(a)-d

 

87
list of advantages:23
1. obtains professional management of assets;
2. guarantees the orderly succession of
management of the assets in case the

grantor dies;

3. gives grantor an Opportunity to preview
a testamentary disposition;

4. reduces the administration and legal ex-
pense at death by reducing the probate

estate: and

5. maintains privacy by keeping things out
of the public's eye.

He then lists as a major disadvantage the cost to set up
and run the trust. Two other disadvantages have been

24

suggested by Frielicher. They are:

l. the prOperty is still included in the
federal gross estate; and

2. the income is still taxed to the grantor.
In general the revocable trust provides many benefits; the
major draWback is that it does not provide any income

and/or estate tax advantage.

23Reid M. Rhoads, "The Revocable Trust: A Useful
Estate Planning Tool," The Journal of Accounting,
NOvember 1969, p. 88.

24Morton Freilicher, Estate Planning_Handbook -
lflfih Forms, Englewood Cliffs, Prentice-Hall, 1970,
pp. 172-'3 o

"
...

eve

...

 

88

Irrevocable Trusts

An irrevocable trust has all of the non-tax benefits
of a revocable one plus some tax benefits. There can be
an income tax savings by passing the income to others in
lower tax brackets. If the trust does not distribute all
of its income, or if it distributes it to several benefi-
ciaries, then there can be a tax savings by having the
income taxed to several peOple rather than just the
grantor. The 1969 Tax Reform Act has removed some of the
benefit of the trust retaining some income. The unlimited
throwback rules will defeat any attempt by the trust to
accumulate income until the beneficiary is in a lower tax
bracket by taxing the income as if it were distributed
when earned. This reduces, but does not eliminate, the
income tax advantage.25 There are two major estate tax
benefits. First, the prOperty is not included in the
grantor's estate so the estate tax will be reduced.
Instead though,tthe grantor may be required to pay a gift
tax. Therefore, the total benefit may be less than the

actual estate tax saving. The second benefit is that it

 

25Some advantage may remain if the beneficiary uses
the short-cut method which figures the tax on the average
increase in the previous three year period. Also, the
interest that can be earned on the postponed tax may be
Significant.

 

 

89

is possible to skip generations. To skip generations
means to provide for several generations to benefit from
the trusts income with the prOperty only ending up in the
estate of the last generation. Without some form of
trust, the prOperty would be subject to estate tax every
time it passes from parent to offspring. These tax bene—
fits, however, are only acquired at a price. In this
case, the grantor must give up control of the prOperty.
From the time the trust is set up, the prOperty and its
income are no longer available to the grantor for his

use or enjoyment. Setting up an irrevocable trust is

equivalent to giving the property away for tax purposes.

Inter vivos Trust vs. Testamentary Trust

An inter vivos trust is classified as either revoc-
able or irrevocable and has the advantages and disadvan-
tages listed above for the class to which it belongs. It
has been suggested that one advantage of an inter vivos
trust still in force at death over a testamentary trust
is that since the prOperty does not go through probate, it
26

will be available for the decedent's purposes sooner.

This appears to be true, but any additional cost due to

 

26Edwin H. Corbin, "Living Trusts in Action,"
Egusts and Estates, July 1967, p. 627.

90
the trust which reduces the overall size of the estate
must be weighed against it. Testamentary trusts have all
the non-tax advantages of irrevocable trust. In addition,
they provide the decedent with "control from the grave."27
This means that the decedent can specify how the corpus
and income will be used after his death and be relatively

certain that his desires will be followed. The same is

not always true of outright gifts and bequests.

Funding the Trust

Once it is decided that a trust should be set up, the
question becomes how it should be funded. The grantor
has several Options. He can use either cash or prOperty.
If he decides on prOperty the question then becomes
whether to use prOperty that has appreciated or depreci-
ated in value. If he decides on cash, which assets should
he sell to obtain it? If the trust property is not going
to be included in his estate because the trust was an
irrevocable inter vivos trust, the question is answered
as if the transfer were an outright gift. If the property

will be included because the trust was revocable or

 

27QE;_E£E-o Kalish and Kupfer, p. 488. This is also
true of inter vivos trusts which stay in force after the
decedent's death.

91
testamentary, the following guidelines have been sug-
gested.28 Appreciated prOperty should be used if the
trust is not going to sell it before the grantor's death.
The trust will get the step-up in basis to the value at
death and the capital gain is not taxed. Property that
has declined in value should be sold and the proceeds
transferred. By selling the prOperty the grantor will
be entitled to a deduction for the loss without the trust
receiving a smaller transfer. It could always buy back
the prOperty at a later date if the particular prOperty
is desired.

An attempt to answer the question whether or not a
trust should be set up depends a great deal on the indi—
vidual case. The decision would be easier if the decedent
knew exactly what the dollar effect of the trust would be.
The calculator would have to consider the estate tax,
gift tax, and income tax, as well as the costs of setting
up and running the trust. Since no general rules exist,
this study will attempt to determine in which cases the
setting up of a trust would be advantageous or disadvan—

tageous from a strictly monetary point of view.

28Ibid., p. 490.

92
The Simulation Model
A simulation model was constructed to determine in
which cases irrevocable inter vivos simple trusts should
be set up. The model restricted itself to monetary con-

siderations only.

Variables

In the model there are seven variables. They are:
rate of return, size of decedenttsestate, past cumulative
gifts by the planner, amount of the transfer to the trust,
remaining life of the planner after the transfer, the in-
come tax bracket of the planner, and the income tax
bracket of the beneficiary.

Rate of Return

Rates of five and six percent were used. These rates
were the before-tax rates of return. Two rates were used
to provide information on the effect of a change in the
rate of return.

Size of the Decedent's Estate

This variable has been included to see if there is a
cut off point below which trusts should not be set up. It
was also needed to prOperly calculate the estate tax
savings from having the prOperty excluded from the gross

estate. The range was from $200,000 to $2,000,000, the

93

same range used in the previous parts of this study. The
increment was by $200,000.

Past Cumulative Gifts by the Planner

In the analyses performed, this variable ranged from
$0 to $500,000 by $50,000. The range was set to allow in-
clusion of cases in which the decedent had engaged in a
practice of making gifts as well as the cases in which he
had not. The variable is necessary to permit the proper
calculation of the gift tax due because of the transfer.

Amount of Transfer to the Trust

The range studied was from $50,000 to the lower of
either eighty percent of the estate before the transfer
or $500,000. The selection of $50,000 as the starting
point was more or less arbitrary. Although trusts could
be established with less, it was felt that this amount
was small enough to cover most actual cases, without being
too small for any income tax savings to be noticeable.
Eighty percent was selected as one upper limit because it
would be unrealistic to assume that the decedent would
irrevocably give away all of his prOperty. Five hundred
thousand was selected as the other limit because a trust
with a larger amount prObably would have several benefi-
ciaries rather than just one. In addition, a decedent

who wished to transfer more than that amount would

 

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94

prObably consider setting up multiple trusts. One addi—
tional limitation was placed on the size of the transfer.
In no case was the gift allowed to get so large that the
sum of the gift and the gift tax exceeded the decedent's
estate. Again, it appeared unreasonable to consider a
decedent leaving himself without any prOperty.

Tax Brackets of Planner and Beneficiary

The range of both variables was from zero to sixty
percent by increments of twenty percent. They were set up
to permit the three possibilities — the planner's tax
bracket being greater than, equal to, and less than the
beneficiary's. It was also intended to cover almost the
full range of possible effective tax rates. It is
possible, but not frequent, that an individual is in the
seventy percent bracket.

Remaining Life of the Planner after the Transfer

The range was from four to twenty years by four.
Four was selected as the starting point to eliminate the
question of gifts in contemplation of death.29 Twenty
was selected as the upper limit to permit a reasonably
long life without increasing the number of cases un-

necessarily. It is possible for the decedent to live

29See Chapter 3.

 

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95
thirty or forty years after establishing the trust, but
it would require the decedent to have an extremely long
life or to have acquired his estate at a very early age.
Therefore, to cover a majority of cases, twenty was

selected.

Methodology

The simulation model was programmed on an IBM 360
computer in the Fortran language. Chart 4-I is a flow
chart of this model. The simulation proceeded as follows:
The rate of return was set at 5%w The decedent's estate
was set at $200,000. Past cumulative gifts were set at
$0. The transfer to the trust was set at $50,000. The
decedent's income tax bracket was set at 0%. The benefi—
ciary's tax bracket was set at 0%. The decedent's remain—
ing life was set at 4 years. The total amount the bene-
ficiary received if the trust was set up was calculated
next. It consisted of three parts. The first part was
the trust corpus which the beneficiary would receive at
the decedent's death. The trust corpus was the amount of
the transfer minus $1,000 for setting up the trust and
for other related expenses. The second part was the
annuity of the trust income which was distributed to the

beneficiary annually. This amount was reduced by a 5%

 

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96

CHART 4-I

FLOW CHART FOR SIMPLE INTER VIVOS TRUSTS

 

 

IVary Rate of Return (ROR) 52 or 6%

I

 

Ubty Decedent's Estate (DE)20000%—2000000 by 200000

 

 

[Vary Past Cumulative Glgts (CGIFT) 0-500000 by 50000

 

Vary Current Transfer to Trusts (GIFT) 50000, to the
lower of (802 x DE) or 500000 by 50000

 

 

 

(vary Decedent's Tax Bracket (DTAX) 0-60 by 20
J

IVAryBeneficiary's Tax BrackeETKBTAX) 0—60 by 20

r I
EBay Decedent's Remaining;Life (DLETE) 4-20 hy,4

ITHfiT‘fi-Hd'flr

 

iCorpus of Trust (T) - Gift - 1000 i:]
Sum of Income from Trust (1) - Sum value of interestohl
trust reduced by a 52 fiduciary fee and beneficiary's
tax rate reinvested at beneficiaryfs after-tax rate

 

 

Remainder of Estate (DEl) - DE-GIFT—gift tax + interest
-lOZ administration expense - estate tax

 

 

 

__-

[Receipt if Trust (R1) - T + I + DEII j

Receipt if no Trust (R2) - DE + interest - 10% admin-
istration expense - estate tax
I -

(Print R1 - R2 I

 

 

 

 

 

 

 

 

 

 

 

 

 

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97
trustee fee and by the income taxes the beneficiary had
to pay. The third part was the remainder of the decedent's
estate. The decedent's estate was first reduced by the
amount of the gift and the gift tax. To the remainder,
interest was added at the stated rate of return which was
reduced by the amount of the administration costs, which
were estimated at ten percent of the estate. The interest
was reduced by the income tax due on this amount. Finally
the estate was reduced by the estate tax. The total
amount received by the beneficiary was then compared to
the amount that would be received if the trust was not
set up. This consisted of the original estate increased
by the appropriate amount of interest and reduced by the
administration expense and the estate tax. The difference
was then printed. After that, the decedent's life was
increased and the calculations were repeated. In turn,

each variable was increased through its range.

Limitations

There are several limitations in this model. The
first one is that only simple, irrevocable trusts were
considered. The trusts were made irrevocable to include
in the study the income and estate tax benefits that are

available only to these trusts. They were all simple

 

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98

trusts to minimize the calculations involved in deter-
mining the sum value of the income distributions. With
the unlimited throwback rules (see page 88), there is no
longer a benefit in letting the trust accumulate the in—
come. This limitation, therefore, simplified the calcu-
lations without restricting the conclusions that can be
drawn from the study.

The second limitation is that all of the administra—
tion expenses were deducted on the estate tax return

30 This

rather than on the estate's income tax return.
was done for simplicity. Without this, other assumptions
would have to be made concerning the life of the estate
and the distributions from it. It was felt that this
assumption was not very restricting, since in most cases
the expenses would be deducted on the estate tax return,
which would have the higher tax rate.

The next limitation is the assumption that the
estate continues to increase after the transfer. This
assumption was made to simplify the calculation of the

amount of income forfeited due to the gift and gift tax.

If the assumption does not apply to a particular case,

 

 

30See Chapter 6 for a discussion of the election as
to the deduction of such expenses for income tax versus
the estate tax.

“I".

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75

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99
one only has to consider the estate plus interest as the
value of the estate at the date of transfer.

The final limitation is that all the beneficiaries
have the same income tax bracket. This is actually not
as restricting as it may appear, since it is a simple
procedure to interpolate between cases if the benefi-

ciaries have different brackets.

Results

A total of 84,480 cases were generated. Table 4-I
gives a breakdown of these cases. When the rate of return
was set at 5%, only 1,097 cases showed a reduction in the
total receipts by the beneficiary because of the trust.
When the rate was 6%, the number of simulated cases pro-
ducing disadvantageous results was 1,478. This statistic
only tends to support current thinking that trusts are a
very important estate planning device.

A comparison of the results in Table 4-I using the
two different rates of return supports the assumption
that the higher the rate of return the decedent can earn,
the less profitable a trust is. It is less profitable
because of the earnings forfeited on the gift tax and
the cost of setting up the trust.

The cases in which a reduction appears in the

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100

TABLE 4-I

CASES IN WHICH TRUST ADVANTAGEOUS AND DISADVANTAGEOUS
BREAKDOWN BY RATES OF RETURN

 

 

Rate of Trust Trust

Return Advantageous Disadvantageous Total
52 41,143 1,097 42,240
6% 40,762 1,478 42,240
Total 81,905 2,575 84,480

 

receipts of the beneficiaries were first analyzed by size
of estate, cumulative gifts and current gifts. None of
these factors was the dominant one in and of itself. For
example, the disadvantageous cases appeared in estates as
small as $200,000 and as large as $1,400,000. Even with
a given estate size, cumulative gifts is not an important
variable. For example, with the estate set at $200,000
and the past cumulative gifts at $0, there were twenty—two
cases in which the trust was disadvantageous. There were
twelve disadvantageous cases when the estate was
$1,400,000 and cumulative gifts were $0. The same type
of results were obtained by using current gifts. Gifts
as small as $50,000 (the smallest permitted in this study)
were disadvantageous in several cases in estates ranging,

again, from $200,000 to $1,400,000.

 

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101

Since the three variables mentioned above could not
be used to isolate the disadvantageous case, the remaining
three variables (decedent's tax bracket, beneficiary's
tax bracket and decedent's remaining life) were analyzed.
However, instead of using both the decedent's income tax
bracket and the beneficiary's tax bracket, the difference
between the tax brackets was used.

Tables 4-II and 4-III show the analyses. It is evi-
dent from these tables that the only time a trust is dis-
advantageous is when the beneficiary's income tax bracket
exceeds the decedent's tax bracket. In other words, the
income tax savings that a trust could offer are more im-

portant than the other monetary considerations.

Summary

Trusts have generally been considered important
estate planning devices. They provide important monetary
and non-monetary advantages. The question that has not
generally been fully examined is whether the trusts can
be justified strictly on monetary grounds.

The results of this part of the study support the
hypothesis that trusts can save money even after sub-
tracting the costs and fees involved. In fact, the only

time that trusts are disadvantageous is when the

.-.
4.65 ’
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o

102

TABLE 4-II

CASES IN WHICH TRUST IS DISADVANTAGEOUS
BREAKDOWN BY RELATIVE TAX RATES AND REMAINING LIFE

 

Rate of Return - 52
Remaining Life __
4 8 12 16 20 Total

 

V v ~

Decedent's and Beneficiary's
Tax Rates equal:

0% O 0 0 0 0 0
202 0 0 0 O 0 0
40% 0 0 0 0 0 0
602 O O 0 0 0 0

Decedent's Tax Rate Greater
Than Beneficiary's by:

202 0 0 0 0 0 0
40% 0 0 0 0 0 0
602 O 0 0 0 0 0

Decedent's Tax Rate Less
Than Beneficiary's by:

 

 

202 0 l 5 ll 15 32
402 2 10 34 140 252 438
60 §_ .18 129 211 264 627
Total. ; g 168 362 531 1,097

 

 

 

 

fl w vY—fi

103

TABLE 4-III

CASES IN WHICH TRUST IS DISADVANTAGEOUS
BREAKDOWN BY RELATIVE TAX RATES AND REMAINING LIFE

 

Rate of Return = 6%
RemaininggLife

 

 

 

4 8 12 16 20 Total
Decedent's and Beneficiary's
Tax Rates equal: 0 0 0 0 0 0
OZ 0 0 O O 0 0
20: O O 0 O O 0
401 O O O 0 0 0
602 0 0 0 0 0 0
Decedent's Tax Rate Greater
Than Beneficiary's by:
201 0 O O 0 0 O
402 0 O 0 0 0 O
602 O 0 0 O 0 0
Decedent's Tax Rate Less
Than Beneficiary's by:
201 O 2 9 14 27 52
401 4 13 89 232 305 643
602 _5_ 2‘1 l_7_8_ _2_§_l_ 295 783
Total 2 g 276 49_____7_ 627 _J_._,_4_Z§_

 

 

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104

beneficiary's income tax bracket exceeds that of the
planner. If the beneficiary's tax bracket exceeds the
planner's, then the longer the planner's remaining life,
the larger the possibility that the trust will be dis-
advantageous. In all other cases the setting up of a
trust resulted in a larger receipt by the beneficiary.

None of the above conclusions is intended to
minimize the non-monetary benefits available from trust.
There are many cases in which the decedent should and
would set up a trust even though it means a reduction in
the total receipts by the beneficiary. However, for
those cases in which the monetary benefits are over-
riding, this study points out the principle variables

to be considered.

CHAPTER 5

SELECTION OF ESTATE'S TAX YEAR

After the decedent's death, there are many things the
executor or administrator must do. Included in his respon-
sibilities is seeing that all the tax returns are filed on
time. One of the tax returns is the income tax return for
the estate.

The length of the estate's first income tax year is
selected by the executor or administrator. By law, it may
not be longer than twelve months. There are no rules to
guide the executor or administrator in the selection. The
purpose of this part of the study is to develOp a rule
which will assist in the selection of the Optimal first

tax year.

.ghg_paw Related to the Selection of the Income Tax gear
As discussed in the previous chapter, the income of

emtates is taxed in a manner similar to that of an indi—

Vidual. Therefore, an estate comes under section 441 of

the Code. This section permits the selection of either

105

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106
a calendar or fiscal year as the estate's taxable year.
The selection of the year is made on the first return
filed for the estate.1

The executor has the right to select as the estate's
tax year either a calendar year or any fiscal year. The
first tax year of the estate will run from the day follow-
ing the decedent's death to the end of the tax year
selected. For example, if the executor selects a calendar
year for the estate, the first tax year will run from the
day following death through December 3lst, the day before
the start of the calendar tax year. If the executor does
not select a tax year, a fiscal year will be assigned.
The fiscal year will be twelve months starting with the
day following decedent's death. All tax years must end
on the last day of a month.

If the return for the first tax year covers a period
of less than twelve months, it comes under section 443 of
the Code. According to this section, the income will not
have to be annualized because the taxpayer (the estate)
was not in existence for the entire year. Likewise, when
the estate is terminated, a return for a period which may

be less than twelve months will have to be filed. Again,

 

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107
the income does not have to be annualized.

In the final taxable year of the estate, a unique
situation exists. The full amount of the income and
excess expenses are deemed distributed to the benefi-
ciaries. Therefore, the beneficiaries may deduct the
expenses of the estate on their own tax returns. See

Chapter 4 for a more complete discussion of this point.

Estate Planning

The selection of the estate's taxable year can be
an important planning device. The selection of the best
tax year can mean a significant savings on the income
tax due on the estate's income.

Several reasons have been given for the selection of
less than twelve full months as the first tax year. It
has been pointed out that even though the period is
short, the estate is still entitled to the full amount
of the exemption.2 The income will be taxed at lower
rates because the smaller amount of income that is
reported for the short period will be taxed at the lowest
possible rates since it does not have to be annualized.

It would appear that major gains would also be received

 

2Henry C. Smith, "Frequently OverloOked Pitfalls and
Opportunities in Estate Planning," The Practical Lawyer,

April 1967, p. 59.

108
if the final tax year were a short one. If the total life
of the estate was set, then the selection of the length of
the first tax year so that both the first and the last
years were short could provide the estate with one tax
year more than it would have if its first year was twelve
months long. The advantage of this is that the estate
then gets an extra $600 exemption as well as dividing the
income into more parts, which reduces the tax rates
applied to the income.

As a final reason for selecting a short first tax
year, it has been suggested that a short year facilitates
large tax-free distributions.3 Unless the distribution
is a bequest of a specific sum of money or prOperty, it
will first come out of the estate's distributable net
income. If these non-specific distributions are made
during the short tax year, most of it will be in excess
of distributable net income and therefore will be tax-
free because the estate’s distributable net income will
be small. This, of course, will work only if the estate
is liquid enough to make large distributions early in

the period of administration.

 

3Sig O. Joraanstad, "Planning Estate Distributions;
Many Tax-Saving Opportunities Available," The Journal of
Taxation, March 1963, p. 149.

 

 

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109

The prOper selection of tax year and distributions
can save money.4 The law provides that if the estate and
beneficiary have different tax years, distributions from
the estate will be taxable to the beneficiary in the
beneficiary's tax year, with or within which the estate's
tax year ends. For example, if the estate's fiscal year
ends 1/31/73, all distributions to a calendar year tax—
payer would be includible on his 1973 calendar year
return. If the distribution was made in January, the
estate would get an immediate tax deduction, while the
beneficiary would not have to pay tax for over one full
year.5

No matter what tax year is selected, all distributions
should be carefully planned. The general rule has been
stated as follows.6 First, leave at least $600 worth of
taxable income. This permits the estate to make full use

of the exemption granted to it. Second, make distribu-

tions which will make the estate's and beneficiary's tax

 

4Ibid., p. 149.

51f the individual is required to file an estimated
tax, the postponement would be less than one year.

6Harry M. Halstead and Shelton s. Baker, "Post—
Mortem Estate Planning-Federal Tax Considerations,"
American Bar Association Journal, June 1963, p. 601.

tassequal. The on
has the estate

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110
rates equal. The example presented to illustrate the rule
shows the estate with taxable income of $25,000. If the
beneficiary's income is $5,000, $10,000 should be distri-
buted from the estate. Last, distributions in payment of
expenses should probably be delayed until the final tax
year of the estate. If the expenses exceed the income,
the excess will be deductible from the beneficiary's tax
return. This, of course, presumes that the beneficiary
is in a higher tax bracket and will, therefore, benefit
from the deductions.

The whole question of the length of the estate's
final tax year has not been given proper publicity. Most
authors, if they mention it, refer to the possibility of
carrying over excess expenses to the beneficiary. How-
ever, what happens if the final year shows a net income?
It will have to be distributed and therefore becomes tax-
able to the beneficiary. If the presumption that the
beneficiary is in a higher tax bracket is accepted, then
this carryover will lead to higher taxes. It would
appear, then, that the shorter the final year, the better.
If, on the other hand, the estate is constantly having
more expenses than income, the longer the tax year, the
more the beneficiary will be able to deduct. The inter—

relationships among the other variables have not been

111
fully examined. These are the objectives of this part

of the study.

The Simulation Model

 

Variables

There are seven variables in this model. They are:
revenue of the estate, deductible expenditures by the
estate, the beneficiary's income tax bracket, the life of
the estate, the pattern of receipts of the revenue, the
pattern of disbursements of the expenditures, and the
length of the first tax year.

Revenue of the Estate

This is the total taxable income inflow to the
estate before deducting expenses. It ranged from $10,000
to $100,000 by increments of $10,000. Although there are
estates with more or less revenue, it was felt that this
range would permit the drawing of generally applicable
conclusions.

Expenditures by the Estate

This is the total of the deductible expenditures for
tax purposes. It includes all the administration costs
as well as interest, taxes, etc., which can be deducted
on the income tax return. It does not include the estate's

$600 exemption. The range was from $10,000 to $100,000 by

112

increments of $10,000. This is the same range as the
revenue. It was selected so that the study would include
estates which would have over their entire lives, posi-
tive, negative and zero income.

Beneficiary's Income Tax Bracket

The range was from 0% to 60% by increments of 20%.
This is the same range as was used in the previous parts
of this study.

Life of the Estate

The life was set at either 14, 18, or 24 months.
Fourteen months was selected as the shortest term so that
each estate would have at least two tax years. It is
possible for an estate to be terminated in less time, but
usually it would take at least this long for the admin-
istration to be handled prOperly. Twenty-four was selected
as the upper limit to include those estates which take two
full years to be administered. It is quite possible for
the administration to take more than two years, but if it
is assumed the administrator tries to distribute the
assets as soon as possible, two years should include most
estates.

Pattern of Receipts of Revenue

Three patterns were used. A constant pattern was

used for the special case of estates which receive the

113

exact same amount of revenue each month. The other two
were an increasing and a decreasing pattern. They were
calculated on the sum-of-the-month-digit method.

Pattern of Disbursements of Expenditures

Three patterns were used - constant, increasing, and
decreasing. The constant pattern had each month's ex-
penditures equal. It was felt that the expenditures
would not follow quite as rigid a pattern as the revenue,
therefore, in the increasing and decreasing patterns,
instead of using the sum-of-the-months-digit method, the
following was used. Either the first or last month had
25% of the expenditures and in all the‘other months the
expenditures were constant. Although no estate would
have these exact patterns it was felt that they were
close enough to real situations that useful conclusions
could be drawn from them.

Length of the First Tax Year

The length was varied from one month to twelve
months by increments of one month. This covered all the

possibilities from the shortest to the longest first year.

Methodology
Chart S-I is a flow chart of the program written to

simulate the model. The program proceeded as follows:

114

First, the revenue of the estate was set at $10,000.
Next the expenditures were set at $10,000. The benefi-
ciary's tax bracket was then set at 0%. The life of the
estate was set at 14 months. A pattern for the revenue
was selected and the revenue was allocated to the dif-
ferent months. A pattern for the expenditures was
selected and the disbursements were allocated to the
apprOpriate month. Next, the length of the first tax
year was selected. It was started at one month. The
income or loss was calculated for the tax year. If the
estate did not end with the tax year, the tax due if any
was calculated. Then the income for the next tax year
was calculated. If the estate still had not terminated
the previous step was followed. If the estate had ended
the income or loss was assumed transferred to the bene-
ficiary, and the tax due or benefit was calculated. The
total taxes paid because of the estate's income was then
calculated. This included all taxes paid by the estate
and'beneficiary, minus any reduction in the beneficiary's
tax because of the carryover of excess expenses. The
result was then printed. The first tax year was then
increased by one month. The calculations were redone.
.After the tax year equalled 12 months, the other variables

then changed in turn.

115

CHART S—I

FLOW CHART FOR TAX YEAR

 

 

Wary Estate's Revenue (INC) - 1o.ooo-1oo,ooo by 10,000 1s—
1.

 

 

Katy Estate's Expenditure (EXP) - l0,000'-100)OOO by 10,0Q§:]*-

 

 

EarlBeneficiary's Tax Rate (?TAX) - 0‘60 by 202 jze

 

 

EEEy Estate's Life (LIFE) - 1?418 or 24 _J<

 

 

Ehry Pattern of Receipts - Constant, IncreaseJ Decrease #J<

 

 

 

 

 

 

 

 

Eggpgate INC to Months ]
Wary Pattern of EXP - Constanillncrease, Decrease 1‘3""1
Ellocate EXP to Months ]
Narprength of First Year - 1£-12 by 1 AJ‘1

 

l
Balculate Taxable Income (TINQ) ]

 

 

No

alculate Tax Calculate Tax
Tax - TINC x ET
1

tat Yes

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Calculate Taxable Ind '
alculate Total
come for Next Year
J Taxes Paid

 

 

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Erint Result :]

 

 

 

 

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116

Two programs were written. The first one followed
the exact procedure outlined above. The second one made
an adjustment. In the second program, it was assumed
that for the estate to pay its taxes, it would have to
liquidate an income producing asset. Therefore, future
revenues would be reduced. This was accomplished by
reducing the revenue in each month following the end of
the tax year by 1/2 of 1% of the tax due. There was no
reduction if the estate ended and the income was deemed
distributed to the beneficiary. Each month was reduced
equally because it would be impossible to guess all the
possible variations in future income flow. This permitted
the inclusion of the assumption of lost income without

having to write many different programs.

Limitations

There are several limitations in these models.
First, the study was concerned about the total tax paid
rather than the actual distributions received by the
beneficiary. Since it was assumed that no distributions
were made out of the estate's income during the life of
the estate, the length of the first year which led to the
smallest tax due was also the length which led to the

largest distribution to the beneficiary. They both give

117

the same optimal length for the first tax year. No dis—
tributions were allowed during the estate's life to show
the maximum.effect of the selection of the tax year. To
allow earlier distributions would confuse the issue of the
length of the first tax year with the question of which
assets would be distributed. To allow earlier distribu-
tions would require additional assumptions concerning the
availability of assets for distribution and the effect on
future cash inflows and outflows.

The next limitation is that all expenses are deducted
on the income tax return. Some of the expenses could have
been deducted on the estate tax return instead. The choice
is the t0pic of the study presented in Chapter 6. There-
fore, the option was not included in this part of the study.

The next limitation is that there is either only one
beneficiary or that all the beneficiaries have the same
income tax bracket. This is the same assumption as was.
used in the previous studies.

The final limitation is that none of the income is
"in respect of the decedent." This was left out because
it was felt that the inclusion would result in a confusion
of the original purpose of this chapter. The entire ques-
tion of income "in respect of the decedent" should be the

tepic of a separate study.

Results
On each ru
were generated,

.ergth of first

seated in Tat le

3.. - .

“51% of .
:LPM‘

"ed-d be use
Cf H.

118

Results

On each run of the computer program, 10,800 cases
were generated. A breakdown of the Optimal decisions by
length of first tax year and life of the estate is pre-
sented in Tables S—I and S—II. Table 5-I shows the
result without the adjustment for the interest lost on
the tax paid by the estate. Table S—II shows the result
with the adjustment. A comparison of the two tables shows
that the benefit from the postponement of the tax is not
very important. In other words, the decision as to the
length of the tax year is not greatly affected by the
decision of which assets (income or non income producing)
should be used to pay the tax. Because of this, the rest
of the analysis will be restricted to the run in which
the adjustment for interest was made (as in Table S-II).

A review of Table S-II indicates that the Optimal
decision is to select a tax year so that the final year
will have twelve months.7 This decision would be optimal
if the beneficiary either will pay less tax on the income
or receive more benefit from the expenses. To further

study this point Table S-III was prepared.

 

7Since the length of the estate was pre-set, the
selection of the first year dictates the final year.

119

TABLE S—I

OPTIMAL DECISIONS REGARDING LENGTH OF FIRST TAX YEAR
BREAKDOWN BY LIFE OF ESTATE AND LENGTH OF FIRST TAX YEAR

No Reduction in Revenue to Pay the Tax*

 

 

 

 

Length of Life of Estate
First Year 14 18 24
1 545 78 70
2 1,511 96 101
3 107 128 123
4 99 169 161
5 93 718 255
6 94 1,485 131
7 97 53 161
8 96 57 57
9 60 64 28
10 64 48 27
11 70 58 643
12 764 __§_4_6_ 1&4;
Totals meg 2.299. am

 

 

 

 

*Assets were non income producing.

120

TABLE S-II

OPTIMAL DECISIONS REGARDING LENGTH OF FIRST TAX YEAR
BREAKDOWN BY LIFE OF ESTATE AND LENGTH OF FIRST TAX YEAR

Reduction in Revenue due to Payment of Tax*

 

 

 

 

 

Length of Life of Estate
First Year 14 18 24 {I
1 557 81 80 $1“‘
2 1,514** 102 107 g .
3 101 126 123 ;I4
4 100 179 174
5 88 709 255
6 82 1,472** 133
7 91 57 161
8 88 58 49
9 71 62 28
10 62 48 22
11 72 60 648
12 774 __£gg; .11§29**
T°tals 31929—2 14112—2 fl

 

*Assets were income producing and 6% investment interest was lost
through payment of estate income tax.
**Final tax year will contain twelve months.

 

121

Table 5-III shows a breakdown of the Optimal deci-
sions by estate life, net income and length of first tax
year. This table seems to support the Observation pre—
sented above. Only when the estate income is zero does
the majority Of the Optimal decisions indicate selecting
a tax year which will place other than 12 months in the
final year.

To complete this part of the analysis, Table S—III
was brOken down even further. Table S—III A shows the
Optimal decisions for those cases in which the estate's
income was negative except those cases in which the bene-
ficiary's tax bracket was zero. These cases were left
out of Table S-III A as being very unlikely. It should
be noticed that over 75% Of the cases within each estate
life indicate that a twelve month final year is Optimal.
Tables 5—III B and C breakdown the cases in which the
estate's income is positive and the beneficiary's tax rate
is either 0% or 20% or 40% or 60%. In those cases in
which the beneficiary's tax rate is low (0% or 20%) the
majority of cases indicates selection of a tax year so
that the final year has 12 months. When the beneficiary’s
tax rate is high (40% or 60%), the majority indicates the
selection of a tax year so that the final year has one

month.

122

 

 

 

 

 

 

 

 

 

 

 

 

 

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123

TABLE S-I I I A

CASES IN WHICH ESTATE INCOME NEGATIVE (OMITTING CASES
IN quCE BENEFICIARY'S TAX BRACKET wAS ZERO)
BREAKDOWN OF OPTIMAL DECISIONS BY LIFE OF
ESTATE AND LENGTH OF FIRST TAX YEAR

 

 

 

Length of Life of Estate
First Year 14 18 24
l 67 20 29
2 969 19 20
3 ll 15 18
4 25 14 8
5 36 113 8
6 29 941 8
7 25 26 6
8 16 26 9
9 5 19 12
10 S 12 9
ll 4 2 146
12 23 8 942
Total 1.1.2112 11.2.1; 1122.2.

 

 

 

 

124

TABLE S—III B

CASES IN WHICH ESTATE INCOME WAS POSITIVE AND
BENEFICIARY'S TAX RATE WAS EITHER 0% OR 20%
BREAKDOWN OF OPTIMAL DECISIONS BY LIFE OF
ESTATE AND LENGTH OF FIRST TAX YEAR

 

 

 

Length of Life of Estate
First Year 14 18 24
l 19 6 35
2 469 6 57
3 49 16 63
4 39 49 79
5 35 45 109
6 33 479 17
7 31 29 32
3 30 25 11
9 28 22 6
10 25 25 o
11 23 24 12
12 .22. .82 .282
T°tals 810 g 2.12

I!

125

TABLE S—II I C

CASES IN WHICH ESTATE INCOME WAS POSITIVE AND
BENEFICIARY'S TAX RATE WAS EITHER 40% OR 60%
BREAKDOWN OF OPTIMAL DECISIONS BY LIFE OF
ESTATE AND LENGTH OF FIRST TAX YEAR

 

 

 

Length of Life of Estate
First Year 14 18 24
1 348 16 3
2 50 32 8
3 31 60 14
4 28 87 38
5 15 456 112
6 20 32 78
7 19 2 99
8 23 7 12
9 24 11 8
10 28 11 11
11 33 13 387
17- 1.21. _8.3_ .22
Totals 810 .219 810

 

126

Tables S-IV, S—V and S—VI show a breakdown of the
optimal decisions by the flow of revenue and expenditures.
A review of these tables points out two things. First,
the pattern of the receipts Of revenue is more important
than the pattern of the expenditures. This can best be
seen.by reviewing the number Of cases that are included
in the length of the first year which has the largest
number of cases. The number is reasonably constant
within each type of revenue flow, while it is not within
each type of expenditure flow. The second point is that
the final tax year should be long if the period will show
excess expenditures and short if it will show a profit.
Table S-VI is the best example. With a decreasing receipt
flow, the chart shows no cases in which a final year of
one month will be Optimal. A twelve month final year is
Optimal in most cases under this condition. If the
revenue increases, the number Of cases in which the
Optimal decision is a one month final year is large;
however a twelve month final year is still better in
more cases.

Tables 5-IV, 5-V and S-VI do not give a clear indi-
cation Of Optimal decisions because they include all
cases'without distinguishing those cases in which the

estate income is positive from those cases in which the

127

 

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130
income is negative. This breakdown was done. For example,
with an estate life of 18 months, positive income and con-
stant flows of both revenue and expenditures, 89 cases
showed a 5 month tax year as Optimal and 91 cases showed
a 6 month tax year as optimal. Further analysis by bene—
ficiary's tax bracket showed that in 81 of the 89 cases
the tax bracket was 20% or less. In 80 of the 91 cases
the tax bracket was 40% or more. Therefore, it appears
that no one variable dictates the correct first tax year
and that all of them must be considered. This could be
done by rerunning the computer program written for this
study for the specific variables.

The importance of selecting the Optimal length Of
the first tax year cannot be overstated. A comparison Of
the tax cost of selecting twelve months rather than the
Optimal was done. The range of the additional tax cost
was from under $200 to about $40,400. The arithmetic
mean was $4,590.15. This is significant when it is
remembered that in about 1/2 the cases the estate had a
net loss. The arbitrary selection of either a 12 month
fiscal or a calendar year for the first tax year could

adversely affect the beneficiary.

131
Summary

It has been suggested in tax literature that there
is an advantage to selecting a short first income tax
year. The exact cases in which it would be beneficial
were not specified.

This part of the study tried to determine if a short
year should be selected. Although a general rule could
not be determined from the cases generated, it does indi-
cate that the emphasis has been in the wrong place. In
selecting the tax year, the effects Of the distribution
Of the income to the beneficiary in the final year should
be considered the primary determinant. An exact solution
would require an examination of the variables in the indi-
vidual cases. This does not mean that an arbitrary selec-
tion Of either 12 months fiscal or a calendar year is
acceptable. As was pointed out, the selection Of the
wrong year could significantly reduce the receipts by

the beneficiary.

CHAPTER 6
DEDUCTION OF ADMINISTRATION EXPENSES

The executor or administrator Of an estate should
attempt to minimize the amount of taxes the estate has to
pay. To do this, he should claim all the deductions per-
mitted under the code. There are several deductions
which can either be claimed on the estate tax return or
the estate's income tax return. The return selected
will have an effect on the total tax paid. Which return

they should be deducted on is the t0pic of this chapter.

Theygaws Affecting Deductions
Section 2053-Deduction on the Estate Tax Return

Section 2053(a) allows a deduction in determining
the taxable estate for expenditures for funeral expenses,
administration expenses, claims against the estate, and
indebtedness on property included in the estate. Sub-
section (b) allows a deduction for administration of

Imoperty not subject to claims, but properly included is

the gross estate.

132

 

 

 

133
The regulations define administration expenses as
"expenses...actually and necessarily incurred in the
administration of the decedent's estate; that is, in the
collection Of assets, payments Of debts, and distribution
of property to the persons entitled to it."1 The regu-
lation goes on to state that unless the expenditure is
essential to the administration of the estate, it will
not be deductible. The fact that it will benefit the
beneficiaries is not sufficient. The regulation specifi—
cally lists executor's commissions, attorney's fees and
mi-Scellaneous expenses as being included in administration
expenses.
The amount Of the executor's commission and attorney's
fees that may be deducted are the amounts actually paid
by the return's filing date and the "amount which...may

2 If the will specifies

reasonably be expected to be paid."
the commission to be paid, then that is the amount which
may be deducted. However, if instead of a fee, the
ekecutor is to receive a bequest, then no deduction is

allowed.

"Miscellaneous administration expenses include such

1Reg. §20.2053(a)

2Reg. §20.2053-3(b) and (c)

134

expenses as court costs, surrogates' fees, accountants'

fees, appraisers' fees, clerk hire, etc."3 Brokerage

fees and other selling expenses are deductible on nec-

 

essary sales of prOperty. Necessary sales are ones made

in order to pay expenses, debts or to effect distribution.
Included in the term selling expenses is the difference

between the amount realized on a sale to a dealer and the

 

lower of either the fair market value used for estate tax

Purposes or the fair market value on date of sale.

Deductions on the Income Tax Return

The Code permits the estate to take a deduction on

its income tax return for those deductions which an indi-

vidual would be allowed. In addition. R69- 51-212‘1(i)

peT-‘u'li‘ts a deduction for the administration expenses.

These expenses include fees and litigation expenses. The

regulation specifically excludes deductions allocated to

tax exempt income .

Administration expenses are deductible on either the

eRotate tax return (52053 and 52054) or the estate's in-

QC”the tax return (5212) . These expenses may not be deducted

°11 both returns at the same time. Section 642(g) denies

the income tax deduction for any administration expenses

‘

3Reg. §20.2053-3(d)(l)

135

that are deductible on the estate tax return unless a
waiver of the estate tax deduction is filed. The selec—
tion of the return on which the expenses will be deducted
is left up to the executor's or administrator's discre-
tion- In fact, Regulation 51.642 (g)-2 permits, "One
deduction or portion of a deduction... for income tax
purposes... while another deduction or portion is allowed
for estate tax purposes." The only restriction on the
selection is that once the Option to deduct the expenses
on the income tax return is made and the form filed, the
decis ion may not be reversed.4 The executor can change
the election if the expenses are deducted on the estate
tax return. The denial of double deduction does not
apply to. items deductible because they relate to "income

in respect of a decedent."5

US'fiin Estate glanning
whel‘e to Deduct Expenses
Several authors have noted the Options Open as to
the deduction of the administration expenses. None of
the authors has determined which return should be used,

although several have set forth the variables they think

\

4Reg. 51.642(g)-l

5Reg. §1.642(g)-2

 

 

136
should be considered. For example, one author has sug-
ges ted comparing the tax brackets and deducting the ex-
penses on the return with the highest bracket.6 The
amrtlior realized that the solution was not that simple by
going on to state that in determining the tax bracket, the
nuariistal deduction provision should be considered.
Another author listed the following variables:

estate tax rate, income tax bracket Of the estate, bene—
ficiary's income tax bracket, and the timing Of income
and other expenses.7 Although this list seems complete,
it still doesn't state how all the variables should be

evaluated and upon what basis the final decision should

be made .

Available Double Deductions

As was mentioned earlier, section 642(9) denies a
double deduction Of expenses. However, some authors
Still feel that there can be a double deduction.

One author points out that taxes, interest, and

6Henry C. Smith, "Frequently OverlOOked Pitfalls and
Opportunities in Estate Planning," The Practical gawyer,
April, 1967, p. 58.

7Sig O. Joraanstad, "Planning Estate Distributions:
Many Tax-Saving Opportunities Available," Journal of
Taxation, March, 1963, p. 149.

 

 

137
business expenses that are associated with "income in
respect Of the decedent" are deductible on both the
estate tax return and the estates' income tax return.8
Since these expenses do appear on both returns they can
be viewed as double deductions. It is more logical to
View the whole transaction as the inclusion of the net
income Of the decedent in the gross estate and the levy—
ing of an income tax on the same net income.

Another author points out that the deduction Of com-
missions and selling expenses of assets included in an
eat-ate has been allowed on both the estate and income tax
return.9 They were deducted on ‘.th’e«estate tax‘vreturn' as
adruinistration expenses and used as a reduction in the
91088 receipts from the sale on the income tax return.
This would appear to be a true double deduction since the

rationalization is not very convincing that an offset to
sales price is not a deduction.

It is possible that there are other double deductions,
ailthough it would prObably take the definition of the item
f°r income tax purposes as something similar to a reduc—
tion rather than as an expense for it to escape section

642(9) .
802. cit., Smith, p. 59.

9Philip E. Heckerling, "Post—Mortem Double Deduc-
tion," Tax Advisor, December 1970, p. 764.

138
The S imulat ion Model

A simulation model was develOped to test the very

simple rule that the expenses should be deducted on the

return with the highest tax rate.

Variables

Four variables were considered. They were: the
marital deduction,

the size of the decedent's estate, the

income of the estate, and the amount of the administrative
exPenses.

Marital Deduction

The marital deduction had two levels: zero and one-
half the adjusted gross estate.

Zero was selected to

COVer all those cases in which less than the maximum

amtDunt was transferred to the surviving spouse. One-half
the adjusted gross estate was selected because it is the

maximum amount for estate tax purposes. If more was
tral‘nsferred to the surviving spouse, it would not affect

the result .
Size of Decedent's Estate

The size of the decedent's estate ranged from

$200,000 to $2,000,000 by increments of $200,000. This
Was the same range as was used in the other parts Of the

Study. The size of the estate was used rather than just

 

139

the tax rate for two reasons. The first reason was so

that the effective tax rate could be determined and the
second was hopefully to allow conclusions to be drawn
based on the relationship between the size of the estate
and amount Of income.

Income of the Estate

The income Of the estate was varied from $10,000 to

$390, 000 by amounts of $20,000. This range was used to

approximate most of the probable earnings that an estate

would have. The full range of incomes was used for each

estate rather than just specifying a rate of return to
attempt to measure the effect of many different earnings

rates .

Amount of Administration Expenses

The final variable was the amount of the administra-
ti°n expenses. The amount went from $10,000 to twenty-

fiVe percent of the decedent's estate by amounts Of

$20.000. An upper limit of twenty-five percent Of the

ea'cate is probably larger than any actual deduction. It

was used to try to determine the effect of varying the

eitpenses .

140
Methodology
Chart 6-I is a flow chart Of the program used to
simulate the model. The program proceeded as follows.
First, set marital deduction equal to zero. Then the
estate was set at $200,000. The estate's income was set
at $10,000 and the administration expenses were set at
$10, 000. The percent of the expenses deducted on the
income tax return was set at 0%. The dollar amount of
the expenses deducted against income was calculated by
multiplying the percentage by the total amount of the
expense. The difference between the total expense and
the amount deducted against income was assumed deducted
for estate tax purposes. The amount of the marital
deduction was subtracted from the estate. The amount of
the estate tax due was calculated. The amount transferred
t“) aJJ.beneficiaries from the gross estate was calculated
by subtracting the administration expenses deducted for
estate tax purposes and the estate tax from the gross
estate. The net amount of income reported was calculated
'bY'subtracting the expenses for income tax purposes from
the estate's income. The income tax due on this amount
“as calculated. The amount that would be transferred tO
the‘beneficiaries out of income was calculated by sub-

tracting the income tax from the net income reported.

 

 

141

CHART 6-I

FLOW CHART FOR DEDUCTION OF ADMINISTRATIVE EXPENSES
AGAINST INCOME TAX OR ESTATE TAX

Ear}; Marital Deduction (MDL 0 or 1L2r adj. gross estate }<--—————-
lVary Decedent's Estate (DE) 200,000-i2y000L000 by 200L000_](—————

Ma's Income (INC) 191000-39LO,OOO by 204000 )e---- (’3

Wary Administration Expenses (ADMEXP) "m
‘ 10,000-(251 x DE) b1 ZOLOOO F

 

 

 

 

 

 

 

ary Percent Deduct on Income Tax Return (PER)

 

 

 

 

0-100 by 10 ‘71 a :
. LA .

cunt of Expenses Deducted on Income Tax Return -

ADMEXP 1: PER L

 

 

cunt of EXpenses Deducted on Estate Tax Return
EXPZ - ADMEXP - EXPl

__ 1
Writgl Deduction from Decedent's Estate I

I
W Tex: F J
“n"- Received by Beneficiaries from Principal of
EEBtate (TI) - DE - EXPZ - ESTATE TAX
1
me (ND-INC-Elfl’l ]
WI 5 J
c“late Income Tax on NI ]

1
waived by Beneficiaries from Estate Income
T2 - NI - INCOME w:

I
%eceip;g by Beneficiaries (TL - T1 + T2 ]

1% 1 1

 

 

 

 

 

 

 

 

 

 

 

 

 

N
C

I

 

 

 

 

40/

 

50

 

 

 

 

142
The sum of the two transfers to the beneficiaries was

calculated and printed out. The percent deducted against

income was increased by 10% and all the calculations were
redone. After the percent equaled 100, all the other

variables were increased in turn.

Limi tations

There are three major limitations on this study. The

 

first one is that all the income and expenses are incurred

within one tax year. However, this is not very restric—

tive- If the estate earns income in more than one year,
then the amounts used are the amounts earned or spent

Within the first year.

The second limitation is that the life of the estate
is one day longer than the estate's tax year. This was
done to prevent any of the estate's (otherwise final year)
income or expenses from appearing on the beneficiaries'

tax return. This limitation will be removed later. See

the discussion under results on page 143.

The final limitation is that the estate makes no
distributions out Of income during the tax year. This
was also included to prevent any of the income being taxed
to the beneficiaries in order that all of the income

a o
Ppear only on one income tax return.

 

 

143

Results

Summary

A total of 5,600 cases were generated. In 2,800
cases, the marital deduction was zero. In the other
2,800 cases, the marital deduction equaled one-half the
adjusted gross estate. Comparing the cases with the
marital deduction to their counterparts without marital
deduction indicated that a greater amount of the expenses
Will be deducted against income tax if the estate tax

marital deduction is claimed.

A review of the zero marital deduction cases showed
that in all cases in which the income was as low as
$10. 000, all the expenses were used on the estate tax
return. As the estates increased from $200,000 to
$loOOO,OOO, the Optimal decisions were to leave estate
income after expenses of between $9,000 to $15,000. As
the estates increased from $1,000,000 to $2,000,000, the
<>3.3"ZJ'.I‘ual amount of income increased to around $20,000 to
$25.000. The program does not allow more precise answers
because the allocation of expenses was limited to set
pe“centage of income ranging from 0% to 100%.

A review of the fifty percent marital deduction

cases showed that when income was as low as $10,000. a

p°rtion of the expenses was subtracted on the income tax

 

144
return. As the size of the estates increased from
$200,000 to $1,000,000, the optimal decision was to leave
estate income between $0 to $5,000. As the estates in-
creased to $2,000,000, the amount of income varied in the

range Of $0 to $10,000, but almost never above $10,000.

Effective Rate Of Taxation

The review Of the two computer runs did not provide
sufficient information to determine a decision rule.
There fore, further analysis was performed on the Optimal
decision for each case. First, the marginal rate of in-
come tax was determined by looking up the taxable income
on a tax table. Then, the marginal rate of estate tax was
determined by looking up the taxable estate in the estate
tax table. The two marginal rates were compared.

For those cases in which the marital deduction was
Zero. the Optimal decision allocated the administration
e3"‘Penses sO that the marginal rates Of tax were equal.
The marginal rates are, therefore, the effective rates of
taMat-Jon, and the decision rule becomes to allocate the
e“Penses so that the effective tax rates are equal.

For those cases in which the marital deduction was
fifty percent, the Optimal decision allocated the admin-

istration expenses so that the marginal income tax rate

145
equaled one-half the marginal estate tax rate. It there-
fore appears that when the maximum marital deduction is
used, the effective estate tax rate is one-half the
marginal rate. A general decision rule can be formulated
as follows: allocate the administration expenses so that

the effective rates of taxation are equal.

Income Taxed to Beneficiaries

In the final estate income tax year, the income of
the estate will be included in the beneficiaries' income
tax returns. Therefore, it was felt that the limitation
Prehibiting any income from being taxed to the benefi-
ciaries was extremely restrictive. TO remove this limita-
tion, the two programs were rerun with the addition Of one
eXtra variable. This was the marginal (effective) income
tax rate of the beneficiaries. The rate went from 10% to

60% by 10%. This rate was applied to the estate's net in-

come rather than the rates from the table.

The results from these two runs were similar to the
two previous runs. If the marital deduction was zero,
the Optimal allocation made the marginal tax rates equal.
when the marital deduction was fifty percent, it made the
effective tax rates equal. The effective estate tax rate

was one-half the marginal rate. Therefore, the general

 

 

 

 

necisim me

also.

“WI!

{5%

I,

I

army ‘01 -.
'9! 0‘: ' .
me the

Ellinistra

tai- .

\ I;rt
tax
Eh

 

 

146

 

decision rule formulated above will apply to this case

also.

Summary and Conclusions

This study tested the very simple decision rule that
the administration expense should be deducted on the tax
return with the highest rate. This rule will not always

provide the optimal decision.

 

The rule can be restated as follows: deduct the
administration expenses on the tax returns so that the
effective tax rates are equal. The effective income tax
rate is either the estate's or beneficiary's marginal in-
come tax rate, depending on whose income tax return the
income is included. The effective estate tax rate depends
on whether or not the maximum marital deduction is
claI'Lmed. If it is not, then the marginal rate is the
effective rate. If the maximum is claimed, then the
effective rate equals one-half the marginal rate.

In none Of the cases was the selection of the
estate's income tax year a decision variable. Its inclu-

Sign would not affect the decision rule that was deter-
mined because the rule is based on the tax rate and a
Bh°rt tax year does not necessitate annualization of the

e . . . .
Staite's income. From an Operational p01nt of View, the

 

selection OE 1
first ignorir.
5.? 'JC’ tier) 1"-
ind the ester

15 done 17
tights" r
:‘nE‘u ‘
a‘rfii’s <
esgafels
state t
‘23? the i

147
selection of the estate's first tax year should be done
first ignoring all administration expenses. The expenses
should then be allocated between the estate tax return
and the estate's income tax return in a manner which would
equate the effective tax rates.

The decision rule holds even in those cases in which
all three tax returns are considered (the estate tax, the
estate's income tax and the beneficiaries' income tax).
In these cases, the expenses should be allocated in a
manner which equates all three effective tax rates. This
is done by allocating the expenses to the return with the
highest rate first, then the next highest, and then the
third. The amount allocated to the estate tax return is
always deductible. To allocate the eXpenses between the
est’u‘élte's income and the beneficiaries' incomes will neces-
sitate the prOper timing of the payment of these expenses

by the executor or administrator.

CHAPTER 7
ALTERMTE VALUATION DATE

The computation of the estate tax depends upon the
value of the estate. The valuation is done either at
the date Of the decedent's death or six months later at
the executor's or administrator's election. It would
appear, and is generally suggested, that the date
selected should be the one which would produce the lower
Valuation and hence the lower estate tax. However, it
has also been prOposed that by selecting the date which
produces a higher estate tax an overall benefit will be
derived from the reduction in the income tax on a gain
3EITnu the future sales of the inherited prOperty. This
pottion Of the current study is designed to investigate
'trua use of the alternate valuation date and provide data
tc’ indicate if it is beneficial to select the alternate
date when the estate has increased in value.

La\Wgelatingq to Valuation

Generally, the estate is valued at date of death.

However, section 2032 provides for an alternate valuation.

148

 

a4

149
The actual value under this alternate method for an indi-
vidual piece of prOperty depends on whether the prOperty
has been ". . . distributed, sold, exchanged, or otherwise
disposed of, within six months after decedent's death. . ."
or not. If the property has not been distributed, it is
valued as Of six months after death. If it has been
distributed within that time period, the value at date of
distribution is used. In determining the value at any

point other than at death, any change due tO the passage

2

Of time is to be ignored. For example, the decline in

the value Of a patent simply because of the reduction in
remaining life would be ignored.
The regulations define distributed as "all possible

ways by which property ceases to form a part Of the gross

estate."3

The prOperty may be distributed by:

"(i) the executor:

(ii) a trustee or other donee to whom the decedent
during his lifetime transferred property in-
cluded in his gross estate under sections
2035 through 2038, or section 2041:

(iii) an heir or devisee to whom title passes
directly under local law;

(iv) a surviving joint tenant or tenant by the

entirety: or

(v) any other person."4'5

 

152032(a)(1) 252032(a)(3)
3Regulation-520.2032-1(c)(1)
4Regu1atien 520.2032-1(c)(3)

5Section 2035 refers to transfer in contemplation of
death. Sections 2038 and 2041 refer to powers Of appoint-
ment. See Chapter 3 for full discussion.

 

150
It appears that any transfer by a party connected with
the estate to an unrelated party will qualify as a distri—
bution.

The selection of the alternate date is made by the
executor on the estate tax return.6 The only restriction
on the election is that the value Of the estate at the
time Of the decedent's death be greater than $60,000,
otherwise the value at time of death governs.7

The beneficiary's basis on inherited prOperty is
either the fair market value at death or six months after
death if the executor selects the alternate valuation

date.8

In other words, the beneficiary's basis is the
value used for estate tax purposes.9 The holding period
for any asset whose basis is determined by the above rule
is considered automatically to have been held for more

than six months.10

Therefore, any gain from the sale of
a capital asset will be treated as a long term capital

gain.

 

652032(c)

7Regu1ation §20.2032-1(b)
81.R.C. §1014b

9For a minor exception to the rule see McConnel,
2m313x32 and Evans, 293ma710.

1L0I.R.c. 51223(11)

 

 

151

Estate Planning

The alternate valuation date was placed in the law
to permit estates which had declined in value to pay a
lower tax. Although this was the intention, the use of
the alternate date is not limited to these circumstances.

Certain authors have recommended the use of the
alternate date even though the estate had increased in
value. For example, it has been pointed out that if the
value at the alternate date has increased but is less
than $120,000, and provision had been made for the use Of
the maximum marital deduction, the alternate value is
preferred. The reason was that the beneficiaries would
get a stepped up basis without having the estate incur
any estate tax.11

Two advantages Of using a higher valuation have been
suggested. The first one relates only to assets which
will give rise to a depreciation or depletion deduction
to the beneficiary. If these assets have a higher basis,
then the amount of the deductible depreciation or deple—
tion will increase. The suggestion is that the income tax

savings from the increased deduction might Offset the

, llLynal E. Hoffman, "Estates and Trusts-Tax Alterna-
tlves." The Oklahoma CPA, January 1953, p, 7.

 

 

152

additional estate tax.12

The second suggestion concerns
assets which will be sold by the beneficiary. The idea is
that the higher basis may reduce the tax on the gain on
the sale sufficiently to Offset the added estate tax. It
is interesting to note that one author said that the sale
must be within a reasonable time while the other said
within a short time.13 In other words, both authors
recognized that the interest which could be earned on the

additional estate tax should be included although they did

not state it specifically.

The Simulation Model

The simulation model was constructed to test the
advantage Of selecting the alternate value, even though
higher, because of the reduction in the taxable gain on

the future sale Of the assets by the beneficiary.1

‘Variables
Six variables are included in the model. They are:

type of assets, marital deduction, size of estate,

12Arch B. Gilbert, ”Post-Mortem Estate Planning,"
Oklahoma Law Review, February 1968, p. 18.

13%.. p. 17 and Hoffman, Q. cit., p. 7.

14The model does not include depreciable prOperty
because its inclusion would require assumptions concern-
lng useful life, depreciation methods and depreciation
recapture which could vary greatly.

 

153

alternate value Of estate, date of sale and beneficiary's
income tax rate.

Type of Asset

The two types considered were capital assets and non-
capital assets. This dichotomy was used because of the
difference in the income taxation of the gain on the
sale. Non-capital gains are taxed at the beneficiary's
ordinary tax rate. Long—term capital gains on the other
hand are effectively taxed at one—half the beneficiary's
regular tax rate with an upper limit of 25% effective rate
on the first $50,000 Of gain. The holding period of the
capital assets was ignored because they are automatically
considered to have been held for more than six months and
to result in long-term capital gains.

Marital Deduction

The amount of the transfer that qualified for the
marital deduction was set either at zero or one-half of
the decedent's estate. One-half was selected as the
upper limit because larger transfers would only give rise

to a deduction Of one-half and therefore would have the

15Only the extreme cases in which either all the
assets are capital or all the assets are not capital were
Considered. For cases in between the results could be
interpolated.

 

154

same result. This was included to determine if the marital
deduction would affect the decision.

Size of Estate

The size of decedent's estate, valued at date of
death, was varied from $200,000 to $2,000,000 by increments
of $100,000. This is the same range as was used in the
previous parts of this study.

Alternate Value of Estate

The initial value was set at 110% of the date of
death value. It was increased by amounts equal to 10%
Of the date of death value until it reached the upper
limit Of 200% of date of death value. The alternate
value was the fair market value six months after death.
This value would be used for the estate tax purposes if
the executor or administrator selected the alternate valu-
ation date. This amount was also the amount received by
the beneficiary on the sale of the assets.

Date of Sale

The date Of sale was included to calculate the amount
Of interest forfeited on the additional estate tax paid.
It was varied from zero months to one hundred twenty
months by increments Of six months. Zero months means
that the beneficiary sold the asset immediately after

receiving the property from the executor. The range was

155

selected to cover the most realistic possibilities. Sales
more than one hundred twenty months after distribution
were not considered because it was felt they were not con-
templated when the suggestions to use alternate value were
made.16

Beneficiary's Income Tax Bracket

The income tax rates considered were 0, 20, 40, 60,
and 70%. Zero and seventy percent were selected because
they are respectively the lowest and highest tax rates
applied against income. Twenty, forty, and sixty were

selected as being the most probable tax rates from which

the beneficiary's income tax would be computed.

Methodology

Chart 7-I is a flow chart of the computer program
written to simulate the model. The program proceeded as
follows: The assets were set as capital assets. The
marital deduction was zero. The value Of the estate at
death was $200,000. The alternate value was $220,000.
The assets were sold immediately (zero months after
receipt). The beneficiary's income tax bracket was set
at 0%. The total receipts by the beneficiary upon comple-

tion Of the sale was calculated if the alternate value was

 

16See page 151.

 

 

156

CHART 7—I

FLOW CHART FOR USE OF ALTERNATE VALUATION

 

{Vary Type of Asset (A) Capital or Non-capital

 

[Vary Marital Deduction 0 or 50%

 

Vary Value of Estate at Death (DE) 200,000—2,000,000 by
100.000
.11

[gag Agemate Valued Estate (QED 10074 013-2007: DE by 10121;]

 

beck- .

 

{Vary Sale Date (DATE) 0-120 by 6 r ]

 

1
ary Beneficiary's Income Tax Bracket (BTAX)

 

 

 

 

 

 

 

 

 

 

 

 

 

0:;0I40160 or 702
Ealculate the Marital Deduction fér DEI y_j
balculgte Estate Taxyon DEI i .J
lalculate the Total Receipts by BJEEficiary (T1) . DEI - l
I Estate Tax + Interest on Transfer - Income Tax on InteresJ
Ealculate the Mar;£§l_Deduction fir DE AJ
Ealgglate the EstateyTax on DE V]

 

 

Calculate Total Receipts by Beneficiary (T2) - DEI - Estate
Tax on DE + Interegt on Transfer - Income Tax on Interest

 

 

 

 

[Reduce T2 by the Amount of the Tax Paid on Gain on the SaIE]

I
(benefit of Alternate Value (SAVE) - T1 - T2 :]

 

 

 

H”

e———

e.— x

6*

 

 

RINT SA
10

N
O

 

 

‘ 1
l’ s
I

 

 

(30

 

 

@

 

so:

 

 

 

 

 

157
used. The amount was arrived at by first determining the
estate tax due on this alternate value after subtracting
the marital deduction. The estate tax was subtracted
from the value of the estate and interest was added to
date of sale at a rate Of 5% compounded semi-annually.l7
The income tax that the beneficiary would pay on the
interest was subtracted. The result was the total
receipts because the beneficiary sold the assets at their
alternate value. The total receipts Of the beneficiary,
if the date Of death value was used, was then calculated.
The estate tax due on this lower value was calculated.
The estate tax on the date of death value was subtracted
from the alternate value (the actual value at distribu-
tion). Interest was then added to the net receipts.
This was reduced by the income tax which would be due.
The amount was further reduced by the tax that the bene—
ficiary would have to pay on the gain on the lower basis.
The difference in the total receipts was then printed.
The beneficiary's tax bracket was then set at 20%. All
the calculations were redone. After the tax bracket

reached 70% the other variables were increased in turn.

 

 

17The 5%.rate was used instead of the 6% rate as in
the other parts Of this study because the amounts in this
model are compounded semi-annually rather than annually.

 

158
Limitations

There are several limitations on this model. First,
a decline in the value of the estate between date of
death and the alternate date was not included. The model
only wanted to test the advantage Of the alternate value
when the assets increased in value. The alternate value
would automatically be used if the value declined because
it would provide immediate savings and because long term
capital losses are only one-half deductible. Second,
the assets neither increased nor decreased in value
between the alternate date and the date Of sale. This is
a minor restriction because any additional increase would,
in most cases, be taxed exactly the same way regardless
of whether the alternate or date of death values was
selected. The declines in value were omitted so that the
maximum benefit possible from the elimination of the tax
on the gain could be determined.

The final limitation is that the beneficiary's basis
equals the value used for estate purposes. This assumes
that none of the distribution to the beneficiary was
considered sales by the estate to the beneficiary. This
assumption does not alter the model materially. It does
permit the use Of a single income tax rate rather than at

least two -- the estate's and the beneficiary's.

 

 

159

Results

A total of 79,800 cases was generated. Table 7-I
gives a breakdown of these cases by type of asset, amount
Of marital deduction and whether or not the alternate date
was advantageous. Analysis of Table 7-I indicates that
in 32,449 cases (8,669 + 23,780), or about 41% of the E}

total number, the alternate value was advantageous.

 

Further analysis of the table indicates that the type of
asset and amount of the marital deduction are important F
variables. Therefore, the results will be presented next

independently for each of the four possible combinations.

Capital Asset - Zero Marital Deduction

There were only 46 cases in this group Of 19,950
cases in which the selection of the alternate date was
advantageous. An analysis of those cases indicated
several things. First, in all of them, the beneficiary's
income tax bracket was 70%. Second, the size of the
estate at death was either $200,000 or $300,000. The
value at the alternate valuation date was at least 160%
of the date Of death value. Finally, all sales of the
assets from estates with an original value (a) Of $200,000
toOk place within 36 months and (b) of $300,000 toOk

place within 18 months.

160
Reviewing all the factors just mentioned, it would
be highly unlikely that these 46 cases represent actual
situations. Therefore, if the estate consists of capital
assets and does not claim a marital deduction, the higher
alternate valuation date should not be used. The results
are reasonable because these gains are taxed at a maximum

of one-half the beneficiary's income tax rate.

TABLE 7-I

ADVISABILITY OF USE OF ALTERNATE DATE
BREAKDOWN OF CASES BY TYPE OF ASSET, MARITAL
DEDUCTION AND ADVANTAGE OF USING ALTERNATE DATE

 

 

 

 

 

 

 

 

T Alternate Date
ZSP:e:f Advantageous Not Advantageous
Marital Dad. 0% 50% 0% 50% Total
Capital 46 10,285 19,904 9,665 39,900
Not Capital 8,623 13,495 11,327 6,455 39,900
TOtal 8,669 23,780 31,231 16,120 79,800
\_

 

Capital Asset - Fifty Percent Marital Deduction

Of a total of 19,950 cases in this group, 10,285
irnflicated that the alternate date should be selected.

An analysis based on the beneficiary's income tax
bracket indicated that in none of the cases in which the
beheficiary's income tax rate was 20% or less did the
alternate date prove to be advantageous. On the other

h . . .
and. lf the benefiCiary's tax rate was 60% or more, the

 

 

1 - ., swells.---

161
alternate valuation basis was always advantageous. If
the beneficiary's tax bracket was 40%, both possibilities
existed.

In an attempt to draw a decision rule for the 40%
tax bracket cases, they were analyzed based on the size
of the estate and future sale date. Table 7—II presents
the results of this analysis.

Table 7-II permits decisions to be made for many
«cases. For example, if the estate at death is valued at
$1,000,000 and all the assets will be sold within 42

HKInths, the alternate date should be selected. If the
assets will not be sold within the next 90 months, then
the date of death value should be selected. For cases
which fall between the times given in the table, indi-
Vixiual decisions have to be calculated taking into con—
Sixieration all the variables. This could be done by re-
rtuaning the computer program written for this chapter

uSing the specific variables.

Not Capital Assets - Zero Marital Deduction

Of 19,950 cases, 8,623 indicated the selection of
the alternate date.

Similar to the previous group, in no case in which

t . .
he benef1c1ary's tax rate was 20% or less was the

162

TABLE 7-11

TABLE FOR SELECTION OF CASES IN WHICH ALTERNATE DATE IS ADVANTAGEOUS

CAPITAL ASSETS - FIFTY PERCENT MARITAL DEDUCTION
- BENEFICIARY'S TAX RATE IS 4073

 

 

Alt. Date Advantageous Alt. Date Not Advantageous
Size of Estate if Assets Sold on or if Assets Sold on or Before
at Death Before (months) (c) (months) (c)
200,000 120 a
300,000 108 a-
400,000 96 108
500,000 90 108
600,000 84 102
700,000 66 90
800,000 60 90
900,000 54 90
1,000,000 42 90
1,100,000 36 66
1,200,000 30 54
1,300,000 24 54
1,400,000 18 54
1.500,000 12 48
1.600.000 0 36
1. 700,000 b 36
1.800 ,000 b 36
1$00,000 b 36
2,000 ,000 b 24
\

 

a. Since the study did not use a sale date further than 120 months, a
Sale date for which the alternate value shouldn't be used could not

be determined.

In these cases, the alternate value was only beneficial in some of
the cases even though there was immediate sale of the assets.

For cases which fall between the dates listed and those cases
11 which the alternate date is not always advantageous, individual
e'eisions must be calculated.

163

alternate date of benefit. When the beneficiary's tax
rate was 40%, the alternate date was advantageous only

if the value of the estate at date of death was $1,200,000
or less. Even if the estate was less than this amount,
the alternate date should not always be used. Table
7-III indicates for these estates when the alternate
Should always be selected and when it should never be
Sealected. Table 7-III has been constructed and should
be used similar to Table 7-II.

The cases in which the beneficiary's tax rate was
6C8% are presented in Table 7-IV and are similar to the
4C¥%;cases in that an absolute answer cannot be given for
all cases. When the value of the estate was $1,400,000
OI? less, the alternate date was always advantageous.
Table 7-IV is similar to Tables 7-II and 7-III.

When the beneficiary's tax bracket was 70%, the

alternate date was always advantageous.

NOtCapital Asset - Fifty Percent Marital Deduction

A total of 13,495 cases out of 19,950 indicated that
the alternate date should be used.

In no case in which the beneficiary's tax bracket
Was zero was the alternate date of benefit to the bene-

ficiary. In all cases in which the income tax bracket

164

TABLE 7-III

TABLE FOR SELECTION OF CASES IN WHICH ALTERNATE DATE IS ADVANTAGEOUS
NOT CAPITAL ASSETS - ZERO MARITAL DEDUCTION
BENEFICIARY'S TAX RATE IS 40%

 

Alt. Date Advantageous Alt. Date Not Advantageous

 

Size of Estate if Assets Sold on or if Assets Sold on or Before
at Death Before (months) (b) (months) (c)
200,000 96 108
300,000 78 96
400,000 60 90
500,000 42 90
600,000 30 54
700,000 18 54
800,000 0 36
900,000 a 36

1,000,000 a 24

1,100,000 a 12

1,200,000 a 12

1,300,000 - 2,000,000 Do not select alternate date

—‘

a. In these cases, the alternate value was only beneficial in some of
the cases even though there was immediate sale of the assets.

b- For those cases which fall between the dates listed and those cases
in which the alternate date is not always advantageous, individual
decisions must be calculated.

1.65

TABLE 7-JV

TABLE FOR SELECTION OF CASES IN WHICH ALTERNATE DATE IS ADVANTAGEOUS
NOT CAPITAL ASSETS - ZERO MARITAL DEDUCTION
BENEFICIARY'S TAX RATE IS 602

 

Alt. Date Advantageous Alt. Date Not Advantageous
Size of Estate if Assets Sold on or if Assets Sold on or Before
at Death Before (months) (months)

 

200,000 - 1,400,000 Alt. Date always advantageous

1, 500,000 108 a
1, 600,000 96 a
1, 700,000 90 a
1, 800,000 78 a
1,900,000 66 a
29000,000 60 120

3. Since the study did not use a sale date further than 120 months, a
Sale date for which the alternate value shouldn't be used could not

be determined.

of the beneficiary was 40% or more, the alternate was of
Value to him (her) .

The cases in which the tax bracket was 20% are
al'lalyzed by size of estate and sale date in Table 7—V.

This table is similar to Tables 7-II-7-IV and can be used

the same way.

166

TABLE 7-V

TABLE FOR SELECTION OF CASES IN WHICH ALTERNATE DATE IS ADVANTAGEOUS
NOT CAPITAL ASSET - FIFTY PERCENT MARITAL DEDUCTION
BENEFICIARY'S TAX RATE IS 2073

 

Alt. Date Advantageous Alt. Date Not Advantageous

 

 

Size of Estate if Assets Sold on or if Assets Sold on or Before
at Death Before (months) (c) (months) (c)
200,000 108 a F14
300,000 84 102 ‘
400,000 72 90
500,000 66 90
600,000 60 78 J
700,000 54 72
800,000 48 72
900,000 42 72
1,000,000 36 72
1,100,000 30 . 48
1,200,000 24 . 42
1,300,000 18 42
1,400,000 12 42
1,500,000 6 42
1,600,000 0 30
1,700,000 b 24
1.800.000 b 24
1,900,000 b 24
2:000,000 b 18
"\

 

8. Since the study did not use a sale date further than 120 months, a
Sale date for which the alternate value shouldn't be used could not
be determined.

In these cases, the alternate value was only beneficial in some of
':he cases even though there was immediate sale of the assets.

For those cases which fall between the dates listed and those cases
in which the alternate date is not always advantageous, individual
decisions must be calculated.

167

Summary and Recommendation

It has been suggested by numerous other authors that
the selection of the alternate valuation date could be

advantageous to the beneficiary of an estate which has

increased in value during the six months. Although a

larger estate tax will be paid, it was felt that the

income tax savings, because of the stepped up basis,

might offset this additional tax. Caution should be used

before following this suggestion.

The results of this study indicate that the selec-

tion of the alternate date will be beneficial in many

cza-ses. In exactly which cases the alternate date should

be used is significantly affected by the type of asset

and the amount of the marital deduction claimed. This

is reasonable because of the direct effect that these

have on the dollar amount of the tax on the gain and the

dollar amount of the estate tax. Therefore a more accu-

rate decision rule will be based on these two variables.
If the appreciated assets are capital assets and no
marital deduction is claimed, do not select the alternate
Value. If they are capital and a fifty percent marital
deduction is claimed, use the alternate value if the

betleficiary's tax rate is 60% or more. Do not use the

alternate date if it is 20% or less. If it is 40% use

168

Table 7-II. If the assets are not capital assets and no

marital deduction is claimed, use the alternate date if the

beneficiary's tax rate is 70%. Do not use the alternate
date if the tax rate is 20% or less. If the tax rate is
40%, use Table 7-III; if it is 60%. use Table 7-IV. If the
assets are not capital and the marital deduction is fifty
percent, use the alternate date if the beneficiary's tax
rate is 40% or more. Use the date of death value if the
rate is 0%. If the rate is 20%, use Table 7-V.

In all cases in which the actual transfer to the
Surviving spouse is greater than 50%, use the rules for
a fifty percent deduction. (See Chapter 2 for a discus-
sion of the limit on the marital deduction claimed.) If
tl'le actual transfer is between 0% and 50%, individual
solutions have to be worked up considering all the vari-
a1>les. This can easily be done by running the modified
c30mputer program which will be written inserting the
Specific values for the variables. The same technique
must be used for all cases which fall between the sale
datea listed in the tables presented.

By using these new improved rules, the beneficiary
will end up with more assets after completing all sales

than by following the old rule or by simply using the

date of death value.

CHAPTER 8
WAIVER OF EXECUTOR'S COMMISSION

The final rule-of-thumb that was tested related to

the waiver of the executor's commission. If the executor

is unrelated to the planner and is given the choice be-

tween taking a percent of the estate as a commission or

bequest, he should always take the bequest. It will be

advantageous because he will receive the money free of

income tax. If the executor is related to the benefi-

Ciary and is entitled to a percent of the residual estate,

the answer is slightly different. In this case, the

eXecutor has to choose between receiving a commission
(which is taxable) and a share of the remaining estate
or receiving only a share of a larger estate. It has
been suggested that the executor might be better off
receiving just a share of the estate even though it is
sl'tialler than the sum of the conunission and the share of
the residual estate he is entitled to because of the
iIlcon'te tax savings. The rule-of—thumb that a residual
beneficiary should waive his commission has been tested

169

170

to see if the waiver would be beneficial under different

situations.

Law Relating to Executor's Commission

An executor's commission, like other commissions, is
income taxable to the recipient. From the estate's point
of view, the commission is part of the administration ex-
penses and is, therefore, deductible either on the estate
tax return or the estate's income tax return. (See
Chapter 6 for a more complete discussion of the deduct-
ibility of administration expenses.)

A question arises whether an executor who, by terms
of the will, is to receive a bequest instead of a com-
ndssion is then considered to have received prOperty from
a decedent or taxable income. The question was answered
7by'the Supreme Court in U.S. vs Merriam.l In that case,
“the court held that a bequest "...in lieu of all compensa—
txion or commissions to which they would otherwise be
Guititled as executors or trustees" was not taxable income
‘33 the beneficiaries. In an unrelated case, a court
stated that an estate is not entitled to an administration
eXpense deduction for commissions which were waived and

1Sup.Ct. 69, 4 AFTR 3673.

171
therefore never paid.

Another question was whether the executor could uni—
laterally waive his commission and thereby avoid having
taxable income. Revenue Ruling 56—4723 answered the ques-
tion. In the particular situation, the executor had
waived his commission before performing any services.

The Service held that the executor does not realize in—
come if there is a clear and irrevocable waiver of his
commission "unless he has committed an act which would
imply prior acceptance or exercise of ownership, dominion
(or control of the amounts so waived." At the same time,
tihe Service held that the waiver does not constitute a
gift for gift tax purposes.

Somewhat later the Service ruled that an executor
cusuld not waive his commission after having performed
Starvices for several years.4 To clarify exactly when
313 executor may waive his commission, Revenue Ruling
6(5-167 was issued.5 It stated that the waiver need not

Precede all services to be effective. The important

2Mitchell vs. Westover 3 AFTR 2d 1894.

31956-2 cs p. 21.

4Revenue Ruling 64—225, 1964-2 CB p. 15.

51966-1 ca p. 20.

172
point is that the executor intends to render gratuitous
services. Specifically, he may waive his commission in
one of two ways. Either he may send a formal waiver to
the principal beneficiaries within six months after his
initial appointment, or he may imply it by failure to
claim a deduction for the commission on the accountings
that he supplies. Under the latter method, "other facts
and circumstances must indicate the executor's intention."
IExactly what "other facts and circumstances" are necessary

was not defined .

Estate Planning

Several authors have mentioned that the executor
should consider waiving his commission. One author has
mentioned that if the executor is also a beneficiary, he
‘would be waiving taxable income, and in its place receiv-
ing a larger tax free distribution.6 He mentions that the
deductibility of the commissions must be considered also.

A second author has given a more detailed list of

Variables to be considered.7 It includes:

‘__

6William K. Stevens, "How Post—Mortem Estate Plan-
Iling Can Reduce Income and Estate Taxes," Journal of
Taxation, November 1964, p. 288.

 

 

7Irving Evall. "'Hidden' Estate Tax-Saving Tech-
niques can be Found in Interplay of Tax Law," Journal of
Taxation, November 1963, p. 285.

173

l. The cost to the executor of the lost
commissions;

2. the income tax savings if the commissions are
deducted on the income tax return of the estate;

3. the estate tax savings if the commissions are
deducted on that return; and

4. the income and estate tax savings if the
deduction is allocated between the two tax
returns of the estate.

Even this list is not complete. An important variable
that has been overlooked is the executor's share in the
residual estate. If the executor receives less than 100%
of the residual estate, it is possible for all the bene-
ficiaries other than the executor-beneficiary to be better
off by the waiver while the executor is worse off. By
including this variable, it is possible to test the deci-
sion rule to make sure that none of the beneficiaries is
worse off.

This part of the study has been designed to deter-

mine if the executor would be better off to waive his com—

mission and take under the will considering all of the

above factors .

.The Simulation Mode}
Va riables
Four variables were included in the model. They

”Vents: size of the estate, income of the estate, executor's

174
income tax bracket, and the executor's share of the
residual estate. The allocation of the administration
expense deduction between the estate tax return and the
estate's income tax return was not considered a variable.
In each case, the deduction was allocated Optimally. The
optimal allocation was the one which maximized the total
transfers of income and corpus after subtracting the in-
come and estate taxes due.
Size of Estate
The size varied from $200,000 to $2,000,000 by incre—
ments of $100,000. This is the‘same range as has been
used in all the other parts of this study.
Income of the Estate
The income ranged from $0 to $100,000 by increments
of $20,000. Although this does not cover all of the pos-
sibilities, it does include most of the realistic ones and
therefore would permit a valid test of the rule-of-thumb.
Executor's Income Tax Bracket
This variable ranged from 0% to 60% by increments of
320%. This is approximately the same range as the ones
llsed in previous parts when a beneficiary's tax bracket
was specified .
Executor's Share of Residual Estate

The share varied from 25% to 100%,by increments of

 

175
25%. It was included to determine if the executor would
benefit from a waiver if he was not entitled to the full

increase in the estate because of the waiver.

Methodology

Chart 8—I is a flow chart of the program written to
simulate this model. The program proceeded as follows:
The estate was set at $200,000. The estate income was
set at $0. The executor's income tax rate was 0%. The
executor's share of the residual estate was set at 25%.
The dollar amount of the commission was calculated as
10% of the estate. The commission was allocated between
the estate and income tax return to provide the maximum
benefit. (The allocation was performed pursuant to the
rules discussed in Chapter 6). The estate tax was calcu-
lated after deducting the correct percentage of the com—
mission. The income tax was computed after deducting the
I‘emaining commission. The executor's receipt from the
eState as a beneficiary was the sum of l) the executor's
Share multiplied by the value of the estate minus the
Estate tax and commission, and 2) the executor's share
"“Jltiplied by the estate's income minus the income tax
and commission. To this amount was added the after tax

receipt of the commission which was the commission times

 

176

CHART 8-I

FLOW CHART FOR WAIVER OF COMMISSION

 

Wary Size of Estate (D_E) 200,000—$000,000 by lOQLOOO j<—-—-—
I

 

 

 

 

 

 

 

 

Mary Estate Income (INC) 0-100,000 by ZOAOOO :I<—--—1
[Earl Executor's Tax Rate (ETAX) OI-6OZ by 20% jé—1
IV_ary Executor's Share of Estate (SIIARE) 252-1001 by 25% je
Emission - 101 x DE i j

 

' llocate Commission between Income Tax and Estate Tax
Returns to provide thimal Deduction

I

alculate Estate Tax on DE - Deduction for Allocated
Commission
I

Calculate Income Tax on INC - Deduction for Allocated
Commission
I

Calculate Executor's Receipt from Estate (T) - [Share x
(DE - Estate Tax - Commission)] + [Share x (INC -
_Income Tax - Commission)]

 

 

 

 

 

 

 

_l I
Calculate Total Receipt by Executor (R1) - T +
LCommission minus Income Tax due on Commission

 

 

 

 

 

 

_ I
Eglculate Estate Tax on DE without Commission I
__ I
talculate Income Tax on INC without Commission j

 

 

Calculate Receipt by Executor in Waiver (R2) - SHARE x
g(DE - Estate Tax) + SHARE x (INC - Income Tax)

 

 

 

PRINT (R1 - R2)

 

 

 

 

 

10}

 

 

 

 

 

 

177
one minus the executor's tax rate. The receipt by the
executor if he waived his commission was then calculated.
It was the sum of his share times the gross estate minus
the applicable estate tax and the estate income minus the
applicable income tax. The difference in the receipts
was then printed. The executor's share was increased by
25% and all the calculations were redone. After his share

equaled 100%, the other variables were increased in turn.

ZLimitations

There are two limitations on the model. The first
is that the estate lasts exactly one year and one day.
'This limitation was to prevent any of the income from
laeing taxed to the beneficiaries. It does not really
limit the model, but eliminates the problem of specifying
'time and amounts of distribution and the different effec—
tive tax rates of all the beneficiaries who received
these taxable distributions.

The other limitation is that no marital deduction
was provided for. It is assumed that the executor is not
the surviving spouse. If the executor is also entitled
‘to a share of the spouse's estate, which is reasonable,
a1'1 adjustment because of the increased marital deduction

vWould have to be made for the additional tax due

178
when the spouse died. To calculate this, some of the
other variables which would have to be included would be
surviving spouse's estate, surviving spouse's remaining
life, and rate of return. It was therefore felt that it

would be better to eliminate the marital deduction.

Results

In total, 1,824 cases were generated. Table 8-I
gives a breakdown of these cases by size of estate. It
can be seen from Table 8-I that in 191 cases, the executor
should waive his commission. Table 8-II gives a breakdown
by size of estate and estate income of those 191 cases in
which he should waive his commission.

It was mentioned earlier that a waiver of the commis-
sion would increase either the estate tax or the income
tax or both because of the reduction in the deductible
administration expenses. It would be reasonable there—
fore, to expect the number of cases in which the waiver
was beneficial to decrease as either the size of the
estate or the estate's income increased, because of the
increased value of the lost deduction. A review of
Table 8—II indicates that the expectation holds for amount
of income but not always for size of estate. The number

of cases in which the commission should be waived

.179

TABLE 8-I

CASES REGARDING WAIVER OF COMMISSION
BREAKDOWN OF CASES BY SIZE OF ESTATE

 

 

 

 

Size of Waive Do not Waive
Estate Commission Commission Total
200,000 7 89 96
300,000 8 88 96
400,000 9 87 96
500,000 9 87 96
600,000 10 86 96
700,000 10 86 96
800,000 12 84 96
900,000 12 84 96
1,000,000 12 84 96
1,100,000 12 84 96
1,200,000 12 84 96
1,300,000 12 84 96
1,400,000 10 86 96
1,500,000 10 86 96
1,600,000 10 86 96
1,700,000 9 87 96
1,800,000 9 87 96
1,900,000 9 87 96
2,000,000 __ji 87 96
Total 191 _l_,_6_1_3_3_ _l_,_8_2_4_

 

 

 

CASES IN WHICH COMMISSION SHOULD BE WAIVED

18C)

TABLE 8-II

BREAKDOWN BY SIZE OF ESTATE AND ESTATE INCOME

 

 

 

Size of Income
Estate 0 20,000 40,000 60,000 80,000 100,000 Total
200,000 3 3 1 0 0 0 7
300,000 3 3 1 l 0 0 8
400,000 3 3 2 1 0 O 9
500,000 3 3 2 1 0 0 9
600,000 3 3 2 1 1 0 10
700,000 3 3 2 l 1 0 10
800,000 3 3 3 2 1 0 12
900,000 3 3 2 2 1 1 12
1,000,000 3 3 2 2 1 1 12
1,100,000 3 3 2 2 1 1 12
1,200,000 3 3 2 2 1 1 12
1,300,000 3 3 2 2 1 l 12
1,400,000 2 2 2 2 l 1 10
1,500,000 2 2 2 2 l l 10
1,600,000 2 2 2 2 1 1 10
1,200,000 2 2 2 1 1 l 9
1,800,000 2 2 2 l l 1 9
1,900,000 2 2 2 1 1 l 9
2.000.000 .2 __2. .2. .1 _1_ _1_ ....9.
Total _§_(_)_ 10 _3_Z_ _2_7_ _l_5_ 1; 191

 

181
increases through estates of $1,300,000. The explanation
is that the estate's income is the more important vari-
able because it has the higher effective tax rate.

Further analysis of the 191 cases indicates that in
certain generalized situations, the executor should never
waive his commission. If his income tax rate is twenty
percent or less, he should always take his commission.

If the executor's share of the residual estate is 50%,or
less, he should again take his commission. Therefore, the
rule-of-thumb should state that if the executor's marginal
tax rate is twenty percent or less or if his share of the
residual estate is 50% or less, he should not waive his
commission.

If the executor's share of the residual estate is
75%, he should take his commission When his marginal tax
rate is forty percent or less. If his tax rate is sixty
percent, it depends on both the size of the estate and
the estate's income. To facilitate the executor's deci—
sion, Table 8-III was constructed.

If the executor is entitled to 100% of the residual
estate, the decision must be based on all four variables
(namely: size of estate, estate income, executor's share
and executor's tax rate). Therefore, Table 8-IV was

develOped. Both Tables 8-III and 8-IV should permit the

DECISION TABLE FOR WAIVER OF COMMISSION

182

TABLE 8-III

BY ESTATE'S SIZE AND INCOME

Executor's Share
Executor's Tax Rate

75% of Residual Estate

601

 

Size of
Estate

Income of Estate

20,000

40,000

60,000

 

200,000
300,000
400,000
500,000
600,000
700,000
800,000
900,000

1,000,000

1,100,000

1,200,000

1,300,000

1,400,000

1,500,000

1,600,000

1,700,000

1,300,000

1,900,000

2,000,000

x

2282282228822222222

Aw ‘ Waive commission

2222282822222822222

22228222822222222

282822282

If the estate's income is $80,000 or more, do not waive commission.

183

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.MNHm m.MH<Hmm Wm onmmszou mo MH>H<3 mom mqm<H onmHumn

>Hlm mgm<H

184

executor to make timely decisions.

Summary

This part of the study tested the rule—of-thumb that
the executor should waive his commission and take under
the will if he is entitled to part of the residual estate.
The rule-of-thumb is not unqualifiedly sound.

The results indicate that if the executor's share of
the residual estate is 50% or less or his tax rate is
20% or less, he should take his commission and pay the
income tax on that amount. If the executor's share is
75% or 100% of the residual amount, there were cases in
which he should waive his commission. Unfortunately,
they do not present a simple rule-of—thumb. To facilitate
the decision, the executor can refer to Tables 8—III and
8-IV which indicate whether or not to waive his commission
based on the size of the estate, the estate's income and

his own income tax bracket.

CHAPTER 9

SUMMARY AND CONCLUSIONS

In this study seven aspects of estate planning have

been tested. Each is typically handled in terms of "rules-

of-thumb." Included were:

A.

Pre-death

1. Marital Deduction

2. Gifts "in Contemplation of Death"

3. Inter Vivos Trusts

Post-Mortem

1. First Income Tax Year of Estate

2. Deduction of Administration Expenses
3. Alternate Valuation Date

4. Waiver of Executor's Commission

A simulation model was constructed for each of the

seven techniques. These models generated the data which

were analyzed to determine if the general rule—of—thumb

provided Optimal solutions. An Optimal solution was

defined as the one which maximized the sum value of the

transfers to be received by the surviving spouse, the

185

186

children, and other residual beneficiaries.

A.l. Marital Deduction

 

The general rule-Of—thumb connected with the marital
deduction has been to transfer exactly 50% of the estate
to the surviving spouse except if the spouse's estate is
large. It was found that this procedure does not give

Optimal results.

 

The model provided the data to develop new rules to
replace the inaccurate one. In terms of the after-tax
rates Of return the new rule states:

If the spouse's rate is less than or equal to
the other beneficiaries' rates and his(her) estate
is greater than or equal to the decedent's estate,
no qualifying transfer should be made. For those
cases in which the decedent's estate is larger,
transfer between 0% and 40% if the spouse's rate
is less than the other beneficiaries' rates and
between 0% and 50% if the spouse's rate equals
theirs. In most cases, zero will be the Optimal
size of the transfer. If the spouse's rate is
greater than the other beneficiaries', the Optimal
has to be determined independently for each case.

In terms of the surviving spouse's remaining life the

187
rule is:

In most cases the transfer should be zero, un-
less the surviving spouse outlives the decedent by
more than six months. If the remaining life is
sixteen years or more, transfer zero if the spouse's
rate of return is less than that of the other bene-
ficiaries and transfer 100% if the spouse's rate
exceeds the other beneficiaries' rates.

The model was then used to test the cost of over- or
under-qualifying when the Optimal transfer was 50%. The
additional tax cost in many cases turned out to be lower
than the cost of transferring exactly 50%. On average,
it turned out to be better to under-qualify.

In addition to testing the general rule-of-thumb,
the model indicated that the credit for prior taxed

transfers does not completely eliminate double taxation.

A.2. Gifts in Contemplation of Death

The general rule-Of-thumb is that a gift in contem-
plation of death will reduce overall taxation because the
dollars used to pay the gift tax amnot added back into
the estate. The large majority g£_cases verified the
rule-Of-thumb. The only time the gifts were disadvanta-

geous was when the decedent's estate was relatively small

188
and sizeable gifts had been made in the past.

The model pointed out that the earnings of the gift
and the income tax consequences of transferring taxable
income were very important. In fact, these income tax
consequences could more than offset the estate tax savings
derived from the gifts.

One final point illustrated by the model is that the
additional tax cost of a gift ruled in contemplation of
death is relatively small in relation to the size of the
decedent's estate. This raises the question whether the
executor should incur a great deal of costs in rebutting
the presumption that a gift within three years of death

is in contemplation of death.

A.3. Inter Vivos Trusts
Trusts are considered important estate planning
devices. They are supposed to provide both monetary and
non-monetary advantages. The question which has in the
past not been completely answered is whether or not inter
vivos trusts are justifiable strictly on monetary grounds.
The study results ig Chapter gusgpport the general

rule—Of-thumb that trusts are beneficial lg monetary terms

 

(other considerations aside) even after subtracting the

 

ggpts and fees involved. The only time trusts are

189
disadvantageous is when the beneficiary's income tax
bracket exceeds that Of the planner. In all other cases

a trust will increase the total receipt by the beneficiary.

B.l. First Income Tax Year of Estates

It has been suggested that there is an advantage to
selecting a short first income tax year because of the
additional personal exemption and possible lower tax
rates. The exact cases in which it would be beneficial
have not been specified.

The simulation model indicates that there is 22 gas

simple rule that can be followed. It did, however, indi-

 

cate that the emphasis has been in the wrong place. In
the selection of the first tax year, the effects of the
distribution of the estate's income to the beneficiary

in the final year should be considered the primary
determinant. This does not mean that the executor or
administrator should arbitrarily select either a twelve
month fiscal or calendar year. The selection of the wrong
year could significantly reduce the receipts of the bene-
ficiary. The exact solution requires an examination of

the variables in the individual case.

190

B.2. Deduction of Administration Expenses

 

The general rule-of-thumb states that administration
expenses should be deducted on the tax return with the

highest marginal tax rate. This rule will not always pro—

 

vide the thimal decision.

 

The rule can be restated as:

Deduct the administration expenses on the tax
returns so that the effective tax rates are equal.

The effective income tax rate is either the estate's

marginal income tax rate or the beneficiary's marginal

income tax rate depending on who reports the income.

The effective estate tax rate depends on whether or

not the maximum marital deduction is claimed. If

the maximum is not claimed, the marginal rate is

the effective rate. If it is claimed, then the

effective rate equals one-half the marginal rate.

The model did not vary the estate's first income tax
year. However, its inclusion would not change the result.
The first tax year should be selected ignoring the admin-
istration expenses. These expenses should then be allo-

cated based on the above rule.

191

B.3. Alternate Valuation Date

 

The general rule-of-thumb is that the selection of
the alternate valuation date when the assets have in-
creased in value will reduce overall taxation in those
cases in which the reduction in the income tax on the
reduced gain exceeds the increased estate tax. "Those
cases" have not been specified.

The selection 9f the alternate date will be bene-

ficial i3 many cases. The exact cases ig which i; should

 

 

 

be used depends 99 the type 9f asset and the marital

 

 

deduction. Therefore, the following rules have been

 

suggested:

If the assets are capital assets and no marital
deduction is claimed, do not select the alternate value.
If they are capital assets and a fifty percent
marital deduction is claimed use the alternate
value if the beneficiary's income tax rate is 60%
or more. Do not use the alternate date if the rate
is 20% or less. If the rate is 40%, Table 7-II
included in Chapter 7 should be used.

If the assets are not capital assets and no
marital deduction is claimed, use the alternate
date if the beneficiary's tax rate is 70%. Do not

use the alternate value if the tax rate is 20%. If

192
the rate is either 40% or 60% use Tables 7—III
and 7—IV. If the assets are not capital and the
marital deduction is fifty percent, use the alter-
nate date if the beneficiary's tax rate is 40% or
more. Use the date of death value if the tax rate

is 0%. If the rate is 20%, use Table 7—V.

B.4. Waiver of Executor's Commission

 

The general rule-of-thumb is that the executor should
waive his commission and take under the will if he is

entitled to part of the residual estate. This "rule"

 

ehould not always be followed.

 

 

The model indicated that if the executor's share
of the residual estate is 50% or less or his tax
rate is 20% or less he should take his commission
and pay the income tax on that amount. If the
executor's share is 75% or 100% a simple rule—of-
thumb could not be provided. Instead, Tables 8-III
and 8—IV in Chapter 8 were created based on the size
of the estate, the estate's income and the executor's
income tax bracket which will assist him in the

decision.

193

Overall Conclusions

 

This study has tested several rules-of-thumb and
modified some of them. In many areas a simple rule could
not be developed. For these areas, computer models have
been developed which will provide exact answers for the
individual cases.

These models only included the variables used in the
individual parts of this study. It is hOped that in time
these will be expanded to provide solutions to a greater

number of cases.

For The Future

 

This study should not be considered to be exhaustive
of the examination of and improvement potential in estate
planning. Although the conclusions reached may be im-
portant, they should not be the only useful output from
this study. Instead, this study should be considered the
foundation upon which larger and different models should
be constructed which will remove the limitations which
have had to be included.

It is hOped that this study will stimulate others
who are currently using computers in other areas of taxa-
tion and estate planning to do research in this area.

The end product of all this research will be improved

194
estate planning for the public and improved competence
and acceptance of the members of the different professions

who work in this field.

LISTINGS OF TAX

ESTEX

TAXON

GFTTAX

TONG

TOINC

APPENDIX A

Calculation

Calculation

Calculation

Calculation

Calculation

COMPUTATION SUBROUTINES

of taxable estate's and credits
of estate tax

of taxable gift

of gift tax

of estates income tax

195

SUBROUTINE LISTING-ESETX

SUBROUTINE ESFTX
REAL LOSS,MD
INIEGER_PRITRN,DATEPD,CONTEM
COMMON IBLKl/GE,ADMEXP,DEBT59LCSS.CHAR,MD.PRITRN,DATEPD,ZPTRAN,
lPRITE,PRITAX,CONTEM,ZGIFT,ZGIFTX9ZVGIFTgEXCLoESTAX,TAXEST
..,DATA IYES I'YFS'I
1399- ADJQE = GE - IADMEXP + DEBTS + LOSS)
_ TAXEST : ADJGE - (60000. + CHAR + MD)
IF (TAXEST .LF. 0.) GO TO 31
CREDIT : 0.
CRGTX = 0.
CALL TAXCN (SLOP1.TAXESTI
IF (PRITRN .EQ. IYESI GO TO 10
GO TO 20
.10-- IE (DATEPD .GT. 10) as T0 20
ACRED =1.0
IF (DATEPD .LF. 2) GO TO 15
90 ll 1:2,,DATEPD. 2
ACRED=ACRED - .2

J1} CONTINUE

“--.—..-“. ...-.— . . .... _‘

-..-..-
~——_——..__

.15-

16

20

”- .. - ..

-_ 2?

23‘__

.ucfifiTXI1IG‘F'X

196

SUBRUUTINE LISTING-ESETX
CREDI = IIZPTRAN/(PRITE + 60000.))*°9ITAX)*ACRED
SLCPZA = TAXEST - ZPTRAN
CALL TAXCN (SLOP2.SLOPZA)
CREDZ=ISLOPl-SLOPZI*ACRED
IF (CREDI .cr. caeoz1 GO TC 16
CREDIT = CREDI
00 T0 20
CREDIT = caeoz
If ICONTEM .EQ. IVES) 60 T0 21
an TO 30

ZGIFTI = ZGIFT - EXCL

.IfDIZGIle .GT. lVGIFT) GO TO 22

SLOP3 8 ZGIFTI

GO TO 23
,_5E9?3 f zvcht
TEMP! = (SLOP3/(GE - (MD + CHAR)I)*SLOP1

_IF*(ZGIFTX .01. TEMPII GO TO 25

__60 T0 30

FRGTX_= TEMPl

....
H-..

31.

197

_SUBRDUTINE LISTING-ESETX
ssrnx = SLOPI-ICREDIT + CRGTXI
RETURN
E51” .300
RETURN

END

198

SUBROUTINEHLISIINfitlAXON

u-SUBROUIINE TAXOH.ITAX. IXSI)

-DIMENSION UPLIH I25). BASETX I24). TXRAIE (24!

-«-DAIA UPLIM/0.. 5000.. 10000.. 20000.. 30000.. 40000.+-50000..
160000.. 100000.. 250000.. 500000.. 750000.. 1000000.. 1250000..
11500000.. 2000000.. 2503000.. 3000000.. 3500000.. 4000000..
-15000000..6000000..7000000..8000000..10000000.]

DATA bASETX/ 0.. 150.. 500.. 1600.. 3000.. 4800.. 7000.. 9500..
120700.. 65700.. 145700.. 233200.. 325700.. 423200.. 528200..
1753200.. 998200.. 1263230.. 1543200.. 183BZOO..2468200..3138200.9
13830200..4568200./

.DATA TXFATE/.03..07..11..14..16..22..25..28..30..32..35..37..39.
L.42..45..49..53..56..59..63..67..70..73..76/

IFITXST .GT. 10000000.) GO TO 30
-00.10 J= 1. 25
“IF IIXST .GT. UPLIM IJII GO-IU 10

I-K = J-l
l EXCESS = TXSI - UPLIM IK)

. 1--mm_IAK.? BASETX IKI * (EXCESS * IXRATE IKII .

60.10 20

10- _LCONIINUE

.M .. -.'~- --.~-

__._ - 20.
3 C

199

SUBROUTINE LISTING-TAXON

Maui‘s -

RETURN
TAX= 6088200.
RETURN

END

--- —
...- .
-.. .- ..
_..._
-——.
-— u
...- ..
.—
——I. ..-
...— -
— r—o ... _
Arm...- ...-...... u—H . _-
...—... ... .. .-
_____ .. _1_
-C‘ -

+ ITXST-10000000.I*.77

- ...
.a
—.
a». V..-
—.
.. -.-

,--...-- ---m-

. -v- -~. ---.

- -..-999
-..- .10.-

‘--.

‘~—~-h_.-__.~_.

200

_SUBRGUTINE LISTING-GFTTAXWW1_
SUBRDUTINE GFTIAX (IAX..AGIEIIWCGIFTI
PIAXl=O.

PIAX2=0o

TAX =0.

AGIFTl = AGIFI - 3000. _-”_

SGIFT : AGIFTI + cc1sr
IF (CGIFT .EQ. 0.1 50 T0 10
CALL TONG (PIAX29CGIFT’

CALL TQNG 1p11x1, SGIFT)

rAx = PTAXl - PTAXZ

RETURN

EN 0

201

SUBROUTINE LISTING-TONG

SUBRUUTINE 70~0 (TAX. TXGFT)

DIMENSION UPLIM 1251. BASE 1241. RATE124I

DATA UPLIM/0.. 5000. . 10000.. 20000.. 30000.. 40000.. 50000..
160000.. 100000.. 250000.. 500000.. 750000.. 1000000.. 1250000..
11500000.. 2000000.. 2500000.. 3000000.. 35coooo.. 4000000..
15000000..6000000..7000000..8000000..10000000./

DAIA BASE l0.. 112.50. 375.. 1200.. 2250.. 3600.. 5250.. 7125..
115525.. 49275.. 109275.. 174900.. 244275.. 317400.. 396150..
-1503909.. 748650.. 947400.. 1157400.. 1378650..1851150..2353650..
12878650..3426150./

DAIA RATE/.0225. .0525. .0825. .105. .135. .165. .1875. .21. .225.
,1.24. .2625. .2775, .2925. .315. .3375. .3675. .3975. .42. .4425.
1.4725..5025..525..5475..57/

IF (TXGFT .07. 10000000.) 60 70 30
-...QQ-IO J 3 10 25 . .4 -

IF ITXGFT .GT. UPLIH 1111 GD 70 10

K a J-l
J_”§§§§S§ms 7ch7 - UPLIH (K) g
TAX . BASE (K1 + EXCESS . RATE 1K1

GO TO 20

10
20

30

202

SUBROUTINE LISTING-TONG

CONTINUE

RETURN

TAX: 4566150. + (TXGFT - 10000000.)* .5715
RETURN

END

203

SUBRDUTINE L1571N0-701Nc

SUBROUTINE 701Nc I7Ax.7INCI

DIMENSION UPLINIZSI.8A5E7241.RA7E7241

DA7A UPLIN/D..500..1000..1500..2000..4000..6000..8000..10000..
112000..14ooo..16ooo..18000..20000..22000..26000..32000..
138000..44ooc..50000..60000..70000..8oooo..9oooo..100000./
- DAIA BASE/0..7o..145..225..310..690..1130..1630..2190..2§30..
13550.,4330..5170..6D70..7o3o..9030..12210..15510..18990..2259o..
128790..35190..41790..4859o./

DAIA RA7E/.14..15..16..17..19..22..25..28..32..36..39..42..45..48,
1.50..53..55..58..60..62..64..66..68..69/

7INc1=7INc-6oo.

IF 171N01.07.100000.1 00 70 40

IF ITINCI .LE. 0.1 00 7D 30

DD 10 121.26

[EHIIINCI .07. DPLINIgII 00 7D 10

KsJ-I

excess 2 TINCl-UPLIHIK)
.JjgggmBASEIK) + Excess . RATEIKD

00 7D 20

10 CONTINUE

20
30

40

204

SUBROUTINE LISTING-TOINC

RETURN
TAXIO.
RETURN
TAX=55490.+ITINCI'IOOOOO.1*.7
RETURN

END

APPENDIX B

COMPUTER PROGRAM LISTINGS

Marital Deduction

Gifts in Contemplation of Death
Inter Vivos Trusts

First Income Tax Year

Deduction of Administration Expenses
Alternate Valuation Date

Waiver of Executor's Commission

205

PROGRAM LISTING FOR MARITAL DEDUCTION

REAL L055.MD.MDPER.MDI

INTEGER PRITRN.DATEPD.CONTEM

DIMENSIDN 73771

COMMON /dLK1/OE.ADMEXP.0EBT3.LOSS.CHAR.MD.PRITRN.DATEPD.ZPTRANO
1PRITE.PRITAX.CUNIEM.ZGIFT.ZGIFTX.ZVGIFT.EXCL.ESTAX.TAXEST
DA7A IND/'N0'/.IYES/'YES'/

DO 1000 IA=ZOUUQO.ZUUOOOU.ZOUOOO

DE=1A

DO 990 [83200000.20000009200000

SS=IB

ICl=6

DO 980 IC=6.36.6

ICZ=IC~ICI

RDRSS = Icz/Ioo.

DO 970 ID36936.6

101=ID-Ic1

RORB=IDIIIOO.

PRINT 10.1A

FORMAT ('0'.1X.'DECEDENT tSTATE'.10X.IBI

pRINT 20913

206

PROGRAM LISTING FOR MARITAL DEDUCTION

20 FORMAT I/.1X.'SPUUSE ESTATE'.1OX.18)

PRINT 30.102
30 FORMAT (/.1X.'SPUUSE RATE OF PETURN'.10X.I3I

PRINT 40.101
40 FORMATI/.1X.'BENEFICIARY RATE OF RE70RN'.10x.I31

PRINT 50
50 FORMAT I'0'.IX.'LIFE'.10X.'MARITAL DEDUCTION PERCENTAGE'I

PRINT 6o
60 FORMAT (1.23x.'0'.13x.120'.13x.-4o'.13x.'50'.13x.-60'.13x.-80'.13x

1.1100')

00 960 DAIEpD=1.22.3
99999 1:0

RORSSI=|1.*RDRSSI**DATLPO

R0RBI=(I.+R0RBI**DATEDD

PRITRN=INO

IE1=+20

DD 950 IE=20.60.20

IE2=IE - IFI

GE=0E

MDPER = IE2/IOO.

207

PROGRAM LISTING FUR MARITAL DEDUCTION

MD=GE*MUPER
SSI=S$+MD*RORSSI
CALL ESETX
T=GE-MD-ESTAX
T1=T*ROR31
GE=SSI
MD=O.
CALL ESETX
T2=$$I-ESTAX
I=I+1
T3III=T1+T2

950 CONTINUE
GE=DE
MD=GE*.5
SSI=SS+HD*RUR$SI
CALL ESETX
T=GEsMD-ESTAX
T1=T*ROR61
GE=SSI

MD=OO

208

PROGRAM LISTING FOR MARITAL DEDUCTION

CALL ESETX
T2=S$1-EST4X
I=I+l
T3III=T1+T2
DO 940 IF=60.100.20
GE=DE
PRITRN=INO
MDPER=IFIIOO.
MDI=GE*MDPER
MD=GE*.5
lPTRAN=MDl-MD
CALL ESETX
PRITE= TAXEST
PRITAX=ESTAX
T=GE-MUl-ESTAX
IF I T .LT. 0. I GO TO 100
T1=T*RDRBI

200 SSI=SS+MD1*RORSSI
PRITRN=IYES

GE=SSI

940

70

960
970
980
990

1000

100

999

209

PROGRAM LISTING FOR MARITAL DEDUCTION

MD=0.

CALL ESETX

T2=SSI-ESTAX

I=I+1

T3111=T1+T2

CONTINUE

PRINT 70.0ATEPD.(T3(JI.J=I.TI
FORMAT (I.IX.13.IIX.ITIF13.2.ZXIII
CONTINUE

CONTINUE

CONTINUE

CONTINUE

CONTINUE

GO TO 999

T1=0.

M01 = GE-ESTAX

ZPTRAN = MDl - MD

GO TO 200

CONTINUE

STOP

210

PROGRAM LISTING FOR GIFT IN CONTEMPLATION

REAL LUSS.MD
INTEGER PRITRN.DATEPD.CONTEM
.DIMENSION SAVING (3) .
COMMON /BLK1/Gt.ADMEXP.DEBTS.LOSS.CHAR.HD.PRITRN.OATEPD.ZPTRAN.
IPRITE.PRITAX.CONTEM.ZGIFT.ZGIFTX.ZVGIFT.EXCL.ESTAX
1“” - DATA IND I'NO'I
DATA IYES I'YES'I
DATA ROR/.06/
DATA RORl/.06/
IA 8 I
10 IF (IA .E0. 1) GO TO 30
IF (IA .E0. 2) GO TO 20
RORI= ROR1* .6
GO TO 30
.22.--- .ROB.I.=_.RURI* 1-25
30 DE 3 100000.
00 1000 18 = 1.19
,1“. ..DE.$-0EWA 100000. . H1-
CGIFT = -50000.

00 900 IC = I. 11

4O

50

60..-.

7O

80

211

PROGRAM LISTING FOR GIFT IN CONTEMPLATION

CGIFT = CGIFT + 50000.

IF (DE .LT. 700000) GO TO 40

.ALIM = 500000.

GO TO 45

ALIM 8 DE * .8

”PRLNT 59! IA

FORMAT ('1'. 20X. 'RUN NUMBER'o IX. I2)

PRINT 609 DE

.FDRHAT (' '.20X. 'DECEDEN7 ES7A7E-,1x.F9.01

PRINT 70. CGIFT
FORMAT I' '.20X. 'CUMULATIVE GIFTS'. 1X. F9.0)

PRINT 80

FURMATI'O'.'GIFT'.30X.'I YEAR‘.I9X.'2 YEARS'.19X.'3 YEARS'.19X.

I'SAVING')

ZGIFT = 00
IO = ALIM/SOOOO.

DO 90 IE = 1. ID

_ZGIFT = ZGIFT + 50000.

ZVGIFT = lGIFT

DO 100 ILIFE = 1.3

100

150

""410

90

212

PROGRAM LISTING FUR GIFT IN CONTEMPLATION
CALL GFTTAX IZGIFTX. ZGIFT. CGIFT)
DEl = OE - ZGIFT - ZGIFTX
IF I 0E1 .LT. O. ) GO TO 90
GESOE1+IIZGIFT+ZGIFTX)*II.+ROR1)**ILIFE)
CONTEM=INO
.1 CALL ESETX
A=GE~ESTAX
GE=DE-ZGIFTX
CONTEM=IYES
CALL ESETX
B=DEI~ESTAX+IZGIFT*I1.+ROR)**ILIFE)
SAVINGIILIFE)=B-A
IF ISAVINGIILIFE) .LE. 0.) JS=1
IOO CONTINUE
-.IF 1.1.5.60. 1) GO TO 200
150 JS=0
PRINT 110.ZGIFT.(SAVINGIIF).IF=I.3).SAV
-.110 ......EQBMATI'0'._.F9.0.15X.I3IF18.2.10X)_).:F18-2)
SAV=0.
90 CONTINUE

 

PROGRAM
900 comm-U.
M00 CONTINUE
IA = IA *
IF (IA .17
GO TO 900
1C0, GE‘DEI
CONTE!=1
IALL Egg
C‘EE1-E.
GE=UEI+
CALL ES
D=GE-C5
SAV=C-!
0070 1
.9999 COMM
STOP

END

900

1000

..290,

.29 9?-

213

PROGRAM LISTING FOR GIFT IN CONTEMPLATION

CONTINUE

CONTINUE

IA = IA + 1

IF (IA .LT. 41 00 70 10

00 7D 9999

GEEDEI .

CONTEM=INO

CALL ESETX
c=DE1-E57Ax+7201F7*71..R081**41
GE=DE1+IIZGIFT+ZGIFTX)*I1.+ROR1)**4)
CALL ESETX

D=0E-Es7Ax

SAV=C-D

0070 150

CONTINUE

$709

END

214

PROGRAM LISTING FOR GIFT TO TRUST
REAL LUSS.MD
INTEGER PRITRN.DATEPD.CUNTEM
...DIMENSION SAVING I5)
COMMON lBLKI/GE.ADMEXP.DtBTS.LOSS.CHAR.MD.PRITRN.DATEPD.ZPTRAN.
lPRITE.PRITAX.CONTEM.ZGIFT.ZGIFTX.ZVGIFT.EXCL.ESTAX
DATA IND l'NO'I
DATA IYES I'YES'I
ROR=.OS
“W 00, IO IA=200000.2000000.200000
DE=IA
JA=IOOOOO
..DO 20 IB= 100000.600000.100000
CGIFT=IB - JA
IF (DE .LT. 800000) GO TO 30
__._I-_LH=509000
GO TO 50
3C LIM= .8*DE
--iQ- .--DD- 60 IC=5 0000 .L. IN . 5.0000
ZGIFT=IC
PRINT 70. DE

-—--_

70

80

200

_-¢--.

130

999

215

PROGRAM LISTING FOR GIFT TO TRUST

00.- .

FORMAT I'I'. 20X. 'DECEDENT ESTATE’. 2X.

PRINT 80. CGIFT

FORMAT I'O'.20XQ 'CUMULRTIVE GIFTS', 2X,

PRINT 200. ZGIFT

FORMATI'O'.ZOX.'GIFT TO TRUST'.2X.F9.0)

. -931!” L3. 0
FORMAT I'O'.1X.'UEC. TAX RATE'95X0'BEN0TAX RATE'920XQ

1.4.914X.'8'913X9'12'.I5X9'Ib'

JB=ZO

DO 100 ID=20.80.20
A=0.
DTAX=IID-JB)/IOO.
DO 110 IE=20.80.20
A=A*1.

BTAngIIEfJBI 7100.

'16 3 0

DO 120 LIFED = 4.20.4

‘DRQR=ROR r Il.-DTAX)

DEI= DE*II1.+DROR)**LIFED)

GE=DE1*.9

.14X.'ZO')

F9.0)

F9.0)

...... .

'LIFE'ISOX.

PROGRAM L

CALL ESETX
ZBENI=0E-7
-IRUSTI=LQ
IDISII:.:
IDISTZ=7
RDRBsRCF
IBENA =

CALL CF

“ - DE2=DE-

IF (0E2

No

120

216

PROGRAM LISTING FOR GIFT TO TRUST

-.—

CALL ESETX

lBENI=GE-ESTAX

-.TRUST1=ZGIFT - 1000.

TDIST1=.95* ITRUSTI*ROR)

TDIST2=TDISTI*Il.-BTAK)

RORBsROR # I1.-BTAX)

ZBENA

TDIST2*IIII1.+RORB)**LIFED)-I.)IRORB)

CALL GFTTAX IZGIFTX. TRUST1.CGIFT)

DE2=DE-ZGIFT-ZGIFTX 2

IF IDEZ.LT. 0.) GO TO 20

UE3= DE2* II1+DROR)**LIFED)

66:09 * DEB

CALL ESETX

ZBENB=

IG 8 10 f I

GE-ESTAX

SAVING IIG)=ZBENA+ZBENB*TRUSTI-ZBENI

CONTINUE

IFIA .GT. I.) 60 T0 150

PRINT 140. DTAX98TAX. ISAVING III). II=IIS)

FORMAT

I'0'.11X.F3.2.16X.F3.2.5X. I5IFI5.2.1X)))

-4 - -Q.---- ‘ -

150
101
110
100
.99
20

10

217

PROGRAM LISTING FOR GIFT TO TRUST

GO TO 110

PRINT 101, BTAX, (SAVING (II),II=195)
FORMATI'0'930X9F3.295X9 I5IFIS.29IX)I)
CONTINUE

CONTINUE

_CONTINUE

CONTINUE
CONTINUE
STOP

END

218

PROGRAM LISTING FOR TAX YEAR

DIMENSION DIST (12,9)
DATA DIST/108*O./
DO 10 1810000.LQQOOO.IOOQO
EINC=I
DO 20 IA=IOOUO.IUUUOO,IOOOO
EEXP=IA
DO 30 IB=20.80.20
BTAX=IIB-20I/IOO.
PRINT 40gEINC
40 FORMAT ('1'93OX9'ESTATE INCOME'.IX.F8.0)
PRINT 50.EEXP
50 . FORMAT ('0'930X9'ESTATE EXPENSES',IX,F8.0I
PRINT 609IC
60 FORMAT I'O'.3OX,'BENEFICIARY INC TAX RATE',1X,I4.IX.'2')
“El—.lffi" 1.4-. -
CALL TAXYR (DIST,EINC,EEXP,BTAX,ELIFEI
PRINT 70
-.lQ.--,..._f.OB.flAJ. I! '1 'Lle 0F'y3X¢7LENG~TH 0'“ 123.81 'PATTERN-D£..RECEIPIS[
IEXPENSES'IZXy'ESTATE'g3X,'FIRST YEAR', on'SL/SL'.6X"SL/DEC'96X,

l'SL/ACC'pSXc'ACC/SL'94X.'ACC/DEC'94X.'ACC/ACC'g5X.'DEC/SL'94X.

80

_LQQ~

9C

200

110

.—r

“3.90. ---

219

PROGRAM LISTING FOR TAX YEAR

I'DEL/DEC'.4X.’DECIACC')

PRINT BO.ELIFE,(DIST(I,ll).ll=1.9)

‘FORMAT I'0'.4X,F3.0.7x.'l‘,7x,9(F10.g,1X)I
00 9o J=2.12

PRINT 100.J.(015r(J.1v:.1v=1.9)

FORMAT t'o',13x.12,7x.9(F10.2.1x))
CONTINUE

ELIFE=18

CALL TAXYR (0151.5INc.EExp.arAx.ELIFE)
PRINT zoo, ELIFE.(DIST(1.IZ),IZ=1,9I
FDRMATI'O'ol/.5X.F3.U.7x.'l'.7x.9(F10.2.1X!)
DO 110 4:2.12

PRINT 100.J.IDIST(J.IY).IY=1.9)

CONTINUE

ELIFE=24

CALL TAXYRIDIST.EINC.EEXP.BTAX.ELIFE)
PRINT 300.ELIFE.(01$T(1.Il).11=1.9)
FORMATI'I'.QXLF3.Og7X,'1'97X.9IF10.291X))
DO 120 J=2.12

PRINT IOOkoIDISTIJoIYIoIY=199I

120
30
20 -

10

20

4o

- -..—“- -— oar—J

PROGRAM LISTING FOR TAX YEAR

CONTINUE
CONTINUE
CONTINUE
CONTINUE
STOP

END

SUBROUTINE TAXYRIDISTvEINCoEEXPoBTAXoELIFEI

DIMENSION DISTIIZ:9IoEMINCIZéIgEMEXPIZ4)oEMINCAI24)

ISLOP9=0.

SOM=O.

ILIFE=ELIFE

on 10 1:1;3

IF (1.51.1) GO T0 40
oo 20 IA =1.ILIFE
EHINCIIAIEEINC/ELIEE
CONTINUE

GO TO 100

SQNEIIIELLEE’l-LféLIFEIIZoI

IF (I.GT.2I GO TO 80

ELIFEI=ELIFE

.- 89..

90

100

110

60

221

PROGRAM LISTING FOR TAX YEAR
00 60 IC=1.ILIFE
EHINCIICI=EINC*IELIFEI/SOHI
ELIFEJ=ELIFEI‘Io
CONTINUE
GU TO 100
00 90 ID?J!ILIFE
EHINCIIUI‘EINC*IID/SOMI

CONTINUE

DO 30 IE’Iv3

IF (IE-GToII GO TO I20
DU I10 IG‘IoILIFE
EMEXPIIGI=IEEXPIELIFEI
CONTINUE

GO TO 200
LL15£4=ELIFE-1

IF (IE-GT. 2. GO TO 140
EHEXPIILIFEI3025*EEXP
REXP=EEXP-EMEXP(ILIFE)
DO 130 IH=IgILIFE2

EHEXPIIHI=REXPIILIFE2

I30

.140

ISO

200

1.219

-W-o-
“0‘.”

222

PROGRAM LISTING FOR TAX YEAR

CONTINUE
GO TO 200

EMEXPIII:.Z5*EEXP
REXP=EEXP-EMEXPII)
DO 150 II=2,ILIFE
EMEXPIIIIQREXP/ILIFEZ
CONTINUE

CONTINUE

ISLOP9:ISLOE9+1
DO 201 ITYR=1912

TINC=O.
DO ZIOMIJ=IleYR
TINC=TINC+EMINCIIJI-EMEXPIIJ)

EMINCAIIJI=EMINCIIJI

.CQNIINUE

CALL TOINCITAX9TINCI

OISTIITYRpISLOPQI=TAX

VTINC:OQL

ELIFE48ELIFE-ITYR

[K = ITYR + l

900

230

240

"LOIST_I[TYRLISLOP9I70ISTIITYRoISLOP91+TAX

223

PROGRAM LISTING FOR TAX YEAR

RE 8 TAX * .005

OD 900 IAZ=IK,ILIFE
EMINCAIIAZI=EMINCIIAZI - RE

IF IEMINCAIIAZ) .LT. 0.) EMINCAIIAZI = 0.

CONTINUE

,_IFJ1ELIFEQQGT.12)_GU TO 230

Yl=0.

IK1=O

GO TO 250

IK=ITYR+1

IK1=IK+11

DO 240 IleKleI

TINC=TINC + EMINCAIIL) - EMEXPIILI
CONTINUE

vgalz

IFIIKI.EQ.ILIFEI GO TO 270
CALL TOINC ITAx9TINC)

IM IKI + 1

RE TAX * .005

--.—.... .... -

901

250

260
270

902
L350
201

-..-1 -‘
“...—c“

224

PROGRAM LISTING FOR TAX YEAR
00 901 IAX=IM.ILIFE
EMINCAIIAXI=EMINCAIIAXI - RE
" 1F LEMlNCALLAX) .LT. u.) EMLNCAIIAXJ = 0.
CONTINUE
IM=IK1+1
IINC=O.
IF (IKI .EQ.0I IM=ITYR+I
DO 260 IN=IH.ILIFE
TIN£=TINC-+ EMINCAIIN) - EHEXPIIN)
CONTINUE
CONTINUE
TAX=TINC*BTAX
DISTIITYR.ISLUP9)=DIST(ITYR.ISLOP9I+TAX
REV = 0.
DO 902-1383121LIFE
REV = EMINCA(IBM) + REV

CONTINUE

..LLDISTIIIYRLI5L0P9I385V ‘ EEXP -.0I51L1TYR2ISLQEQL,

CONTINUE
CONTINUE

225

PROGRAM LISTING FOR TAX YEAR
30 CONTINUE
10 CONTINUE
RETURN

END

7 .....- A- -‘ ' W

226

PROGRAM LISTING FOR ALTERNATE EXPENSE
REAL LDSSTMD
INTEGER PRITRN.OATEPO.CONTEM
.-,._DIMENSIDN RtLlJ _pr

COMMON IGLKI/GE.AOHEXP.OEOT$.LOSS.CHAR.HO.PRITRN.DATEPO.ZPTRAN.
LPRITE.PRITAx.CONTEN.zGIFT.zGIETx.ZVGIFT.EXCL.ESTAx.TAXEST

OO 10 I=200000.2000000.200000

GE=I

OO 20 IA=IOOOO.39000O.20000

-....PRLNI 101.1.IA -

100 FORMATI'I'.20x.'RuN 1°.//.21x.'ESTATE VALUE'.1x.I9.//.21x.'ESTATE
IREVENUE'.1x.Ie.//.'EXPENSES'.zox,'PERCENT DEDUCTED FROM INCOHE'TIT
L11x.'0'.11x.'10',ax.'20'.9x.'3o'.10x,°40',8x.'50',9x13GO'.9x,'70'.
19x.'eO',9x.'90',9x.'IOO'I

9999 EINC=IA

-0-._-L_--_...1LLB_..=.ZS*.G_E _ .. - ..--..,-. ,
00 30 IB=10000.ILIM,20000
EEXP=IB

-LV___.____JL£;::1S1.L --mn. . I _ .- - .,L , ,H___ . , -"._. , _-_.-
11:0
00 so IO=10.110.10

 

50

200

20

IO

,_ r”;

227

PROGRAM LISTING FOR ALTERNATE EXPENSE

II=II+I
A=IID-ICI/IOO.

EXP=A*EEXP

ADMEXP=EEXP~EXP

MD=.5*(GE-ADMEXPI

..CALL ESETX

B=GE-ADMEXP-ESTAX
TINC=EINC-ExP

CALL TOINC ITAx,TINCI

C=TINC-TAx

RTIII=O+C

CONTINUE

PRINT 200.EEXP,TRIJI.J=I.LII

FORMAT I'U'.12TELO.O.1xII
CONTINUE

CONTINUE

CONTINUE

STOP

END

228

PROGRAM LISTING EOR ALIERNATE VALUE

CEREAL_LOSSLMD.
INTEGER PRITRNDDATEPDICONTEM
-_DIHENSIDN CISI . .-. w-
_COMMQN [BLKI/GE.ADHEXP,Q§BTS,LOSS,CHAR.MDIPRITRNgoATEPDzZPTRAN,
LPRITE'PRITAX.CONTEM.ZGIFT,ZGIFTX,ZVGIFT.EXCLIESTAngAXEST
.DATA INQI'NQ'I
DATA [YES I'YES'I .
”DATA-Rl,025/L
DO 10 {.32000QQ!-2..009_99Q9190000
DEsI
AINCSDE*.I
,IDEI=DE+INC
IDEZ=DE*2
DO 20 IA=IDEI,IDEZ.INC
ALPEQPIA
PRINT 30 .OE.OE3
3Q_ ‘rFORMATI'I'920Xg'RUN NUMBER I'IZIX.'ESTATE VALUE AT DEATH'.15.F10.2
L“AZEAXR'AETERNAIELVAEQE'JIXTFLOvZ’
.ERINT 40

40 _EORNATI'OI,IX,ISALE OATE'.3Ox.'INCOME TAx RATEI/zsx.'o'.zox.'zo'.

 

_. -_ ..-._-.
..., -.—

 

60

Orv—w .

..- -..-7-4...-

-—.+_<__— ——————

.UlTO.60.

229

.....-

PROGRAE LISTING F93 ALTERNATE VALQE

 

-—'I u . . .du. 9. % a"- u y. -—.-- n - rmr . .p In“ - 1.5... ..‘u .-I v A. .—

118x,0400.11x.{§03,20x.070')

ICIse
OO 70 IC:6,L;QLG In”
DSALE=ICTICI_
IGso
.WIBLFJO - «

DO 50 183101§QTL0
IFIIa.EO.Lo.OR.Ie.Eq.3O.OR.IO.EO.so.OR.Ia.Eo.To.qR.IB.EQ.80I GO

GO TO so
aTAx=IIa-IBIIIIOO.
.‘GE*DE3 -L.",h___ . I L
MD=.5 * GE
CALL ESETx
“PSEiP§?t§§TA¥ --H-..- - . . -MLH_L < ......
IIA x DSALE/b.
EARN : IESlfI13§R)**IIA!-ESI

EAR~.!.=_EAR_.~*Uo-8TML.

.~-.—-. 'w‘v, ., . a “n*-Q . q . A . A n».*"‘“. --. . .‘n ‘-rn

A=ESI+EARN1
GEsDE

.80

90

100

50

- «-
-..mfl' ' .

-TAX'EINC3fIQIAX/Zq).-

9L9¥19+1m..

230

,PROGRAM LISTING FOR ALTERNATE VALUE

MD*.5 ? GE_I

CALL ESETX

ESZ!DE3?ESTAX

EARN =IIE$ZEIlofRI**IIAI-ESZ

EARN2=EARN¥I1.-BTAXI

.EINCB=DE3<DE

IFIBTAX.LT..50) GO TO 80

GO TO 90

GO TO Iso
IFIEINC3.LT.SOOOO.) GO TO 100

GO TO IIo

TAXsEINC3*.ZS

GO TO 150
IAXPTElNCQ-SQOOQoLESQTAXCQe’TlZSOQa
CONTINUE

B=EARN2+ESZ-TAX

CIIG)=A-B

CONTINUE

231

PROGRAM_LI$TING EUR ALTERNATE VALUE
PRINT 160.05ALE.ICIIXI.Ix=I.SI
_l60 FORMATI'o'.F5{o.15x.ISIFII.2.IOXIII
To CONTINUE
”20 CONTINUE

‘10 CONTINUE

STOP

5 , .m’w . GT. ~—
END

— a __.—-., o—u-vw M

- ._, . “...,“ ~-‘- ~ ~ , ... o ,- - - - - . - .o—v—w-ow-n—
C. -. .9 on — c—um .- m ’-a-
k A... ...... - ....
“- “2." ~A w "a—

;- “yrs-.7

1Q _

7 “~-

‘DO 20 IB=20000,I§OOOOTEOOOO

O.

232

PROGRAM LISTING FOR WAIVER OF COMMISSION
REAL LOSSDMD
INTEGER PRITRNIDATEPogCONTEM

DIMENSION GL4)

COMMON IBLKl/GE'ADMEXP'DEBT59L0559CHAR'MD’PRITRN’DATEPD’ZPTRAN'

IPRITEOPRITAXQCONTEHOZGIFrilGIFTXDZVGIFrcEXCLIESTAX'TAXEST

.DO 10 I=200000J2000000a100000

DE=I

IA=20300

EINC=IB-IA

PRINT 309 DE'EINC

, FORMATI'I'gZOXg'ESTATE VALUE'yIX.FII.2/ZZIX9'ESTATEOINCOME'.IX¢

lFll.2//IX.'EXEC. TAX 2',30X.'EXEC. SHARE'I3OX9'25'TIZXI'SO'pIZX.

I'T5'.IZX9'IOO'I

ID=ZO
DO 40 IC=20'80,20
IE=IC~ID
Em=I§1Io.9._ ,

IZ=0

DD 50 IG=259100925

SO

_ AC").U

4C)
2()

‘.GIIZI=F-g

233

PROGRAM LISTING FOR HAIVER OF COMMISSION

IZ=IZ+1
SHARE=IGI100.
EEXP=DE*,1

CALL TXYR IDE,EINC.EEXP,RI
A=R*SHARE
B=EEXP*I1.-ETAX)
C=A+B

GE=DE

ADMEXP=O.

CALL ESETX
D=DE-ESTAX

CALL TOINCITAx.EINC)
E=D+EINC-TAX

F=E*SHARE

CONTINUE

PRINT 1009 IEpIGIJIIJ=194I
,E,°3.'1§T"°.1'3?‘.'1fi' lemma-23m I
CONTINUE

CONTINUE

234

PROGRAM LISTING FOR WAIVER OF COMMISSION

CONTINUE

STOP

END , -

SUBROUTINE TXYR IDEyEINCgEExpgR)

REAL LOSS,MD

INTEGER PRITRN.DATEPD,CONTEM

COMMON IBLKI/GE,ADMExpgDERTSoLOSS,CHAR.MD,PRITRN,DATEPD,ZPTRAN.
IPRITEppRITAX,CONTEM.ZGIFT.ZGIFTX.ZVGIFT,EXCL.ESTAX.TAXEST

GE=DE

EXP=O.

ADMEXP=EEXP

CALL ESETX
B=GE~ADMEXP~ESTAX
TINC=EINC-EXP

CALL TOINCITAijINC).
C=TINC-TAX

R:B+C

DO 10, M? 10 1.190 x10
A=IAI100.

EXP=EEXP*A

IO

20

235

PROGRAM LISTING FOR WAIVER OF COMMISSION

ADMEXP=EEXP~EXP

CALL ESETX
BB=GE~ADMEXP-ESTAX
TINC=EINC—EXP

CALL TOINC ITAX.TINC)
CC=TINC~TAX

RR=BO+CC

IF (R.GT.RR) GO TO 20
R=RR

CONTINUE

RETURN

END

APPENDIX C

FLOW CHARTS FOR TAX COMPUTATION SUBROUTINES

ESTEX

TAXON

GFTTAX

TONG

TOINC

 

 

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zen.»

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237

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239

 

 

 

 

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APPENDIX D

FLOW CHARTS FOR COMPUTER PROGRAMS

Marital Deduction

Gifts in Contemplation of Death
Inter Vivos Trust

First Income Tax Year

Deduction of Administration Expenses
Alternate Valuation Date

Waiver of Executor's Commission

 

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BIBLIOGRAPHY

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