Module 39: Other Taxation Topics

Overview

This module presents a review of several independent taxation topics. Coverage is first presented regarding the federal gift, estate, and generation-skipping transfer taxes. Next reviewed is the income taxation of estates and trusts. That is followed by coverage of exempt organizations. Multijurisdictional taxation is then reviewed, including state and local taxation (SALT) and international taxation. Next, the module provides a review of the sources of federal tax authority including the federal tax legislative process, as well as the Internal Revenue Code, regulations, and rulings. The module concludes with an overview of some tax planning possibilities.

I. Gift and Estate Taxation

A. The Gift Tax

B. The Estate Tax

II. Generation-Skipping Tax

III. Income Taxation of Estates and Trusts

A. US Income Tax Return for Estate or Trust

B. Classification of Trusts

C. Computation of Estate or Trust Taxable Income

D. Treatment of Simple Trust and Beneficiaries

E. Treatment of Complex Trust and Beneficiaries

F. Grantor Trusts

G. Termination of Estate or Trust

IV. Exempt Organizations

A. Types of Organizations

B. Filing Requirements

C. Unrelated Business Income (UBI)

V. Multijurisdictional Taxation

A. State and Local Taxation (SALT)

B. International Taxation

VI. Sources of Federal Tax Authority

A. Primary Authorities

B Federal Tax Legislative Process

C. Internal Revenue Code (IRC)

D. Regulations

E. Revenue Rulings

VII. Tax Planning

A. Timing

B. Income and Deduction Shifting

C. Conversion

Key Terms

Multiple-Choice Questions

Multiple-Choice Answers and Explanations

Simulations

Simulation Solutions

I. GIFT AND ESTATE TAXATION

The estate, gift, and generation-skipping transfer (GST) taxes form a unified transfer tax system. The estate tax is based on property transferred at an individual’s death, while the gift tax is based on property transferred during an individual’s lifetime. The generation-skipping transfer tax ensures that property does not skip a generation without a transfer tax being assessed. The estate tax, gift tax, and GST share a single progressive tax rate schedule.

The American Taxpayer Relief Act of 2012 permanently provides for a maximum federal gift and estate tax rate of 40 percent with an annually inflation-adjusted $5 million exclusion for gifts during an individual’s lifetime and estates of decedents dying after December 31, 2012. Additionally, the estate of a surviving spouse is entitled to the unused portion of his or her predeceased spouse’s applicable exclusion amount if the appropriate election was made by the predeceased.

A. The Gift Tax

1. Gift Tax Formula
Gross gifts (cash plus FMV of property at date of gift) $xxx
Plus: One-half of spouse’s gifts to third parties if gift splitting elected x
Less:
One-half of gifts to third parties treated as given by spouse if gift splitting elected $ x
Annual exclusion (up to $14,000 per donee) x
Unlimited exclusion for tuition or medical expenses paid on behalf of donee x
Unlimited exclusion for gifts to political organizations x
Charitable gifts (remainder of charitable gifts after annual exclusion) x
Marital deduction (remainder of gifts to spouse after annual exclusion) x xx
Taxable gifts for current year $ xx
Add: Taxable gifts for prior years x
Total taxable gifts $xx
Transfer tax on total taxable gifts $ xx
Transfer tax on total taxable gifts $ xx
Less: Transfer tax on taxable gifts made prior to current year x
Transfer tax for current year $ xx
Transfer tax credit $ xx
Less: Transfer tax credit used in prior years x x
Net gift tax liability $xx
2. A gift is a transfer for less than adequate consideration in money or money’s worth. A gift occurs when a transfer becomes complete and is measured by its fair market value on that date. A gift becomes complete when the donor has relinquished dominion and control and no longer has the power to change its disposition, whether for the donor’s benefit or for the benefit of another.
a. The creation of joint ownership in property is treated as a gift to the extent the donor’s contribution exceeds the donor’s retained interest.
b. The creation of a joint bank account is not a gift; but a gift results when the noncontributing tenant withdraws funds.
c. The transfer of property to a revocable trust is not a completed gift because the transferor may demand the return of the property or change the beneficiaries of the trust.
3. Gross gifts less the following deductions equal taxable gifts:
a. Annual exclusion—of up to $14,000 per donee ($13,000 for 2012) is allowed for gifts of present interests (not future interests). A present interest is an unrestricted right to the immediate use, possession, or enjoyment of property or the income from property. A future interest includes reversions, remainders, and other interests that are limited to commence in use, possession, or enjoyment at some future date or time.
(1) Trusts for minors (Sec. 2503(c) trusts) allow parents and other donors to obtain an annual exclusion for gifts to trusts for children under age twenty-one even though the trust does not distribute its income annually. To qualify, the trust must provide
(a) Until the beneficiary reaches age twenty-one, the trustee may pay the income and/or the underlying assets to the beneficiary, and,
(b) Any income and assets not distributed must pass to the beneficiary when the beneficiary reaches age twenty-one. If the beneficiary dies before age twenty-one, the income and underlying assets are either payable to the beneficiary’s estate, or are payable to any person the minor may appoint if the minor possesses a general power of appointment over the trust property.
(2) Crummey trusts allow a donor to obtain an annual exclusion upon funding a discretionary trust. This type of trust is more flexible than a Sec. 2503(c) trust because the beneficiary can be of any age and the trust can terminate at any age. To qualify, a beneficiary must have the power to demand a distribution equal to the lesser of the donor’s annual exclusion ($14,000), or the beneficiary’s pro rata share of the amount transferred to the trust each year
b. Gift-splitting—a gift by either spouse to a third party may be treated as made one-half by each, if both spouses consent to election. Gift-splitting has the advantage of using the other spouse’s annual exclusion and unified transfer tax credit.
EXAMPLE
H is married and has three sons. H could give $28,000 to each of his sons during 2013 without making a taxable gift if H’s spouse (W) consents to gift-splitting.
H W
Gifts $84,000
Gift-splitting (42,000) $42,000
Annual exclusion (3 × $14,000) (42,000) (42,000)
Taxable gifts $ 0 $ 0
c. Educational and medical exclusion—an unlimited exclusion is available for amounts paid on behalf of a donee (1) as tuition to an educational organization, or (2) to a health care provider for medical care of donee.
d. Political gifts—an unlimited exclusion is available for the transfer of money or other property to a political organization.
e. Charitable gifts—(net of annual exclusion) are deductible without limitation.
f. Marital deduction—is allowed without limitation for gifts to a donor’s spouse.
(1) The gift must not be a terminable interest (i.e., donee spouse’s interest ends at death with no control over who receives remainder).
(2) If donor elects, a gift of qualified terminable interest property (i.e., property placed in trust with income to donee spouse for life and remainder to someone else at donee spouse’s death) will qualify for the marital deduction if the income is paid at least annually to spouse and the property is not subject to transfer during the donee spouse’s lifetime.
(3) In lieu of a marital deduction, gifts to an alien spouse are eligible for an annual exclusion of up to $143,000 for 2013 ($139,000 for 2012).
4. The tax computation reflects the cumulative nature of the gift tax. A tax is first computed on lifetime taxable gifts, then is reduced by the tax on taxable gifts made in prior years in order to tax the current year’s gifts at applicable marginal rates. Any available transfer tax credit is then subtracted to arrive at the gift tax liability.
a. For 2013, the transfer tax credit is $2,045,800, which is equivalent to an exemption of the first $5.25 million of taxable gifts from the gift tax.
b. For 2012, the transfer tax credit is $1,772,800, which is equivalent to an exemption of the first $5,120,000 of taxable gifts from the gift tax.
5. A gift tax return (Form 709 United States Gift [and Generation-Skipping Transfer] Tax Return) must be filed on a calendar-year basis, with the return due and tax paid on or before April 15th of the following year.
a. A donor who makes a gift to charity is not required to file a gift tax return if the entire value of the donated property qualifies for a gift tax charitable deduction.
b. If the donor dies, the gift tax return for the year of death is due not later than the due date for filing the decedent’s federal estate tax return (generally nine months after date of death).
6. The basis of property acquired by gift
a. Basis for gain—basis of donor plus gift tax attributable to appreciation
b. Basis for loss—lesser of gain basis or FMV at date of gift
c. The increase in basis for gift tax paid is limited to the amount (not to exceed the gift tax paid) that bears the same ratio to the amount of gift tax paid as the net appreciation in value of the gift bears to the amount of the gift.
(1) The amount of gift is reduced by any portion of the $14,000 ($13,000 for 2013) annual exclusion allowable with respect to the gift.
(2) Where more than one gift of a present interest is made to the same donee during a calendar year, the $14,000 (or $13,000) exclusion is applied to gifts in chronological order.
EXAMPLE
Joan received property with an FMV of $60,000 and an adjusted basis of $80,000 as a gift. The donor paid a gift tax of $12,000 on the transfer. Since the property was not appreciated in value, no gift tax can be added in the basis computation. Joan’s basis for computing a gain is $80,000, while her basis for computing a loss is $60,000.
NOW REVIEW MULTIPLE-CHOICE QUESTIONS 1 THROUGH 9

B. The Estate Tax

1. Estate Tax Formula
Gross estate (cash plus FMV of property at date of death, or alternate valuation date) $xxx
Less:
Funeral expenses $x
Administrative expenses x
Debts and mortgages x
Casualty losses x
State death taxes x
Charitable bequests (unlimited) x
Marital deduction (unlimited) x xx
Taxable estate $xxx
Add: Post-76 adjusted taxable gifts xx
Total taxable life and death transfers $xxx
Transfer tax on total transfers $ xx
Less:
Post-76 gift taxes (specially computed at estate tax rates in effect at time of death) $x
Transfer tax credit ($2,045,800 for 2013) x
Foreign death and prior transfer tax credits x x
Foreign death and prior transfer tax credits x x
Net estate tax liability $ xx
2. Gross estate includes the FMV of all property in which the decedent had an interest at time of death.
a. Concurrently held property
(1) If property was held by tenancy in common, only the FMV of the decedent’s share is included.
(2) Include one-half the FMV of community property, and one-half the FMV of property held by spouses in joint tenancy or tenancy by the entirety.
(3) Include one-half of FMV if the property held by two persons in joint tenancy was acquired by gift, bequest, or inheritance (1/3 if held by three persons, etc.).
(4) If property held in joint tenancy was acquired by purchase by other than spouses, include the FMV of the property multiplied by the percentage of total cost furnished by the decedent.
b. The FMV of transfers with retained life estates and revocable transfers are included in the gross estate.
c. Include the FMV of transfers intended to take effect at death (i.e., the donee can obtain enjoyment only by surviving the decedent, and the decedent prior to death had a reversionary interest of more than 5% of the value of the property).
d. Include any property over which the decedent had a general power of appointment (i.e., decedent could appoint property in favor of decedent, decedent’s estate, or creditors of decedent or decedent’s estate).
e. Include the value of life insurance proceeds from policies payable to the estate, and policies over which the decedent possessed an “incident of ownership” (e.g., right to change beneficiary).
f. Include income in respect of a decedent.
g. Include gifts of life insurance within three years of the decedent’s date of death.
h. Include gift tax paid on all transfers made within three years of death.
3. Property is included at FMV at date of decedent’s death; or executor may elect to use FMV at alternate valuation date (generally a date six months subsequent to death), if such election will reduce both the gross estate and the federal estate tax liability.
a. If alternate valuation is elected, but property is distributed, sold, exchanged, or otherwise disposed of within six months of death, then use FMV on date of distribution, sale, exchange or other disposition.
b. Election is irrevocable and applies to all property in estate; cannot be made on an individual property basis.
4. Estate tax deductions include funeral expenses, administrative expenses, debts and mortgages, casualty losses during the estate administration, state death taxes, charitable bequests (no limit), and an unlimited marital deduction for the FMV of property passing to a surviving spouse.
a. A terminable interest granted to surviving spouse will not generally qualify for marital deduction.
b. If executor elects, the FMV of “qualified terminable interest property” is eligible for the marital deduction if the income from the property is paid at least annually to spouse and the property is not subject to transfer during the surviving spouse’s lifetime.
c. Property passing to a surviving spouse who is not a US citizen is not eligible for the estate tax marital deduction, except for property passing to an alien spouse through a qualified domestic trust (QDT).
d. Property passing from a nonresident alien to a surviving spouse who is a US citizen is eligible for the estate tax marital deduction.
e. An unlimited charitable deduction is available for amounts transferred by bequest, devise, or legacy to qualified charitable organizations, including foreign charities. However, the amount of charitable deduction must be reduced by any estate, legacy, or inheritance taxes that are payable in whole or in part from the bequest, devise, or legacy.
f. The decedent’s medical and funeral expenses are allowed as deductions on the estate tax return Form 706. However, if the decedent’s medical expenses are paid within twelve months of death, they instead can be deducted on the decedent’s final income tax return Form 1040 if the estate’s executor makes the appropriate election to waive the deduction on the decedent’s estate tax return. The decedent’s medical and funeral expenses are never allowed as deductions on the estate’s income tax return Form 1041.
5. Post-76 taxable gifts are added back to the taxable estate at date of gift FMV. Any gift tax paid is not added back.
6. A transfer tax is computed on total life and death transfers, then is reduced by the tax already paid on post-76 gifts, the unified tax credit, foreign death tax credit, and prior transfer tax credit (i.e., percentage of estate tax paid on the transfer to the present decedent from a transferor who died within past ten years).
7. Portability of unused exclusion between spouses. Effective for deaths occurring after 2010, the estate of a surviving spouse may qualify to utilize the unused portion of the estate tax applicable exclusion amount ($5.25 million for 2013) of his or her last predeceased spouse. To take advantage of this provision, a special election must have been made by the predeceased spouse’s estate. Thus, even though an estate tax return is not required to be filed, it must be filed in order to make this election. The applicable exclusion amount for a surviving spouse will be the sum of a basic exclusion amount ($5.25 million for 2013), plus the aggregate deceased spousal unused exclusion amount. The provision applies to only the unused exclusion of the last deceased spouse. It is not possible for individuals who have been married multiple times to tack on multiple applicable exclusion amounts of their predeceased spouses.
EXAMPLE
Henry died in 2012 with a taxable estate of $2 million. An election is made on Henry’s estate tax return to permit his wife, Wilma, to use his unused exclusion of $3.12 million. Wilma, who had not made any lifetime taxable gifts, dies in 2013 with a taxable estate of $9 million. The total applicable exclusion amount available to Wilma’s estate will consist of her basic exclusion amount of $5.25 million plus the $3.12 million of Henry’s unused exclusion amount, for a total exclusion of $8,370,000.
8. Form 706 United States Estate (and Generation Skipping Transfer) Tax Return must be filed if the decedent’s gross estate exceeds $5,250,000 for 2013 ($5,120,000 for 2012). The return must be filed within nine months of decedent’s death, unless an extension of time has been granted.
9. The basis of property acquired from a decedent is generally the FMV at date of decedent’s death, or the alternate valuation date if elected for estate tax purposes.
a. Use FMV on date of disposition if alternate valuation is elected and property is distributed, sold, or otherwise disposed of during the six-month period following death.
b. FMV rule does not apply to appreciated property acquired by the decedent by gift within one year before death if such property then passes from the donee-decedent to the original donor or donor’s spouse. The basis of such property to the original donor (or spouse) will be the adjusted basis of the property to the decedent immediately before death.
EXAMPLE
Son gives property with FMV of $40,000 (basis of $5,000) to terminally ill father within one year before father’s death. The property is included in father’s estate at FMV of $40,000. If property passes to son or son’s spouse, basis will remain at $5,000. If passed to someone else, the property’s basis will be $40,000.

II. GENERATION-SKIPPING TAX

This tax is imposed on transfers in addition to the federal gift and estate taxes and is designed to prevent individuals from escaping an entire generation of gift and estate taxes by transferring property to, or in trust for the benefit of, a person that is two or more generations younger than the donor or transferor.

A. The tax approximates the transfer tax that would be imposed if property were actually transferred to each successive generation, and is imposed on taxable distributions, taxable terminations, and direct skips to someone at least two generations below that of the donor or transferor.
1. A taxable distribution is a distribution out of a trust’s income or corpus to a beneficiary at least two generations below that of the grantor (unless the grandchild’s parent is deceased and was a lineal descendant of the grantor) while an older generation beneficiary has an interest in the trust.
2. A taxable termination means that by reason of death, expiration of time, or otherwise, the interest of a nonskip person terminates (i.e., someone less than two generations below the donor or transferor) and a skip person (i.e., someone at least two generations below the donor or transferor) becomes the recipient of the trust property or the only beneficiary.
3. A direct skip occurs when one or more generations are bypassed altogether and property is transferred directly to, or in trust for, a skip person.
B. The generation-skipping transfer tax is imposed at a flat rate that equals the maximum unified transfer tax rate of 40% (35% for 2012).
C. Exemptions available
1. A $5,250,000 exemption per transferor for 2013 ($5,120,000 for 2012)
2. An unlimited exemption is available for a direct skip to a grandchild if the grandchild’s parent is deceased and was a lineal descendant of the transferor
NOW REVIEW MULTIPLE-CHOICE QUESTIONS 10 THROUGH 26

III. INCOME TAXATION OF ESTATES AND TRUSTS

Although estates and trusts are separate taxable entities, they will not pay an income tax if they distribute all of their income to beneficiaries. In this respect they act as a conduit, since the income taxed to beneficiaries will have the same character as it had for the estate or trust.

A. US Income Tax Return for Estate or Trust (Form 1041) must be filed by an estate if it has gross income of $600 or more, or has a beneficiary who is a nonresident alien. Form 1041 must be filed by a trust if it has gross income of $600 or more, any taxable income, or a beneficiary who is a nonresident alien.
1. Return is due by the 15th day of the fourth month following the close of the estate or trust’s taxable year.
2. A trust must adopt a calendar year as its taxable year. An estate may adopt a calendar year or any fiscal year.
3. For 2013, estate and trusts are taxed as follows:
a. First $2,450 of taxable income is taxed at 15%
b. Over $2,450 but not over $5,700 is taxed at 25%
c. Over $5,700 but not over $8,750 is taxed at 28%
d. Over $8,750 but not over $11,950 is taxed at 33%
e. Over $11,950 is taxed at 39.6%
4. The alternative minimum tax applies to estates and trusts and is computed in the same manner as for individuals. The AMT exemption for an estate or trust is $23,100 for 2013.
5. For tax years beginning after December 31, 2012, an estate or trust is subject to the 3.8% Medicare Contribution Tax on net investment income. The tax is imposed on the lessor of (a) an estate or trust’s undistributed net investment income, or (b) the excess of an estate or trust’s AGI over the dollar amount at which an estate or trust’s highest income tax bracket begins ($11,950 for 2013).
6. Estates and trusts are generally required to make estimated tax payments using the rules applicable to individuals. However, estates do not have to make estimated payments for taxable years ending within two years of the decedent’s death.

B. Classification of Trusts

1. Simple trust is one that (1) is required to distribute all of its income to beneficiaries each year, (2) cannot make charitable contributions, and (3) makes no distribution of trust corpus (i.e., principal) during the year.
2. Complex trust is any trust other than a simple trust.

C. Computation of Estate or Trust Taxable Income

1. Gross income for an estate or trust is generally the same as for individual taxpayers.
a. Generally no gain or loss is recognized on the transfer of property to beneficiaries to satisfy specific bequests.
b. Gain or loss is recognized on the transfer of property to beneficiaries in lieu of cash to satisfy specific cash bequests.
2. Allowable deductions for an estate or trust are generally the same as for an individual taxpayer.
a. A personal exemption is allowed.
(1) $600 for estate
(2) $300 for trusts required to distribute all income currently
(3) $100 for all other trusts
b. Charitable contributions can be made by estates and trusts (other than simple trusts).
(1) Contributions can be deducted without limitation if paid out of income.
(2) Contributions are not deductible to the extent paid out of tax-exempt income.
c. Expenses incurred in the production of tax exempt income are not deductible.
d. Capital losses offset capital gains and a net capital loss of up to $3,000 can be deducted with the remainder carried forward.
e. Any unused capital loss and net operating loss (NOL) carryovers from the decedent’s final Form 1040 are not allowed as deductions.
3. An income distribution deduction is allowed for distributions of income to beneficiaries.
a. Distributable net income (DNI) is the maximum amount of deduction for distributions to beneficiaries in any taxable year and also determines the amounts and character of the income reported by the beneficiaries.
b. Generally, DNI is the same as the estate’s or trust’s taxable income computed before the income distribution deduction with the following modifications:
(1) Add
(a) Personal exemption
(b) Any net capital loss deduction (limited to $3,000)
(c) Tax exempt interest (reduced by related nondeductible expenses)
(2) Subtract
(a) Net capital gains allocable to corpus
(b) Extraordinary dividends and taxable stock dividends allocated to corpus of simple trust
c. Deduction will be the lesser of DNI or the amount distributed to beneficiaries (i.e., taxable income required to be distributed, plus other amount of taxable income distributed).

D. Treatment of Simple Trust and Beneficiaries

1. Income is taxed to beneficiaries, not to trust.
2. Beneficiaries are taxed on the income required to be distributed (up to DNI), even though not actually distributed during the year.
3. Income passes through to beneficiaries retaining its characteristics (e.g., tax-exempt income passes through retaining its exempt status).
4. If multiple beneficiaries, DNI is prorated in proportion to the amount of required distribution to each beneficiary.

E. Treatment of Complex Trust and Beneficiaries

1. A two-tier income distribution system is used.
a. First tier: Distributions of the first tier are income amounts that are required to be distributed and include distributions that can be paid out of income or corpus, to the extent paid out of income.
b. Second tier: Distributions of the second tier are all other amounts that are actually paid during the year or are required to be paid.
2. DNI is first allocated to distributions in the first tier. Any remaining DNI is prorated to distributions in the second tier.
EXAMPLE
A trust has DNI of $9,000. The trust instrument requires that $6,000 of income be distributed annually to Alan. Further, it permits distributions to Baker and Carr of income or corpus in the trustee’s discretion. For the current year, the trustee distributes $6,000 to Alan, $4,000 to Baker, and $2,000 to Carr.
Since Alan’s distribution is a first tier distribution, all $6,000 distributed is taxable to Alan. This leaves only $3,000 of DNI to be allocated to the second tier distributions to Baker and Carr. Since DNI would be allocated in proportion to the amounts distributed, $2,000 of Baker’s distribution and $1,000 of Carr’s distribution would be taxable.
F. Grantor Trusts are trusts over which the grantor (or grantor’s spouse) retain substantial control. The income from a grantor trust is generally taxed to the grantor, not to the trust or beneficiaries. A grantor trust generally exists if any of the following conditions are present:
1. Trust income will, or in the grantor’s or nonadverse party’s discretion may be, distributed to the grantor or grantor’s spouse (or used to pay life insurance premiums of either).
2. The grantor (or nonadverse party) has the power to revoke the trust.
3. The grantor (or grantor’s spouse) holds a reversionary interest worth more than 5% of trust corpus.
4. The grantor (or nonadverse party) can deal with trust property in a nonfiduciary capacity (e.g., purchase trust assets for less than adequate consideration or borrow trust property at below market rate).
5. The grantor (or grantor’s spouse) or nonadverse party controls the beneficial enjoyment of the trust (e.g., ability to change beneficiaries).

G. Termination of Estate or Trust

1. An estate or trust is not entitled to a personal exemption on its final return.
2. Any unused carryovers (e.g., NOL or capital loss) are passed through to beneficiaries for use on their individual tax returns.
3. Any excess deductions for its final year are passed through to beneficiaries and can be deducted as miscellaneous itemized deductions.
NOW REVIEW MULTIPLE-CHOICE QUESTIONS 27 THROUGH 41

IV. EXEMPT ORGANIZATIONS

A. Types of Organizations

1. Tax-exempt organizations are listed by class of organization in the Internal Revenue Code. Generally, an exempt organization serves some common good, is operated as a not-for-profit entity, its net earnings do not inure for the benefit of specified individuals, and the organization does not exert undue political influence. To obtain exempt status, the organization must be one of those specifically identified in the Code, and generally must apply for and receive an exemption.
IRC 501 Type of Organization Description
(c) (1) Federal and Regulated Agencies Federal Credit Unions, FDIC, Federal Land Bank
(c) (2) Title Holding Corporation for Exempt Organization Corporation holding title to fraternity or sorority house
(c) (3) Religious, Educational, Charitable, Scientific, Literary, Testing for Public Safety, Foster National or International Amateur Sports Competition, Prevention of Cruelty to Children or Animals Organizations Activities of a nature implied by description of class of organization (e.g., church, school, museum, zoo, planetarium, Red Cross, Boy Scouts of America)
(c) (4) Civic Leagues, Social Welfare Organizations, and Local Associations of Employees Promotion of community welfare (e.g., community association, volunteer fire companies, garden club, League of Women Voters)
(c) (5) Labor, Agricultural, and Horticultural Organizations Educational or instructive, to improve conditions of work, and to improve products and efficiency (e.g., teacher’s association)
(c) (6) Business Leagues, Chamber of Commerce, Real Estate Boards, etc. Improvement of business conditions of one or more lines of business (e.g., trade of professional associations, Chambers of Commerce)
(c) (7) Social and Recreation Clubs Recreation and social activities (e.g., Country Club, Sailing Club, Tennis Club)
(c) (8) Fraternal Beneficiary Societies and Associations Lodge providing for payment of life, sickness, accident, or other benefits to members
(c) (9) Voluntary Employees’ Beneficiary Associations Providing for payment of life, sickness, accident, or other benefits to members
(c)(10) Domestic Fraternal Societies and Associations Lodge devoting its net earnings to charitable, fraternal, and other specified purposes, but no life, sickness, or accident benefits to members
(c)(11) Teachers’ Retirement Fund Associations Payment of retirement benefits to teachers
(c)(12) Benevolent Life Insurance Associations, Mutual or Cooperative Telephone Companies, etc. Activities of a mutually beneficial nature
(c)(13) Cemetery Companies Operated for benefit of lot owners who purchase lots for burial
(c)(14) State Chartered Credit Unions Loans to members
(c)(15) Mutual Insurance Companies or Associations Providing insurance to members substantially at cost
(c)(16) Farmers Cooperative Organizations to Finance Crop Operations Financing of crop operations in conjunction with activities of marketing or purchasing association
(c)(17) Supplemental Unemployment Benefit Trusts Payment of supplemental unemployment compensation benefits
(c)(19) Member of Armed Forces Post or Organization Veterans of Foreign Wars (VFW)
(d) Religious and Apostolic Associations Communal religious community that conducts business activities. Members must include pro rata share of organization’s income in their gross income
(e) Cooperative Hospital Service Organizations Performs cooperative service for hospitals (e.g., centralized purchasing organization)
(k) Child Care Organizations Provides care for children
2. Sec. 501(c)(3) organizations (religious, educational, charitable, etc.) generally must apply for exemption by filing Form 1023 within fifteen months from the end of the month in which they were organized. To qualify, (1) the organization must meet an organizational and operational test, (2) no part of the organization’s net earnings can inure to the benefit of private shareholders or individuals, and (3) the organization cannot, as a substantial part of its activities, attempt to influence legislation (unless it elects an exception permitting certain lobby expenditures) or directly participate to any extent in a political campaign for or against any candidate for public office.
a. Some organizations do not have to file for exemption (e.g., churches or an organization [other than a private foundation] normally having annual gross receipts of not more than $5,000). They automatically are exempt if they meet the requirements of Sec. 501(c)(3).
b. The organizational test requires the articles of organization limit the organization’s purposes to one or more exempt purposes described in Sec. 501(c)(3), and must not expressly empower the organization to engage in activities that are not in furtherance of its one or more exempt purposes, except as an insubstantial part of its activities.
c. The operational test requires that an exempt organization be operated exclusively for an exempt purpose. An organization will be considered to be operated exclusively for an exempt purpose only if it engages primarily in activities that accomplish its exempt purpose. An organization will not be so regarded if more than an insubstantial part of its activities is not in furtherance of an exempt purpose.
d. Inurement is private benefit provided to insiders who have the institutional opportunity to direct the organization’s resources to themselves, to entities in which they have an interest, or to family members. Inurement issues may arise because of excessive compensation, payment of excessive rent, receipt of less than fair value from sales of property, and inadequately secured loans.
e. An organization (other than churches and private foundations) can elect to replace the substantial part of activities test with a limit defined in terms of expenditures for influencing legislation. Attempting to influence legislation includes (1) any attempt to influence any legislation through an effort to affect the opinions of the general public (i.e., grassroots lobbying), and (2) any attempt to influence any legislation through communication with any member or employee of a legislative body, or with any government official or employee who may participate in the formulation of legislation (i.e., direct lobbying).
(1) Attempting to influence legislation does not include appearing before or communicating with any legislative body with respect to a possible decision of that body that might affect the powers, duties, exempt status, or the deduction of contributions to the organization.
(2) If the election to be subject to the lobbying expenditures limits (instead of the substantial part of activities test) is made, an organization will not lose its exempt status unless it normally makes lobbying expenditures in excess of 150% of lobbying nontaxable amount or normally makes grassroots expenditures in excess of 150% of grassroots nontaxable amount.
(3) If the election is made, an organization will be subject to a 25% excise tax on the excess of its lobbying and grassroots expenditures over the lobbying and grassroots nontaxable amounts.
3. Private foundations are Sec. 501(c)(3) organizations other than churches, educational organizations, hospitals or medical research organizations operated in conjunction with hospitals, endowment funds operated for the benefit of certain state and municipal colleges and universities, governmental units, and publicly supported organizations.
a. An organization is publicly supported if it normally receives at least one-third of its total support from governmental units and the general public (e.g., support received in the form of gifts, grants, contributions, membership fees, gross receipts from admissions, sales of merchandise, etc.)
b. Private foundations may be subject to taxes based on investment income, self-dealing, failure to distribute income, excess business holdings, investments that jeopardize charitable purposes, and taxable expenditures. The initial taxes (with the exception of the tax on investment income) are imposed because the organization engages in prohibited transactions. Additional taxes are imposed if the prohibited transactions are not corrected with a specified period.
4. Feeder organizations do not qualify for tax-exempt status. A feeder organization carries on a trade or business for the benefit of an exempt organization and remits its profits to the exempt organization.

B. Filing Requirements

1. Most exempt organizations must file an annual information return Form 990 (Return of Organization Exempt from Income Tax). Organizations not required to file Form 990 include churches, federal agencies, organizations whose annual gross receipts do not exceed $50,000, and private foundations.
2. Exempt organizations with unrelated business income must file Form 990-T (Exempt Organization Business Income Tax Return) if the organization has gross income of at least $1,000 from an unrelated trade or business. The obligation to file Form 990-T is in addition to the obligation to file Form 990. Additionally, Form 990-T may be required even though Form 990 is not required to be filed.
3. Private foundations must annually file Form 990-PF (Return of Private Foundation). If an organization is subject to any of the excise taxes imposed on private foundations, Form 4720 (Return of Certain Excise Taxes on Charities and Other Persons) must be filed with Form 990-PF.
4. Small exempt organizations whose gross receipts are $50,000 or less are required to annually file an electronic Form 990-N (e-Postcard). Organizations eligible to file the 990-N can instead elect to file Form 990.
5. Exempt organizations who are not eligible to file the 990-N but have gross receipts less than $200,000 and total assets less than $500,000 are required to file Form 990-EZ or Form 990.
6. Forms 990, 990-EZ, 990-T, 990-PF, and 990-N are generally due by the 15th day of the 5th month after the end of the tax year (e.g., May 15th for a calendar-year organization).
7. An exempt organization that fails to file its required return for three consecutive years will lose its tax-exempt status. The revocation of the organization’s tax-exempt status will not take place until the filing due date for the third year.
NOW REVIEW MULTIPLE-CHOICE QUESTIONS 42 THROUGH 56

C. Unrelated Business Income (UBI)

1. UBI is income from a business that is (1) regularly carried on, and (2) is unrelated to the organization’s exempt purpose. A business is substantially related only if the activity (not its proceeds) contributes importantly to the accomplishment of the exempt purposes of the organization.
2. Income derived from debt-financed property unrelated to the exempt function of the organization is included in UBI. The amount of such income to be included in UBI is based on the proportion of average acquisition indebtedness to the property’s average adjusted basis.
3. Income from commercial product advertising in journals and other publications is generally UBI.
4. Activities specifically treated as resulting in related income (not UBI) include
a. An activity where substantially all work is performed without compensation (e.g., a church runs a second-hand clothing store with all work performed by volunteers).
b. A trade or business carried on for the convenience of students or members of a charitable, religious, or scientific organization (e.g., university bookstore).
c. The sale of merchandise received as gifts or contributions.
d. Income from dividends, interest, annuities, and royalties. However, such income will be included in UBI if it results from debt-financed investments.
e. Income derived from renting real property. However, income derived from renting personal property is considered UBI unless the personal property is leased with the real property and personal property rents do not exceed 10% of total rents.
f. Conducting bingo games if the games are not in violation of any state or local law, and are conducted in a jurisdiction that ordinarily confines bingo games to exempt organizations.
5. UBI is taxed to the extent in excess of $1,000. UBI is taxed at regular corporate rates if the organization is a corporation, taxed at rates applicable to trusts if the organization is a trust.
6. An organization must make estimated tax payments if it expects its tax for the year to be more than $500.
NOW REVIEW MULTIPLE-CHOICE QUESTIONS 57 THROUGH 64

V. MULTIJURISDICTIONAL TAXATION

A. State and Local Taxation (SALT)

1. There are various types of state and local taxes such as income, sales, use, property, franchise, employment, excise, severance, and estate and inheritance taxes. Each state controls the taxation of persons within its jurisdiction and may apply tax rules that differ from the rules that are applied in other states.
2. The US Constitution prohibits a state from taxing a nonresident unless the nonresident has sufficient connection to the state. The presence or activity required within a state before the state may tax a nonresident is referred to as nexus. There are different nexus standards for different types of taxes. Simply engaging in an activity or a business transaction within a state may be sufficient to result in nexus for income tax purposes in many states. Property ownership, derivation of income from sources within a state, or the presence of an office within a state also may produce nexus. On the other hand, nexus is generally not established merely because of the solicitation of sales of tangible personal property within a state.
3. For state income tax, many states conform to the federal income tax model, with a state relying on information from a federal return for its own tax base. As a result, a state income tax base might begin with federal taxable income which is then modified by adjustments required by state law (e.g., no deduction allowed for state income taxes).
4. When a business can be taxed by more than one state, it becomes necessary to develop rules that allocate particular types of income to specific states, and to apportion other types of income among the several states that can tax it.
a. The Uniform Division of Income for Tax Purposes Act (UDITPA) provides rules for allocating and apportioning a multistate or multinational enterprise’s nonbusiness and business income among states and foreign countries. The Multistate Tax Commission adopted model regulations that interpret the UDITPA provisions.
b. Under UDITPA, nonbusiness income is allocated as follows:
(1) Interest and dividends are allocated to the state of the taxpayer’s commercial domicile.
(2) Net rents and royalties from real property are allocated to the state in which the property is located.
(3) Capital gains and losses from sales of real property are allocated to the state where the property is located.
(4) Capital gains and losses from the sale of intangible personal property are allocated to the state of the taxpayer’s commercial domicile.
(5) Net rents and royalties from tangible personal property are allocated to a state to the extent that the property is utilized within that state. Alternatively, all rents and royalties from tangible personal property will be allocated to the state of the taxpayer’s commercial domicile if the taxpayer is not organized in or taxable in the state in which the property is utilized.
(6) Capital gains and losses from sales of tangible personal property are allocated to a state if the property was situated in that state at the time of sale. Alternatively, the gains and losses will be allocated to the state of the taxpayer’s commercial domicile if the taxpayer is not taxable in the state in which the property was situated.
(7) Patent and copyright royalties are allocated to a state to the extent that the patent or copyright is utilized by the payer in the state. Alternatively, the royalties will be allocated to the state of the taxpayer’s commercial domicile if the taxpayer is not taxable in the state in which the patent or copyright was utilized.
c. States use various formulas to apportion a taxpayer’s business income derived from multistate operations. Although the formulas used may differ, the objective is to derive an apportionment percentage to determine the amount of income subject to tax in each state. UDITPA recommends a formula using three equally weighted factors: sales, payroll, and property. Business income is then apportioned to a state by multiplying the taxpayer’s business income by a fraction; the numerator of which is the total of the sales factor plus the payroll factor plus the property factor, and the denominator is three (3), to average the factors. Many states that levy an income tax use a modified three-factor formula in which sales are double-weighted (i.e., the sales factor is counted twice and the factor total is divided by four). Some states use just one or two of the factors.
(1) The sales factor is the ratio of total sales to in-state customers divided by total sales from all sales made by the taxpayer. Total sales means total net sales after discounts and returns.
(2) The payroll factor is the ratio of compensation paid to employees working in a state divided by the total compensation paid by the taxpayer.
(3) The property factor is the ratio of the average cost of real and tangible personal property owned or rented and located in a state divided by the total average cost of all such property owned or rented by the taxpayer.
EXAMPLE
Assume Multistate Corp. conducts business in several states and provided relevant information as follows:
Total State A
Sales $4,000,000 $1,000,000
Average property 5,000,000 2,000,000
Compensation 1,000,000 200,000
Business taxable income before apportionment 500,000
State A uses the UDITPA apportionment formula to compute state taxable income for Multistate Corp.’s business income. The sales factor for State A would be $1,000,000 / $4,000,000 = 25%. The property factor would be $2,000,000 / $5,000,000 = 40%. The compensation factor would be $200,000 / $1,000,000 = 20%. The apportionment factor would be (25% + 40% + 20%) / 3 = 28.33%. As a result, $500,000 × 28.33% = $141,667 of Multistate Corp.’s business income would be taxed by State A.
EXAMPLE
Assume State A in the above example gives double weight to the sales factor. The apportionment factor would be (25% + 25% + 40% + 20%) / 4 = 27.5%.
5. Under the unitary concept, if one company in a group of entities has nexus with a state, the state’s apportionment factor is applied to the unitary income of the entire group. A unitary business is a single economic enterprise that is made up either of separate parts of a single business entity, or of a commonly controlled group of business entities that are sufficiently interdependent, integrated, and interrelated through their activities. Whether business activities constitute a unitary business is subjective and the courts generally give states great latitude in deciding whether a particular set of activities constitute a unitary business. Under the factors-of-profitability test, business activities will be treated as a unitary business if they are functionally integrated, have centralized management, and show economies of scale.
6. Many states have enacted provisions that require combined reporting in applying the unitary business concept to related entities. In a combined return a taxpayer must apply the unitary concept to the combined income of the entities making up the unitary business. Most states have established a 50% ownership rule as the threshold for combined reporting purposes though some states have chosen to use a different percentage.
NOW REVIEW MULTIPLE-CHOICE QUESTIONS 65 THROUGH 66

B. International Taxation

1. US Taxation of Foreign Persons. Nonresident foreign persons generally are subject to US tax on two categories of income: (1) income that is effectively connected with a US trade or business (ECI), and (2) certain passive types of US source income commonly referred to as fixed and determinable annual or periodical income (FDAP).
a. A foreign person’s income that is effectively connected with a US trade or business (ECI) is subject to tax at regular graduated income tax rates and deductions are allowed in computing the amount subject to tax. A trade or business generally is defined by case law as profit-oriented activities that are regular, substantial, and continuous. Effectively connected with a US trade or business means that (1) the income is derived from assets held for use in the conduct of a US business, and (2) the activity of the US business was a material factor in the realization of the income. Under an income tax treaty, the US may instead agree to tax business profits of a treaty resident only if the profits are attributable to a permanent establishment (PE) in the US. A PE is a fixed place of business through which business is wholly or partially carried on. Simply maintaining storage facilities within the US generally does not by itself amount to a PE.
b. Generally, a nonresident alien who performs personal services within the US is considered to be engaged in a US trade or business. However, the performance of personal services will not constitute a US trade or business if (1) the nonresident alien is present in the US for 90 days or less during the tax year, (2) the amount of compensation received for US services is $3,000 or less, and (3) the nonresident alien works for either a foreign person who is not engaged in a US trade or business, or the foreign office of a US person.
c. Fixed and determinable annual or periodical income (FDAP) is generally subject to a 30% withholding tax that is applied to the gross amount of income with no deductions allowed. Withholding of tax occurs at the source of payment (i.e., the person paying the income is required to withhold the tax and remit it to the IRS). FDAP primarily is from passive, nonbusiness activities including such items as interest, dividends, rents, royalties, and annuities. FDAP generally excludes gain from the sale or exchange of real or personal property, and income that is excluded from gross income by US persons. The 30% withholding tax rate may be reduced or even eliminated by an applicable income tax treaty.
d. Sourcing rules are used to determine whether items of income will be deemed to be US source and consequently subject a nonresident foreign person to US taxation. Although the sourcing rules may be modified by tax treaty, the sourcing rules for specific types of income include
(1) Interest—the domicile of the payor
(2) Dividends—whether the payor is a US or foreign corporation
(3) Rents—the location of the property
(4) Royalties—the location where the property is used
(5) Gain on sale of real property—the location of the property
(6) Gain on sale of inventory—the location where title to the inventory passes
(7) Services—the location where the services are performed
2. US Taxation of US Persons on Foreign Activities. US persons are subject to US tax on their worldwide income. A US person includes a citizen or resident of the US, a domestic partnership or corporation, and any estate or trust other than a foreign estate or trust
a. A US corporation is subject to tax on its worldwide income, including the income of a foreign branch. In contrast, a US corporation is generally not taxed on the net income of a foreign subsidiary corporation until the income is repatriated in the form of dividends to the parent corporation.
EXAMPLE
A US corporation’s foreign subsidiary has $1,000 of earnings but makes no distributions to its US parent during the year. The US corporation is not taxed on the $1,000 of earnings of its foreign subsidiary.
b. Certain types of income, referred to as subpart F income, of a controlled foreign corporation are subject to current US taxation even though the earnings are not distributed to the US parent corporation. A controlled foreign corporation (CFC) is a foreign corporation whose stock is more than 50% owned (by vote or value) by US shareholders that own at least 10% of the combined voting power of the foreign corporation’s stock. The US shareholders get a corresponding basis increase for their CFC stock for the amount of subpart F income taxed to them but not received in the form of dividends. A later distribution of those earnings will be nontaxable and will reduce their basis for the CFC stock.
EXAMPLE
US corporation M owns all the stock of foreign subsidiary N which has $1,000 of earnings from subpart F income but makes no distributions to M during the year. M is currently taxed on the $1,000 of subpart F income of N, and increases its basis for its N stock by $1,000.
c. Subpart F income generally includes foreign passive income as well as certain types of foreign business income that can be readily shifted between taxing jurisdictions to take advantage of a lower foreign tax rate. Included in Subpart F income is income from a CFC’s insurance of risks outside its country of creation or organization, foreign base company income, amounts attributable to international boycott participation, and amounts attributable to illegal bribes and kickbacks. Two examples of foreign base company income are foreign personal holding company income, and foreign base company sales income.
(1) Foreign personal holding company income generally includes such items as dividends, interest, royalties, rents, annuities, and income from personal service contracts.
(2) Foreign base company sales income generally consists of income attributable to sales of personal property if three requirements are met: (1) the subject purchase or sale must be to, from, or on behalf of, a related party (a related party includes all individuals and entities owning, directly or indirectly, more than 50% of the CFC’s stock), (2) the purchase or sale must be for use, consumption, or disposition outside of the CFC’s country of incorporation, and (3) the personal property must be manufactured, grown, produced, or extracted outside of the CFC’s country of incorporation.
As a result of the above requirements, certain sales of personal property will be excluded from foreign base company sales income. For example, Subpart F income does not include income from the sale of personal property that was manufactured, produced, or constructed by the CFC. Also, it does not include income from the purchase and sale of property if the property is used in the jurisdiction wherein the CFC is incorporated.
d. A foreign tax credit against US income tax, for income taxes paid to a foreign country, mitigates the double taxation of foreign-source income. However, the amount of allowable foreign tax credit is limited to the US income tax imposed on the foreign source income.
image
(1) The overall limit on the foreign tax credit must be computed on a separate basis for several income categories including passive category income such as interest and dividends, and general category income, which includes most income other than passive category income. As a result, the foreign tax credit cannot exceed the lesser of the amount of foreign income taxes paid or accrued, or the limitation amount, for each category.
(2) Foreign income taxes paid in excess of the overall limitation can be carried back 1 year and forward 10 years and used to the extent that the taxpayer is below the limitation in those years.
(3) An individual with $300 or less ($600 for married filing jointly) of creditable foreign income taxes in exempt from the overall limitation if all foreign-source income is passive investment income.
(4) Taxpayers have the option of deducting foreign income taxes in lieu of taking a credit.
e. In addition to the foreign taxes actually paid, a US corporation that receives dividends from a 10% or more owned foreign corporation (based on voting stock) is entitled to a deemed paid foreign tax credit for the foreign income taxes paid by that foreign corporation with respect to such dividends. A corporation taking the deemed paid credit must gross-up (increase) the amount of dividend income that it received by the foreign income tax paid on those dividends. The deemed paid credit is subject to the FTC limitation.
EXAMPLE
A US corporation receives a dividend of $75 from a wholly owned foreign subsidiary that has paid $25 of foreign income taxes on the earnings to which the dividend relates. The US corporation’s dividend income of $75 is grossed-up by the $25 of foreign income taxes paid by its subsidiary, to $100. The US corporation is then eligible for a foreign tax credit for the $25 of foreign income taxes that it is deemed to have paid.
3. Transfers of Property to Foreign Corporations
a. Gain (but not loss) is generally recognized on the transfer of property by a US person to a foreign corporation notwithstanding the deferral provision of Subchapter C that otherwise would apply. This prevents gains from escaping US taxation and is accomplished by providing that a “foreign corporation” shall not be considered a corporation for purposes of the Subchapter C provisions (e.g., Sec. 351 transfer to a controlled corporation, Sec. 332 liquidation of a subsidiary, Sec. 361 transfer of property pursuant to a corporate reorganization).
EXAMPLE
US Corporation P owns property with a value of $1 million that has a zero tax basis. Corporation P transfers title to the property to its foreign subsidiary, Corporation S, in exchange for all of the stock of Corporation S. If Sec. 351(a) applied, no gain would be recognized on the transfer of the appreciated property to S. Thereafter, S could sell the property and recognize the gain. Assuming that S does not distribute its earnings to P and that Subpart F does not apply, the gain would escape US taxation. However, since foreign Corporation S is not considered a corporation for purposes of applying Sec. 351, P’s realized gain of $1 million on the transfer of property to S is recognized and subject to US taxation.
b. The above recognition rule does not apply to any property transferred to a foreign corporation for use by such foreign corporation in the active conduct of a trade or business outside of the US. Exceptions requiring gain recognition apply to transfers of certain types of property that are likely to be promptly resold or are highly fungible such as receivables, copyrights, inventory, installment obligations, foreign currency or foreign-currency-denominated investments, and interests in leased property.
4. Transfer Pricing
a. When businesses in different countries that are owned or controlled by the same interests sell products or services or make loans between themselves, they have the opportunity to affect each other’s taxable income and thereby reduce the overall tax liability of the group. This can be accomplished by shifting taxable income from a high-tax country to a lower-tax country.
b. To restrict this artificial shifting of income, Code Sec. 482 gives the IRS the authority to apportion and allocate income, deductions, and credits as is necessary in order to prevent the evasion of taxes or to clearly reflect income.
c. Generally, Sec. 482 requires that organizations under common control conduct business between themselves as if they were unrelated. That is, in determining the taxable income of a taxpayer from transactions with related organizations, the standard to be applied is that of a taxpayer dealing at arm’s length with an unrelated taxpayer.
EXAMPLE
A US Corporation causes income which it has earned by means of its property or activity to be received by its foreign subsidiary, and thus shields such income from US taxation. Sec. 482 empowers the IRS to allocate the income to the US corporation.
EXAMPLE
A US Corporation sells its product to an independent third party as well as to its foreign subsidiary, each of whom operate as distributors of its product in a foreign market. The unit price charged the independent distributor is $200, while the unit price charged its foreign subsidiary is $125. If the US corporation dealt with its subsidiary at “arm’s length,” then the unit price charged the foreign subsidiary would have been $200. The IRS may utilize Sec. 482 to allocate $75 of profit from the subsidiary to the US corporation.
d. Because it may be difficult for a taxpayer to determine what price might be used by unrelated taxpayers dealing at arm’s length, the IRS permits taxpayers to enter into an Advance Pricing Agreement (APA) with the IRS on the best method for determining arm’s length prices for transfers between taxpayers owned or controlled by the same interests. Pursuant to an APA, a taxpayer and the IRS agree as to the transfer pricing method to be used to determine the transfer prices for specified transactions.
NOW REVIEW MULTIPLE-CHOICE QUESTIONS 67 THROUGH 70

VI. SOURCES OF FEDERAL TAX AUTHORITY

A. Primary authorities are official sources of tax law generated by the legislative branch (e.g., Internal Revenue Code, committee reports), judicial branch (e.g., court decisions), and executive/administrative branch (e.g., Treasury regulations, revenue rulings, revenue procedures). Secondary authorities are unofficial tax authorities that interpret and explain the primary authorities such as tax research services, professional periodicals, and IRS publications.

B. Federal Tax Legislative Process

1. Tax legislation usually begins in the House of Representatives. Hearings are held before the Ways and Means Committee. Members of the Committee draft a bill, and after having been approved by the Committee, it is sent to the House for debate and vote by the full House membership. A tax bill passed by the House is sent to the Senate Finance Committee.
2. The Senate Finance Committee may amend bill or draft its own bill, and when approved by the Finance Committee, the bill is sent to the Senate floor for debate before the Senate and possible additional amendments.
3. If the House- and Senate-passed versions of the tax bill differ, the tax bill is sent to the House-Senate Conference Committee for resolution of any differences. The modified bill, when approved by the Conference Committee, is sent back to the House and Senate for approval in its final form.
4. The uniform bill, after passage by the House and Senate, goes to the president for signing. If the president signs the bill it becomes law. If the president vetoes the bill, at least a two-thirds vote of the House and at least a two-thirds vote of the Senate are needed to override the presidential veto for the tax bill to become law.
5. Most tax legislation simply amends the current Internal Revenue Code of 1986. Note that the IRS does not write the tax law, and the Internal Revenue Code was not written by the IRS. Tax legislation is passed by Congress and signed by the president to become law.
C. The Internal Revenue Code (IRC) is the basic foundation of federal tax law, and represents a codification of the federal tax laws of the United States.
1. A series of self-contained revenue acts were first codified into an organized framework with the Internal Revenue Code of 1939. Subsequently, the 1939 IRC was reorganized and replaced with the 1954 IRC. In 1986, the Code’s name was changed to the IRC of 1986, and has been frequently amended since then (e.g., American Taxpayer Relief Act of 2012).
2. The Internal Revenue Code of 1986 is actually Title 26 of the United States Code, and is generally divided into an orderly framework as follows: Subtitles; Chapters; Subchapters; Parts; Subparts; Sections; and Subsections.
3. Subtitles are denoted with a capital letter, with most pertaining to a general area of tax law as follows:
Subtitle Topic
A Income Taxes
B Estate and Gift Taxes
C Employment Taxes
D Miscellaneous Excise Taxes
E Alcohol, Tobacco, and Certain Other Excise Taxes
F Procedure and Administration
G The Joint Committee on Taxation
H Financing of Presidential Election Campaigns
I Trust Fund Code
J Coal Industry Health Benefits
K Group Health Plan Requirements
4. Each subtitle generally contains a number of chapters that are numbered in ascending order throughout the Code. Each chapter generally contains the tax rules that relate to a more narrowly defined area of law than is addressed by a subtitle. For example, Subtitle A—Income Taxes is divided as follows:
Chapter Topic
1 Normal Taxes and Surtaxes
2 Tax on Self-Employment Income
3 Withholding of Tax on Nonresident Aliens and Foreign Corporations
4 [Repealed]
5 [Repealed]
6 Consolidated Returns
5. Chapters of the IRC are further divided into subchapters with each subchapter pertaining to a more narrowly defined area of tax law than is addressed by a chapter. For example, Chapter 1, Normal Taxes and Surtaxes includes Subchapter C—corporate distributions and adjustments, Subchapter K—partners and partnerships, and Subchapter S—tax treatment of S corporations and shareholders.
6. Subchapters are generally divided into parts, which are then frequently divided into subparts. Additionally, subparts are divided into sections that represent the organizational division of the Internal Revenue Code to which persons dealing with tax matters most often refer (e.g., Sec. 351 transfers to a controlled corporation, Sec. 1231 gains and losses, Sec. 1245 recapture).
7. Code sections are often divided into smaller divisions that may include subsections, paragraphs, subparagraphs, and clauses. Sections are denoted by numbers (1, 2, 3, etc.), subsections by lowercase letters (a, b, c, etc.), paragraphs by numbers (1, 2, 3, etc.), subparagraphs by capital letters (A, B, C, etc.), and clauses by lowercase roman numerals (i, ii, iii, etc.). This organizational scheme is important because the IRC contains many cross references which indicate the scope or limit the application of a provision.
EXAMPLE
Sec. 7701 is a definitional section that begins. “When used in this title . . .” and then goes on to provide a series of definitions. As a result, a definition found in Sec. 7701 applies to all of the Internal Revenue of Code of 1986.
EXAMPLE
Code Sec. 311(b) provides a gain recognition rule that applies to a corporation when it distributes appreciated property to a shareholder. However, its application is limited in that it only applies to distributions described in Subpart A (i.e., Code Secs. 301 through 307). Code Sec. 311(b)’s position within the overall Code framework is as follows:
Title: Internal Revenue Code of 1986
Subtitle A: Income Taxes
Chapter 1: Normal taxes and surtaxes
Subchapter C: Corporate distributions and adjustments
Part I: Distributions by corporations
Subpart B: Effects on corporation
Section 311: Tax liability of corporation on distributions
Subsection (b): Distributions of appreciated property
Paragraph (1): In general. If—
Subparagraph (A): “a corporation distributes property . . . in a distribution to which Subpart A applies . . .”
D. The IRC gives the Treasury Department or its delegate (the Commissioner of Internal Revenue) the authority to issue regulations to provide administrative interpretation of the tax law. These regulations may be separated into two broad categories: legislative and interpretive. Legislative regulations are those issued by the IRS under a specific grant of authority to prescribe the operating rules for a statute (e.g., “the Secretary shall prescribe such regulations as he may deem necessary,” or “under regulations prescribed by the Secretary”) and have the force and effect of law. The consolidated tax return regulations are an example of legislative regulations. In contrast, interpretive regulations are issued pursuant to the general rule-making authority granted to the IRS under Sec. 7805(a) and provide guidance regarding the IRS’s interpretation of a statute. Although interpretive regulations do not have the force and effect of law, they are generally accorded substantial weight by the courts.
1. Regulations may also be categorized as proposed, temporary, or final regulations. Regulations are generally issued as Proposed regulations allowing interested parties a period of time of at least thirty days to comment and suggest changes. As a result of the comments received, the IRS may make changes to a proposed regulation before being published as a final regulation. Proposed regulations do not carry the same authority as temporary or final regulations. Temporary regulations are generally issued following recent tax legislation to provide interim guidance until final regulations are adopted. Temporary regulations (issued after 11/20/88) must be concurrently issued as proposed regulations, and these temporary regulations expire no later than three years from date of issue. Prior to its expiration, a temporary regulation is given the same weight as a final regulation. Final regulations are issued after public comments on proposed regulations are evaluated. Final regulations supersede any existing temporary regulations.
2. Regulations are organized in a sequential system with numbers preceding and following a decimal point. The numbers preceding the decimal point indicate the type of regulation or applicable area of tax law to which they pertain, while the numbers immediately following a decimal point indicate the IRC section being interpreted. Some of the more common prefixes include
Number Type
1 Income Tax
20 Estate Tax
25 Gift Tax
301 Administrative and Procedural Matters
601 Procedural Rules
The numbers and letters to the right of the section number indicate the regulation number and smaller divisions of the regulation (e.g., paragraph, subparagraph). These regulation numbers and paragraphs do not necessarily correspond to the subsection of the Code being interpreted. For example, Reg. 1.267(d)-1(a)(4) provides four examples of the application of Code Sec. 267(d) concerning the determination of recognized gain where a loss was previously disallowed. The citation represents subparagraph (4) of paragraph (a) of the first regulation interpreting Code Sec. 267(d). The citation of a temporary regulation includes a “T” which indicates the nature of the regulation as temporary. For example, 1.45D-1T is a temporary regulation that explains the rules and conditions for claiming the new markets tax credit of Code Sec. 45.
E. Revenue rulings have less force and effect than regulations, but are second to regulations as important administrative sources of federal tax law. A revenue ruling gives the IRS’s interpretation of how the Code and regulations apply to a specific fact situation, and therefore indicates how the IRS will treat similar transactions. Revenue rulings can be relied upon as authority by all taxpayers, and are published in the Internal Revenue Bulletin and later in the Cumulative Bulletin. The current status of a revenue ruling can be checked in the most current index to the Cumulative Bulletin. Revenue procedures announce administrative practices followed by the IRS, and are published in the Internal Revenue Bulletin and later in the Cumulative Bulletin. Revenue procedures provide guidelines that taxpayers must meet in order to obtain a revenue ruling, and also indicate areas in which the IRS will not issue revenue rulings. A private letter ruling is a written statement issued to the taxpayer who requested advice concerning a specific transaction. Although issued only to a specific taxpayer, private letter rulings are useful because they indicate how the IRS may treat a similar transaction, and are included in the list of substantial authority upon which a taxpayer may rely to avoid certain statutory penalties.

VII. TAX PLANNING

Tax planning should not be done in isolation, but instead should be a part of a taxpayer’s overall financial goals, and integrated with nontax considerations. Three general tax planning strategies involve (1) the timing of income and deductions, (2) the shifting of income and deductions between taxpayers, and (3) the conversion of the character of income and deductions.

A. Timing

The tax accounting period in which an expense is deducted or in which income is recognized effects the real tax savings or cost because of the time value of money. A simple tax planning strategy would be to accelerate a tax deduction to an earlier period, while deferring the recognition of income to a later period.
1. Installment sale. A taxpayer may want to structure the casual sale of an asset so that at least one payment is received in the year(s) following the year of sale. By using the installment method and spreading the gain over multiple years, the taxpayer’s gain will be deferred and may be taxed in lower brackets
2. Net operating loss. A taxpayer should carefully consider whether to carry back an NOL or elect to forgo the carryback period. A taxpayer may want to only carry the loss forward if the taxpayer anticipates being in a higher marginal tax bracket in carryforward years.
3. Casualty loss. If a casualty loss is sustained in a presidentially declared disaster area, the taxpayer may make an election to deduct the loss in the year preceding the year in which the loss was incurred in order to obtain a more immediate tax benefit for the loss deduction.
4. Medical expenses. Because of the 10% (or 7.5%) of AGI threshold for deducting medical expenses, taxpayers often are unable to take a deduction for unreimbursed medical expenses. However, it may be possible to take a medical expense deduction if the expenses are bunched into one year. Medical expenses are generally deductible when paid, but can be deducted in the year charged to a credit card.
5. Itemized deductions. If a taxpayer’s total itemized deductions are approximately the same as the standard deduction, a taxpayer may benefit from bunching itemized deductions into a year in which the taxpayer intends to itemize, with the intention of taking the standard deduction in the following year. By alternating standard deduction and itemized deductions years, the taxpayer may be able to maximize deductions over a multiyear time frame.
6. Alternative minimum tax. If a taxpayer is not subject to AMT in 2013 but expects to be in 2014, accelerate expenses that are not deductible for AMT into 2013. For example, consider paying off home equity debt since the interest expense is usually not deductible for AMT purposes. Alternatively, if the taxpayer expects to pay an AMT in 2013 but not in 2014, consider accelerating ordinary and short-term capital gain income into 2013 while deferring expenses not deductible for AMT into 2014 (e.g., state and local income taxes, real estate taxes, miscellaneous deductions in the 2% category).
7. Short-term capital gain. If a taxpayer has short-term capital gains (which are taxed at ordinary income tax rates), consider selling capital assets that will generate capital losses in order to offset the short-term capital gain. Taxpayers are allowed to deduct up to $3,000 of net capital loss against ordinary income each year, with any net capital loss in excess of $3,000 carried forward to future years.
8. Estimated tax. An exception that can be used to avoid an underpayment penalty for the current year is for a taxpayer to make estimated payments and withholdings which in total are at least equal to 100% (110% if prior year AGI was greater than $150,000) of the tax liability for the prior year. Income tax withholdings are considered paid equally throughout the year, even if the taxes are withheld near the end of the year. If a taxpayer anticipates that taxes for the current year are underpaid, consider adjusting withholdings for the remainder of the year to avoid the underpayment penalty.

B. Income and Deduction Shifting

This planning strategy seeks to take advantage of the differences in tax rates between taxpayers, or between taxing jurisdictions. The goal is to shift income from high-tax rate to low-tax rate taxpayers or jurisdictions, and to shift deductions from low-tax rate to high-tax rate taxpayers or jurisdictions.
1. Children. Parents can reduce their family’s income tax by shifting income that would otherwise be taxed at higher rates to their children whose income is taxed at lower rates. Even if the kiddie tax applies, the first $2,000 of unearned (e.g., interest) income will be taxed at the child’s rates. Additionally, if the child has no earned income (e.g., wages), the child’s unearned income will be partially offset by a limited basic standard deduction of $1,000.
2. Gift tax exclusion. A taxpayer interested in family wealth planning may want to consider the annual gift tax exclusion when gifting appreciated assets to family members. There is an annual $14,000 exclusion (for 2013) per donee for gifts of a present interest. This means that up to $14,000 of gifts can be given to a donee without making a taxable gift. Additionally, if the appreciated assets are given to family members not subject to the kiddie tax who are in the lowest two brackets, the capital gain on sale of the assets will be taxed at a 0% rate as opposed to a 15% or 20% rate if sold by the parents.
3. Sec. 529 plan. A Sec. 529 educational savings plan could be established for a child or grandchild. Using a special election, a taxpayer could currently fund up to five years of annual exclusions into the plan without making a taxable gift. This would permit up to $70,000 to be deposited into a child’s Section 529 plan where the principal would grow tax-deferred, and later distributions used for the child’s college costs would be exempt from tax.
4. Owners and their businesses. Incorporating a business and thus shifting income from an individual to a C corporation may result in lower current taxation of the business income (e.g., first $50,000 of corporate taxable income taxed at 15% rate). Alternatively, business income could be shifted from a corporation to an owner through tax-deductible expenses paid to the owner (e.g., compensation, rent, interest) allowing the owner to avoid the double taxation of corporate profits. Additionally, corporate level taxes could generally be completely avoided by making an S corporation election which would shift all income and deductions to the S corporation’s shareholders.

C. Conversion

This planning strategy involves converting ordinary income that would be taxed at regular rates into income that will be taxed at a preferential rate. Additionally, this strategy might be applied to convert deductions that would be subject to limitations into ordinary deductions that are deductible without limitation.
1. Sale of a company. If considering the sale of a business, a taxpayer may attempt to structure the transaction as a sale of the company’s stock rather than a sale of the company’s assets. A sale of the company’s stock generally results in gain eligible for reduced capital-gains rates, as opposed to a sale of assets which may be taxed as ordinary income.
2. Qualified dividends. A taxpayer may want to consider replacing investments generating interest income taxed at regular rates, with stocks paying qualified dividends that are taxed at a reduced rate of 15% or 20%, or possibly 0% if the taxpayer is in the 10% or 15% bracket. In order to qualify for the reduced rate, the underlying stock upon which a dividend is paid must be held for at least 61 days during the 121-day period beginning 60 days before the ex-dividend date (91 days of the 181-day period for preferred stock).
3. Passive activities. A taxpayer may be able to increase participation in what would otherwise be a “passive activity” in order to classify the activity as an active business activity whose losses are currently deductible. Alternatively, a taxpayer might be able to decrease participation in a profitable business activity in order to classify the income as passive activity income that could then be sheltered by losses generated from other passive activities.

KEY TERMS

Estate tax. A tax imposed on the transfer of property at death. The tax is part of the unified transfer tax system and takes into account transfers an individual made during lifetime and at death.

Generation-skipping tax. A tax on the transfer of property to, or in trust for the benefit of, a person that is two or more generations younger than the donor or transferor and is designed to prevent individuals from escaping an entire generation of gift and estate taxes. It is imposed in addition to federal gift and estate taxes.

Gift tax. A tax imposed on the transfer of property during an individual’s lifetime. The tax is imposed upon the donor of the gift and is based upon the fair market value of the property on the date of gift.

Grantor trust. A trust over which the grantor (or grantor’s spouse) retains substantial control. The income of a grantor trust is taxed to the grantor, not to the trust or beneficiaries.

Revenue ruling. Gives the IRS’s interpretation of how the IRC and regulations apply to a specific fact situation, and therefore indicates how the IRS will treat similar transactions.

Simple trust. A trust that is required to distribute all of its income to beneficiaries each year, cannot make charitable contributions, and makes no distributions of trust corpus (i.e., principal) during the year.

UDITPA. The Uniform Division of Income for Tax Purposes Act which provides rules for allocating and apportioning a multistate or multinational enterprise’s nonbusiness and business income among states and foreign counties.

Unrelated business income. Income of an exempt organization from a business that is regularly carried on, and is unrelated to the organization’s exempt purpose. UBI is subject to tax to the extent in excess of $1,000.

Multiple-Choice Questions (1–70)

I.A. Gift Tax

1. Steve and Kay Briar, US citizens, were married for the entire 2013 calendar year. In 2013, Steve gave a $32,000 cash gift to his sister. The Briars made no other gifts in 2013. They each signed a timely election to treat the $32,000 gift as made one-half by each spouse. Disregarding the applicable credit and estate tax consequences, what amount of the 2013 gift is taxable to the Briars?

a. $30,000

b. $ 6,000

c. $ 4,000

d. $0

2. In 2013, Sayers, who is single, gave an outright gift of $50,000 to a friend, Johnson, who needed the money to pay medical expenses. In filing the 2013 gift tax return, Sayers was entitled to a maximum exclusion of

a. $0

b. $13,000

c. $14,000

d. $50,000

3. During 2013, Blake transferred a corporate bond with a face amount and fair market value of $20,000 to a trust for the benefit of her sixteen-year old child. Annual interest on this bond is $2,000, which is to be accumulated in the trust and distributed to the child on reaching the age of twenty-one. The bond is then to be distributed to the donor or her successor-in-interest in liquidation of the trust. Present value of the total interest to be received by the child is $8,710. The amount of the gift that is excludable from taxable gifts is

a. $20,000

b. $14,000

c. $ 8,710

d. $0

4. Under the unified rate schedule for 2013,

a. Lifetime taxable gifts are taxed on a noncumulative basis.

b. Transfers at death are taxed on a noncumulative basis.

c. Lifetime taxable gifts and transfers at death are taxed on a cumulative basis.

d. The gift tax rates are 5% higher than the estate tax rates.

5. Which of the following requires filing a gift tax return, if the transfer exceeds the available annual gift tax exclusion?

a. Medical expenses paid directly to a physician on behalf of an individual unrelated to the donor.

b. Tuition paid directly to an accredited university on behalf of an individual unrelated to the donor.

c. Payments for college books, supplies, and dormitory fees on behalf of an individual unrelated to the donor.

d. Campaign expenses paid to a political organization.

6. On July 1, 2013, Vega made a transfer by gift in an amount sufficient to require the filing of a gift tax return. Vega was still alive in 2014. If Vega did not request an extension of time for filing the 2013 gift tax return, the due date for filing was

a. March 15, 2014.

b. April 15, 2014.

c. June 15, 2014.

d. June 30, 2014.

7. Jan, an unmarried individual, gave the following outright gifts in 2013:

Donee Amount Use by donee
Jones $16,000 Down payment on house
Craig 15,000 College tuition
Kande 5,000 Vacation trip

Jan’s 2013 exclusions for gift tax purposes should total

a. $34,000

b. $33,000

c. $31,000

d. $18,000

8. When Jim and Nina became engaged in April 2013, Jim gave Nina a ring that had a fair market value of $50,000. After their wedding in July 2013, Jim gave Nina $75,000 in cash so that Nina could have her own bank account. Both Jim and Nina are US citizens. What was the amount of Jim’s 2013 marital deduction?

a. $ 63,000

b. $ 75,000

c. $113,000

d. $125,000

9. Raff created a joint bank account for himself and his friend’s son, Dave. There is a gift to Dave when

a. Raff creates the account.

b. Raff dies.

c. Dave draws on the account for his own benefit.

d. Dave is notified by Raff that the account has been created.

I.B. Estate Tax

10. Fred and Ethel (brother and sister), residents of a noncommunity property state, own unimproved land that they hold in joint tenancy with rights of survivorship. The land cost $100,000 of which Ethel paid $80,000 and Fred paid $20,000. Ethel died during 2013 when the land was worth $300,000, and $240,000 was included in Ethel’s gross estate. What is Fred’s basis for the property after Ethel’s death?

a. $140,000

b. $240,000

c. $260,000

d. $300,000

11. Bell, a cash-basis calendar-year taxpayer, died on June 1, 2013. In 2013, prior to her death, Bell incurred $2,000 in medical expenses. The executor of the estate paid the medical expenses, which were a claim against the estate, on July 1, 2013. If the executor files the appropriate waiver, the medical expenses are deductible on

a. The estate tax return.

b. Bell’s final income tax return.

c. The estate income tax return.

d. The executor’s income tax return.

12. If the executor of a decedent’s estate elects the alternate valuation date and none of the property included in the gross estate has been sold or distributed, the estate assets must be valued as of how many months after the decedent’s death?

a. 12

b. 9

c. 6

d. 3

13. What amount of a decedent’s taxable estate is effectively tax-free if the maximum basic exclusion amount is taken during 2013?

a. $1,000,000

b. $1,455,800

c. $3,500,000

d. $5,250,000

14. Which of the following credits may be offset against the gross estate tax to determine the net estate tax of a US citizen dying during 2013?

Applicable credit Credit for gift taxes paid on gifts made after 1976
a. Yes Yes
b. No No
c. No Yes
d. Yes No

15. Fred and Amy Kehl, both US citizens, are married. All of their real and personal property is owned by them as tenants by the entirety or as joint tenants with right of survivorship. The gross estate of the first spouse to die

a. Includes 50% of the value of all property owned by the couple, regardless of which spouse furnished the original consideration.

b. Includes only the property that had been acquired with the funds of the deceased spouse.

c. Is governed by the federal statutory provisions relating to jointly held property, rather than by the decedent’s interest in community property vested by state law, if the Kehls reside in a community property state.

d. Includes one-third of the value of all real estate owned by the Kehls, as the dower right in the case of the wife or curtesy right in the case of the husband.

16. In connection with a “buy-sell” agreement funded by a cross-purchase insurance arrangement, business associate Adam bought a policy on Burr’s life to finance the purchase of Burr’s interest. Adam, the beneficiary, paid the premiums and retained all incidents of ownership. On the death of Burr, the insurance proceeds will be

a. Includible in Burr’s gross estate, if Burr owns 50% or more of the stock of the corporation.

b. Includible in Burr’s gross estate only if Burr had purchased a similar policy on Adam’s life at the same time and for the same purpose.

c. Includible in Burr’s gross estate, if Adam has the right to veto Burr’s power to borrow on the policy that Burr owns on Adam’s life.

d. Excludible from Burr’s gross estate.

17. Following are the fair market values of Wald’s assets at the date of death:

Personal effects and jewelry $1,750,000
Land bought by Wald with Wald’s funds five years prior to death and held with Wald’s sister as joint tenants with right of survivorship 3,800,000

The executor of Wald’s estate did not elect the alternate valuation date. The amount includible as Wald’s gross estate in the federal estate tax return is

a. $1,750,000

b. $3,800,000

c. $5,000,000

d. $5,550,000

18. Which one of the following is a valid deduction from a decedent’s gross estate?

a. Foreign death taxes.

b. Income tax paid on income earned and received after the decedent’s death.

c. Federal estate taxes.

d. Unpaid income taxes on income received by the decedent before death.

19. Eng and Lew, both US citizens, died in 2013. Eng made taxable lifetime gifts of $400,000 that are not included in Eng’s gross estate. Lew made no lifetime gifts. At the dates of death, Eng’s gross estate was $3,600,000, and Lew’s gross estate was $4,800,000. A federal estate tax return must be filed for

Eng Lew
a. No No
b. No Yes
c. Yes No
d. Yes Yes

20. With regard to the federal estate tax, the alternate valuation date

a. Is required to be used if the fair market value of the estate’s assets has increased since the decedent’s date of death.

b. If elected on the first return filed for the estate, may be revoked in an amended return provided that the first return was filed on time.

c. Must be used for valuation of the estate’s liabilities if such date is used for valuation of the estate’s assets.

d. Can be elected only if its use decreases both the value of the gross estate and the estate tax liability.

21. Proceeds of a life insurance policy payable to the estate’s executor, as the estate’s representative, are

a. Includible in the decedent’s gross estate only if the premiums had been paid by the insured.

b. Includible in the decedent’s gross estate only if the policy was taken out within three years of the insured’s death under the “contemplation of death” rule.

c. Always includible in the decedent’s gross estate.

d. Never includible in the decedent’s gross estate.

22. Ross, a calendar-year, cash-basis taxpayer who died in June 2013, was entitled to receive a $10,000 accounting fee that had not been collected before the date of death. The executor of Ross’ estate collected the full $10,000 in July 2013. This $10,000 should appear in

a. Only the decedent’s final individual income tax return.

b. Only the estate’s fiduciary income tax return.

c. Only the estate tax return.

d. Both the fiduciary income tax return and the estate tax return.

Items 23 and 24 are based on the following data:

Alan Curtis, a US citizen, died on March 1, 2013, leaving an adjusted gross estate with a fair market value of $5,400,000 at the date of death. Under the terms of Alan’s will, $3,000,000 was bequeathed outright to his widow, free of all estate and inheritance taxes. The remainder of Alan’s estate was left to his mother. Alan made no taxable gifts during his lifetime.

23. Disregarding extensions of time for filing, within how many months after the date of Alan’s death is the federal estate tax return due?

a. 2 1/2

b. 3 1/2

c. 9

d. 12

24. In computing the taxable estate, the executor of Alan’s estate should claim a marital deduction of

a. $ 450,000

b. $ 780,800

c. $ 900,000

d. $3,000,000

25. In 2007, Edwin Ryan bought 100 shares of a listed stock for $5,000. In June 2013, when the stock’s fair market value was $7,000, Edwin gave this stock to his sister, Lynn. No gift tax was paid. Lynn died in October 2013, bequeathing this stock to Edwin, when the stock’s fair market value was $9,000. Lynn’s executor did not elect the alternate valuation. What is Edwin’s basis for this stock after he inherits it from Lynn’s estate?

a. $0

b. $5,000

c. $7,000

d. $9,000

II. Generation-Skipping Tax

26. For 2013, the generation-skipping transfer tax is imposed

a. Instead of the gift tax.

b. Instead of the estate tax.

c. At the highest tax rate under the transfer tax rate schedule.

d. When an individual makes a gift to a grandparent.

III. Income Taxation of Estates and Trusts

27. Under the terms of the will of Melvin Crane, $10,000 a year is to be paid to his widow and $5,000 a year is to be paid to his daughter out of the estate’s income during the period of estate administration. No charitable contributions are made by the estate. During 2013, the estate made the required distributions to Crane’s widow and daughter and for the entire year the estate’s distributable net income was $12,000. What amount of the $10,000 distribution received from the estate must Crane’s widow include in her gross income for 2013?

a. $0

b. $ 4,000

c. $ 8,000

d. $10,000

Items 28 and 29 are based on the following:

Lyon, a cash-basis taxpayer, died on January 15, 2013. In 2013, the estate executor made the required periodic distribution of $9,000 from estate income to Lyon’s sole heir. The following pertains to the estate’s income and disbursements in 2013:

2013 Estate Income
$20,000 Taxable interest
10,000 Net long-term capital gains allocable to corpus
2013 Estate Disbursements
$5,000 Administrative expenses attributable to taxable income

28. For the 2013 calendar year, what was the estate’s distributable net income (DNI)?

a. $15,000

b. $20,000

c. $25,000

d. $30,000

29. Lyon’s executor does not intend to file an extension request for the estate fiduciary income tax return. By what date must the executor file the Form 1041, US Fiduciary Income Tax Return, for the estate’s 2013 calendar year?

a. March 15, 2014.

b. April 15, 2014.

c. June 15, 2014.

d. September 15, 2014.

30. A distribution from estate income, that was currently required, was made to the estate’s sole beneficiary during its calendar year. The maximum amount of the distribution to be included in the beneficiary’s gross income is limited to the estate’s

a. Capital gain income.

b. Ordinary gross income.

c. Distributable net income.

d. Net investment income.

31. A distribution to an estate’s sole beneficiary for the 2013 calendar year equaled $15,000, the amount currently required to be distributed by the will. The estate’s 2013 records were as follows:

Estate income
$40,000 Taxable interest
Estate disbursements
$34,000 Expenses attributable to taxable interest

What amount of the distribution was taxable to the beneficiary?

a. $40,000

b. $15,000

c. $ 6,000

d. $0

32. With regard to estimated income tax, estates

a. Must make quarterly estimated tax payments starting no later than the second quarter following the one in which the estate was established.

b. Are exempt from paying estimated tax during the estate’s first two taxable years.

c. Must make quarterly estimated tax payments only if the estate’s income is required to be distributed currently.

d. Are not required to make payments of estimated tax.

33. A complex trust is a trust that

a. Must distribute income currently, but is prohibited from distributing principal during the taxable year.

b. Invests only in corporate securities and is prohibited from engaging in short-term transactions.

c. Permits accumulation of current income, provides for charitable contributions, or distributes principal during the taxable year.

d. Is exempt from payment of income tax since the tax is paid by the beneficiaries.

34. The 2013 standard deduction for a trust or an estate in the fiduciary income tax return is

a. $0

b. $650

c. $750

d. $800

35. Which of the following fiduciary entities are required to use the calendar year as their taxable period for income tax purposes?

Estates Trusts (except those that are tax exempt)
a. Yes Yes
b. No No
c. Yes No
d. No Yes

36. Ordinary and necessary administration expenses paid by the fiduciary of an estate are deductible

a. Only on the fiduciary income tax return (Form 1041) and never on the federal estate tax return (Form 706).

b. Only on the federal estate tax return and never on the fiduciary income tax return.

c. On the fiduciary income tax return only if the estate tax deduction is waived for these expenses.

d. On both the fiduciary income tax return and on the estate tax return by adding a tax computed on the proportionate rates attributable to both returns.

37. An executor of a decedent’s estate that has only US citizens as beneficiaries is required to file a fiduciary income tax return, if the estate’s gross income for the year is at least

a. $ 400

b. $ 500

c. $ 600

d. $1,000

38. The charitable contribution deduction on an estate’s fiduciary income tax return is allowable

a. If the decedent died intestate.

b. To the extent of the same adjusted gross income limitation as that on an individual income tax return.

c. Only if the decedent’s will specifically provides for the contribution.

d. Subject to the 2% threshold on miscellaneous itemized deductions.

39. On January 2, 2013, Carlt created a $300,000 trust that provided his mother with a lifetime income interest starting on January 2, 2013, with the remainder interest to go to his son. Carlt expressly retained the power to revoke both the income interest and the remainder interest at any time. Who will be taxed on the trust’s 2013 income?

a. Carlt’s mother.

b. Carlt’s son.

c. Carlt.

d. The trust.

40. Astor, a cash-basis taxpayer, died on February 3. During the year, the estate’s executor made a distribution of $12,000 from estate income to Astor’s sole heir and adopted a calendar year to determine the estate’s taxable income. The following additional information pertains to the estate’s income and disbursements for the year:

Estate income
Taxable interest $65,000
Net long-term capital gains allocable to corpus 5,000
Estate disbursements
Administrative expenses attributable to taxable income 14,000
Charitable contributions from gross income to a public charity, made under the terms of the will 9,000

For the calendar year, what was the estate’s distributable net income (DNI)?

a. $39,000

b. $42,000

c. $58,000

d. $65,000

41. For income tax purposes, the estate’s initial taxable period for a decedent who died on October 24

a. May be either a calendar year, or a fiscal year beginning on the date of the decedent’s death.

b. Must be a fiscal year beginning on the date of the decedent’s death.

c. May be either a calendar year, or a fiscal year beginning on October 1 of the year of the decedent’s death.

d. Must be a calendar year beginning on January 1 of the year of the decedent’s death.

IV. Exempt Organizations

42. The private foundation status of an exempt organization will terminate if it

a. Becomes a public charity.

b. Is a foreign corporation.

c. Does not distribute all of its net assets to one or more public charities.

d. Is governed by a charter that limits the organization’s exempt purposes.

43. Which of the following exempt organizations would be eligible to satisfy its annual filing requirement by filing Form 990-N (e-Postcard)?

a. Church.

b. Private foundation.

c. An exempt organization with $20,000 of gross receipts.

d. An exempt organization with $3,500 of gross income from an unrelated business.

44. To qualify as an exempt organization other than a church or an employees’ qualified pension or profit-sharing trust, the applicant

a. Cannot operate under the “lodge system” under which payments are made to its members for sick benefits.

b. Need not be specifically identified as one of the classes on which exemption is conferred by the Internal Revenue Code, provided that the organization’s purposes and activities are of a nonprofit nature.

c. Is barred from incorporating and issuing capital stock.

d. Must file a written application with the Internal Revenue Service.

45. To qualify as an exempt organization, the applicant

a. May be organized and operated for the primary purpose of carrying on a business for profit, provided that all of the organization’s net earnings are turned over to one or more tax exempt organizations.

b. Need not be specifically identified as one of the classes upon which exemption is conferred by the Internal Revenue Code, provided that the organization’s purposes and activities are of a nonprofit nature.

c. Must not be classified as a social club.

d. Must not be a private foundation organized and operated exclusively to influence legislation pertaining to protection of the environment.

46. Carita Fund, organized and operated exclusively for charitable purposes, provides insurance coverage, at amounts substantially below cost, to exempt organizations involved in the prevention of cruelty to children. Carita’s insurance activities are

a. Exempt from tax.

b. Treated as unrelated business income.

c. Subject to the same tax provisions as those applicable to insurance companies.

d. Considered “commercial-type” as defined by the Internal Revenue Code.

47. The filing of a return covering unrelated business income

a. Is required of all exempt organizations having at least $1,000 of unrelated business taxable income for the year.

b. Relieves the organization of having to file a separate annual information return.

c. Is not necessary if all of the organization’s income is used exclusively for charitable purposes.

d. Must be accompanied by a minimum payment of 50% of the tax due as shown on the return, with the balance of tax payable six months later.

48. A condominium management association wishing to be treated as a homeowners association and to qualify as an exempt organization for a particular year

a. Need not file a formal election.

b. Must file an election as of the date the association was organized.

c. Must file an election at the beginning of the association’s first taxable year.

d. Must file a separate election for each taxable year no later than the due date of the return for which the election is to apply.

49. An organization wishing to qualify as an exempt organization

a. Is prohibited from issuing capital stock.

b. Is limited to three prohibited transactions a year.

c. Must not have non-US citizens on its governing board.

d. Must be of a type specifically identified as one of the classes on which exemption is conferred by the Code.

50. Which one of the following statements is correct with regard to exempt organizations?

a. An organization is automatically exempt from tax merely by meeting the statutory requirements for exemptions.

b. Exempt organizations that are required to file annual information returns must disclose the identity of all substantial contributors, in addition to the amount of contributions received.

c. An organization will automatically forfeit its exempt status if any executive or other employee of the organization is paid compensation in excess of $150,000 per year, even if such compensation is reasonable.

d. Exempt status of an organization may not be retroactively revoked.

51. To qualify as an exempt organization, the applicant

a. Must fall into one of the specific classes upon which exemption is conferred by the Internal Revenue Code.

b. Cannot, under any circumstances, be a foreign corporation.

c. Cannot, under any circumstances, engage in lobbying activities.

d. Cannot be exclusively a social club.

52. To qualify as an exempt organization,

a. A written application need not be filed if no applicable official form is provided.

b. No employee of the organization is permitted to receive compensation in excess of $100,000 per year.

c. The applicant must be of a type specifically identified as one of the classes upon which exemption is conferred by the Code.

d. The organization is prohibited from issuing capital stock.

IV.A.2. Sec. 501(c)(3) Organizations

53. Hope is a tax-exempt religious organization. Which of the following activities is (are) consistent with Hope’s tax-exempt status?

I. Conducting weekend retreats for business organizations.

II. Providing traditional burial services that maintain the religious beliefs of its members.

a. I only.

b. II only.

c. Both I and II.

d. Neither I nor II.

54. The organizational test to qualify a public service charitable entity as tax-exempt requires the articles of organization to

I. Limit the purpose of the entity to the charitable purpose.

II. State that an information return should be filed annually with the Internal Revenue Service.

a. I only.

b. II only.

c. Both I and II.

d. Neither I nor II.

55. Which of the following activities regularly conducted by a tax-exempt organization will result in unrelated business income?

I. Selling articles made by handicapped persons as part of their rehabilitation, when the organization is involved exclusively in their rehabilitation.

II. Operating a grocery store almost fully staffed by emotionally handicapped persons as part of a therapeutic program.

a. I only.

b. II only.

c. Both I and II.

d. Neither I nor II.

56. An organization that operates for the prevention of cruelty to animals will fail to meet the operational test to qualify as an exempt organization if

The organization engages in insubstantial nonexempt activities The organization directly participates in any political campaign
a. Yes Yes
b. Yes No
c. No Yes
d. No No

IV.C. Unrelated Business Income (UBI)

57. Which one of the following statements is correct with regard to unrelated business income of an exempt organization?

a. An exempt organization that earns any unrelated business income in excess of $100,000 during a particular year will lose its exempt status for that particular year.

b. An exempt organization is not taxed on unrelated business income of less than $1,000.

c. The tax on unrelated business income can be imposed even if the unrelated business activity is intermittent and is carried on once a year.

d. An unrelated trade or business activity that results in a loss is excluded from the definition of unrelated business.

58. Which of the following activities regularly carried out by an exempt organization will not result in unrelated business income?

a. The sale of laundry services by an exempt hospital to other hospitals.

b. The sale of heavy-duty appliances to senior citizens by an exempt senior citizen’s center.

c. Accounting and tax services performed by a local chapter of a labor union for its members.

d. The sale by a trade association of publications used as course materials for the association’s seminars that are oriented towards its members.

59. If an exempt organization is a corporation, the tax on unrelated business taxable income is

a. Computed at corporate income tax rates.

b. Computed at rates applicable to trusts.

c. Credited against the tax on recognized capital gains.

d. Abated.

60. During 2013, Help, Inc., an exempt organization, derived income of $15,000 from conducting bingo games. Conducting bingo games is legal in Help’s locality and is confined to exempt organizations in Help’s state. Which of the following statements is true regarding this income?

a. The entire $15,000 is subject to tax at a lower rate than the corporation income tax rate.

b. The entire $15,000 is exempt from tax on unrelated business income.

c. Only the first $5,000 is exempt from tax on unrelated business income.

d. Since Help has unrelated business income, Help automatically forfeits its exempt status for 2013.

61. Which of the following statements is correct regarding the unrelated business income of exempt organizations?

a. If an exempt organization has any unrelated business income, it may result in the loss of the organization’s exempt status.

b. Unrelated business income relates to the performance of services, but not to the sale of goods.

c. An unrelated business does not include any activity where all the work is performed for the organization by unpaid volunteers.

d. Unrelated business income tax will not be imposed if profits from the unrelated business are used to support the exempt organization’s charitable activities.

62. An incorporated exempt organization subject to tax on its unrelated business income

a. Must make estimated tax payments if its tax can reasonably be expected to be $100 or more.

b. Must comply with the Code provisions regarding installment payments of estimated income tax by corporations.

c. Must pay at least 70% of the tax due as shown on the return when filed, with the balance of tax payable in the following quarter.

d. May defer payment of the tax for up to nine months following the due date of the return.

63. If an exempt organization is a charitable trust, then unrelated business income is

a. Not subject to tax.

b. Taxed at rates applicable to corporations.

c. Subject to tax even if such income is less than $1,000.

d. Subject to tax only for the amount of such income in excess of $1,000.

64. With regard to unrelated business income of an exempt organization, which one of the following statements is true?

a. If an exempt organization has any unrelated business income, such organization automatically forfeits its exempt status for the particular year in which such income was earned.

b. When an unrelated trade or business activity results in a loss, such activity is excluded from the definition of unrelated business.

c. If an exempt organization derives income from conducting bingo games, in a locality where such activity is legal, and in a state that confines such activity to nonprofit organizations, then such income is exempt from the tax on unrelated business income.

d. Dividends and interest earned by all exempt organizations always are excluded from the definition of unrelated business income.

V.A. State and Local Taxation (SALT)

Items 65 and 66 are based on the following information:

Miramar Corp. has total business income of $1 million, and in State XY has a sales factor of 60%, a payroll factor of 50%, and a property factor of 49%.

65. What is Miramar’s State XY UDITPA appointment factor and State XY business income?

a. 60%; $600,000 business income

b. 50%; $500,000 business income

c. 53%; $530,000 business income

d. 53%; $1,000,000 business income

66. What would be Miramar’s State XY apportionment factor if State XY used an apportionment formula in which the property factor was double-weighted?

a. 50%

b. 52%

c. 54.75%

d. 60%

V.B. International Taxation

67. Which one of the following statements regarding the foreign operations of Glencoe Corporation (a domestic corporation) is correct?

a. Glencoe’s earnings from its foreign operations are not subject to US income tax.

b. Glencoe may take a deduction, but not a credit, for the income taxes paid to a foreign country.

c. Glencoe may take a credit, but not a deduction, for the income taxes paid to a foreign country.

d. Glencoe may take either a deduction or a tax credit, but not both, for the income taxes paid to a foreign country.

Items 68 and 69 are based on the following information:

For the current year, Crocker Corp., a domestic corporation, has US taxable income of $700,000, which includes $100,000 from a foreign division. Crocker paid $40,000 of foreign income taxes on the income of the foreign division.

68. Assuming Crocker’s US income tax for the current year before credits is $210,000, its maximum foreign tax credit for the current year is

a. $ 6,400

b. $30,000

c. $35,000

d. $40,000

69. Crocker Corp.’s unused foreign tax credit:

a. Can be carried back two years and forward twenty years.

b. Can be carried back one year and forward ten years.

c. Can be carried back two years and forward five years.

d. Cannot be carried to other tax years.

70. The following information pertains to Raubolt Corporation’s operations for the current year:

Worldwide taxable income $300,000
US source taxable income 180,000
US income tax before foreign tax credit 96,000
General category income 90,000
Foreign income tax paid on general category income 32,000
Foreign passive category income 30,000
Foreign income tax paid on passive category income 7,500

What amount of foreign tax credit may Raubolt Corporation claim for the current year?

a. $32,000

b. $36,300

c. $38,400

d. $39,500

Multiple-Choice Answers and Explanations

Answers

image

Explanations

1. (c) The requirement is to determine the amount of the $32,000 gift that is taxable to the Briars for 2013. Steve and Kay (his spouse) elected to split the gift made to Steve’s sister, so each is treated as making a gift of $16,000. Since both Steve and Kay would be eligible for a $14,000 exclusion, each will have made a taxable gift of $16,000−$14,000 exclusion = $2,000.

2. (c) The requirement is to determine the maximum exclusion available on Sayers’ 2013 gift tax return for the $50,000 gift to Johnson who needed the money to pay medical expenses. The first $14,000 of gifts made to a donee during calendar year 2013 (except gifts of future interests) is excluded in determining the amount of the donor’s taxable gifts for the year. Note that Sayers does not qualify for the unlimited exclusion for medical expenses paid on behalf of a donee, because Sayers did not pay the $50,000 to a medical care provider on Johnson’s behalf.

3. (d) The requirement is to determine the amount of gift that is excludable from taxable gifts. Since the interest income resulting from the bond transferred to the trust will be accumulated and distributed to the child in the future upon reaching the age of twenty-one, the gift (represented by the $8,710 present value of the interest to be received by the child at age twenty-one) is a gift of a future interest and is not eligible to be offset by an annual exclusion.

4. (c) The requirement is to determine the correct statement regarding the unified transfer tax rate schedule. The unified transfer tax rate schedule applies on a cumulative basis to both life and death transfers. During a person’s lifetime, a tax is first computed on cumulative lifetime taxable gifts, then is reduced by the tax on taxable gifts made in prior years in order to tax the current year’s gifts at applicable marginal rates. At death, a unified transfer tax is computed on total life and death transfers, then is reduced by the tax already paid on post-1976 gifts, the unified transfer tax credit, foreign death taxes, and prior transfer taxes.

5. (c) The requirement is to determine which gift requires the filing of a gift tax return when the amount transferred exceeds the available annual gift tax exclusion. A gift in the form of payments for college books, supplies, and dormitory fees on behalf of an individual unrelated to the donor requires the filing of a gift tax return if the amount of payments exceeds the $13,000 ($14,000 for 2013) annual exclusion contrast, no gift tax return need be filed for medical expenses or college tuition paid on behalf of a donee, and campaign expenses paid to a political organization, because there are unlimited exclusions available for these types of gifts after the annual exclusion has been used.

6. (b) The requirement is to determine the due date for filing a 2013 gift tax return (Form 709). A gift tax return must be filed on a calendar-year basis, with the return due and tax paid on or before April 15th of the following year. If the donor subsequently dies, the gift tax return is due not later than the date for filing the federal estate tax return (generally nine months after date of death). Here, since Vega was still living in 2014, the due date for filing the 2013 gift tax return is April 15, 2014.

7. (b) The requirement is to determine Jan’s total exclusions for gift tax purposes for 2013. In computing a donor’s gift tax, the first $14,000 of gifts made to a donee during calendar year 2013 is excluded in determining the amount of the donor’s taxable gifts. Thus, $14,000 of the $16,000 given to Jones, $14,000 of the $15,000 given to Craig, and all $5,000 given to Kande can be excluded, resulting in a total exclusion of $33,000. Jan’s gift to Craig does not qualify for the unlimited exclusion of educational gifts paid on behalf of a donee because the amount was paid directly to Craig. All $15,000 could have been excluded if Jan had made the tuition payment directly to the college.

8. (b) The requirement is to determine the amount of Jim’s gift tax marital deduction for 2013. An unlimited marital deduction is allowed for gift tax purposes for gifts to a donee, who at the time of the gift is the donor’s spouse. Thus, Jim’s gift of $75,000 to Nina made after their wedding is eligible for the marital deduction, whereas the gift of the $50,000 engagement ring does not qualify because Jim and Nina were not married at date of gift. The gift tax annual exclusion of $14,000 applies to multiple gifts to the same donee in chronological order, reducing the taxable gift of the engagement ring to $50,000 − $14,000 = $36,000. Since there is no remaining annual exclusion to reduce the gift of the $75,000 bank account, it would be completely offset by a marital deduction of $75,000.

9. (c) The requirement is to determine when a gift occurs in conjunction with Raff’s creation of a joint bank account for himself and his friend’s son, Dave. A gift does not occur when Raff opens the joint account and deposits money into it. Instead, a gift results when the noncontributing tenant (Dave) withdraws money from the account for his own benefit.

10. (c) The requirement is to determine Fred’s basis for the property after the death of the joint tenant (Ethel). When property is held in joint tenancy by other than spouses, the property’s fair market value is included in a decedent’s estate to the extent of the percentage that the decedent contributed toward the purchase. Since Ethel furnished 80% of the land’s purchase price, 80% of its $300,000 fair market value, or $240,000 is included in Ethel’s estate. Thus, Fred’s basis is $240,000 plus the $20,000 of purchase price that he furnished, a total of $260,000.

11. (b) The requirement is to determine the correct treatment of medical expenses paid by the executor of Bell’s estate if the executor files the appropriate waiver. The executor may elect to treat medical expenses paid by the decedent’s estate for the decedent’s medical care as paid by the decedent at the time the medical services were provided. To qualify for this election, the medical expenses must be paid within the one-year period after the decedent’s death, and the executor must attach a waiver to the decedent’s Form 1040 indicating that the expenses will not be claimed as a deduction on the decedent’s estate tax return. Here, since Bell died during 2013, and the medical services were provided and paid for by Bell’s estate during 2013, the medical expenses are deductible on Bell’s final income tax return for 2013 provided that the executor attaches the appropriate waiver.

12. (c) If the executor of a decedent’s estate elects the alternate valuation date and none of the assets have been sold or distributed, the estate assets must be included in the decedent’s gross estate at their FMV as of six months after the decedent’s death.

13. (d) The requirement is to determine the amount of a decedent’s taxable estate that is effectively tax-free if the maximum basic exclusion amount is taken for 2013. The maximum estate tax credit is the equivalent of an exemption of $5,250,000 and effectively permits $5,250,000 of taxable estate to be free of tax.

14. (d) The requirement is to determine which of the credits may be offset against the gross estate tax in determining the net estate tax of a US citizen for 2013. In computing the net estate tax of a US citizen, the gross estate tax may be offset by the applicable tax credit, and credits for foreign death taxes, and prior transfer taxes. For 2013, the applicable tax credit is equivalent to an exemption of the first $5,000,000 of taxable gifts or taxable estate from the unified transfer tax. Only adjusted taxable gifts made after 1976 are added back to a donor’s taxable estate in arriving at the tax base for the application of the federal estate tax at death. To the extent these taxable gifts exceeded the exemption equivalent of the applicable credit and required the payment of a gift tax during the donor’s lifetime, such tax is then subtracted from a donor’s tentative estate tax at death in arriving at the gross estate tax. Thus, although post-1976 gift taxes reduce the net estate tax, they are not subtracted as a tax credit from the gross estate tax.

15. (a) The requirement is to determine the correct statement with regard to the gross estate of the first spouse to die when property is owned by them as tenants by the entirety or as joint tenants with right of survivorship. Under the general rule for joint tenancies, 100% of the value of jointly held property is included in a deceased tenant’s gross estate except to the extent that the surviving tenants can prove that they contributed to the cost of the property. However, under a special rule applicable to spouses who own property as tenants by the entirety or as joint tenants with right of survivorship, the gross estate of the first spouse to die automatically includes 50% of the value of the jointly held property, regardless of which spouse furnished the original consideration for the purchase of the property.

16. (d) The requirement is to determine the amount of insurance proceeds included in Burr’s gross estate with regard to a policy on Burr’s life purchased by Adam in connection with a “buy-sell” agreement funded by a cross-purchase insurance arrangement. The gross estate of a decedent includes the proceeds of life insurance on the decedent’s life if (1) the insurance proceeds are payable to the estate, (2) the proceeds are payable to another for the benefit of the estate, or (3) the decedent possessed an incident of ownership in the policy. An “incident of ownership” not only means ownership of the policy in a legal sense, but also includes the power to change beneficiaries, to revoke an assignment, to pledge the policy for a loan, or to surrender or cancel the policy. Here, since the policy owned by Adam on Burr’s life was not payable to or for the benefit of Burr’s estate, and Burr had no incident of ownership in the policy, the full amount of insurance proceeds would be excluded from Burr’s gross estate.

17. (d) The requirement is to determine the amount includible as Wald’s gross estate for federal estate tax purposes. If an executor does not elect the alternate valuation date, all property in which the decedent possessed an ownership interest at time of death is included in the decedent’s gross estate at its fair market value at date of death. If property was held in joint tenancy and was acquired by purchase by other than spouses, the property’s total fair market value will be included in the decedent’s gross estate except to the extent that the surviving tenant can prove that he/she contributed toward the purchase. Since Wald purchased the land with his own funds, the land’s total fair market value ($3,800,000) must be included in Wald’s gross estate together with Wald’s personal effects and jewelry ($1,750,000), resulting in a gross estate of $5,550,000.

18. (d) The requirement is to determine the item that is deductible from a decedent’s gross estate. Unpaid income taxes on income received by the decedent before death would be a liability of the estate and would be deductible from the gross estate. Foreign death taxes, income tax paid on income earned and received after the decedent’s death, and federal estate taxes are not deductible in computing a decedent’s taxable estate. Note that although foreign death taxes are not deductible in computing a decedent’s taxable estate, a limited tax credit is allowed for foreign death taxes in computing the net estate tax payable.

19. (a) The requirement is to determine whether federal estate tax returns must be filed for the estates of Eng and Lew. For a decedent dying during 2013, a federal estate tax return (Form 706) must be filed if the decedent’s gross estate exceeds $5,250,000. If a decedent made taxable lifetime gifts such that the decedent’s applicable transfer tax credit was used to offset the gift tax, the ($5,250,000) exemption amount must be reduced by the amount of taxable lifetime gifts to determine whether a return is required to be filed.

Since Lew made no lifetime gifts and the value of Lew’s gross estate was only $4,800,000, no federal estate tax return is required to be filed for Lew’s estate. In Eng’s case, the $5,250,000 exemption is reduced by Eng’s $400,000 of taxable lifetime gifts to $4,850,000. However, since Eng’s gross estate totaled only $3,600,000, no federal estate tax return is required to be filed for Eng’s estate.

20. (d) The requirement is to determine the correct statement regarding the use of the alternate valuation date in computing the federal estate tax. An executor of an estate can elect to use the alternate valuation date (the date six months after the decedent’s death) to value the assets included in a decedent’s gross estate only if its use decreases both the value of the gross estate and the amount of estate tax liability. Answer (a) is incorrect because the alternate valuation date cannot be used if its use increases the value of the gross estate. Answer (b) is incorrect because the use of the alternate valuation date is an irrevocable election. Answer (c) is incorrect because the alternate valuation date is only used to value an estate’s assets, not its liabilities.

21. (c) The requirement is to determine when the proceeds of life insurance payable to the estate’s executor, as the estate’s representative, are includible in the decedent’s gross estate. The proceeds of life insurance on the decedent’s life are always included in the decedent’s gross estate if (1) they are receivable by the estate, (2) the decedent possessed any incident of ownership in the policy, or (3) they are receivable by another (e.g., the estate’s executor) for the benefit of the estate.

22. (d) The requirement is to determine the proper income and estate tax treatment of an accounting fee earned by Ross before death, that was subsequently collected by the executor of Ross’ estate. Since Ross was a calendar-year, cash-method taxpayer, the income would not be included on Ross’ final individual income tax return because payment had not been received. Since the accounting fee would not be included in Ross’ final income tax return because of Ross’ cash method of accounting, the accounting fee would be “income in respect of a decedent.” For estate tax purposes, income in respect of a decedent will be included in the decedent’s gross estate at its fair market value on the appropriate valuation date. For income tax purposes, the income tax basis of the decedent (zero) transfers over to the estate or beneficiary who collects the fee. The recipient of the income must classify it in the same manner (i.e., ordinary income) as would have the decedent. Thus, the accounting fee must be included in Ross’ gross estate and must also be included in the estate’s fiduciary income tax return (Form 1041) because the fee was collected by the executor of Ross’ estate.

23. (c) The requirement is to determine within how many months after the date of Alan’s death his federal estate tax return should be filed. The federal estate tax return (Form 706) must be filed and the tax paid within nine months of the decedent’s death, unless an extension of time has been granted.

24. (d) The requirement is to determine the amount of marital deduction that can be claimed in computing Alan’s taxable estate. In computing the taxable estate of a decedent, an unlimited marital deduction is allowed for the portion of the decedent’s estate that passes to the decedent’s surviving spouse. Since $3,000,000 was bequeathed outright to Alan’s widow, Alan’s estate will receive a marital deduction of $3,000,000.

25. (b) The requirement is to determine Edwin’s basis for the stock inherited from Lynn’s estate. A special rule applies if a decedent (Lynn) acquires appreciated property as a gift within one year of death, and this property passes to the donor (Edwin) or donor’s spouse. Then the donor’s (Edwin’s) basis is the basis of the property in the hands of the decedent (Lynn) before death. Since Lynn had received the stock as a gift, Lynn’s basis before death ($5,000) becomes the basis of the stock to Edwin.

26. (c) The requirement is to determine the correct statement regarding the generation-skipping transfer tax. The generation-skipping transfer tax is imposed as a separate tax in addition to the federal gift and estate taxes, and is designed to prevent an individual from escaping an entire generation of gift and estate taxes by transferring property to a person that is two or more generations below that of the transferor. The tax is imposed at the highest tax rate (40% for 2013) under the transfer tax rate schedule.

27. (c) The requirement is to determine the amount of the estate’s $10,000 distribution that must be included in gross income by Crane’s widow. The maximum amount that is taxable to beneficiaries is limited to the estate’s distributable net income (DNI). Since distributions to multiple beneficiaries exceed DNI, the estate’s $12,000 of DNI must be prorated to distributions to determine the portion of each distribution that must be included in gross income. Since distributions to the widow and daughter totaled $15,000, the portion of the $10,000 distribution that must be included in the widow’s gross income equals ($10,000/$15,000) × $12,000 = $8,000.

28. (a) The requirement is to determine the estate’s distributable net income (DNI). An estate’s DNI generally is its taxable income before the income distribution deduction, increased by its personal exemption, any net capital loss deduction, and tax-exempt interest (reduced by related nondeductible expenses), and decreased by any net capital gains allocable to corpus. Here, the estate’s DNI is the $20,000 of taxable interest reduced by the $5,000 of administrative expenses attributable to taxable income, or $15,000.

29. (b) The requirement is to determine the due date for the Fiduciary Income Tax Return (Form 1041) for the estate’s 2013 calendar year. Form 1041 is due on the 15th day of the fourth month following the end of the tax year. Thus, an estate’s calendar-year return is generally due on April 15th of the following year.

30. (c) The requirement is to determine the maximum amount to be included in the beneficiary’s gross income for a distribution from estate income that was currently required. Distributable net income (DNI) is the maximum amount of distributions that can be taxed to beneficiaries as well as the maximum amount of distributions deduction for an estate.

31. (c) The requirement is to determine the amount of the estate’s $15,000 distribution that is taxable to the sole beneficiary. The maximum amount that is taxable to the beneficiary is limited to the estate’s distributable net income (DNI). An estate’s DNI is generally its taxable income before the income distribution deduction, increased by its exemption, a net capital loss deduction, and tax-exempt interest (reduced by related nondeductible expenses), and decreased by any net capital gains allocable to corpus. Here, the estate’s DNI is its taxable interest of $40,000, reduced by the $34,000 of expenses attributable to taxable interest, or $6,000.

32. (b) The requirement is to determine the correct statement regarding an estate’s estimated income taxes. Trusts and estates must make quarterly estimated tax payments, except that an estate is exempt from making estimated tax payments for taxable years ending within two years of the decedent’s death.

33. (c) The requirement is to determine the correct statement regarding a complex trust. A simple trust is one that (1) is required to distribute all of its income to designated beneficiaries every year, (2) has no beneficiaries that are qualifying charitable organizations, and (3) makes no distributions of trust corpus (i.e., principal) during the year. A complex trust is any trust that is not a simple trust. Answer (a) is incorrect because a complex trust is not required to distribute income currently, nor is it prohibited from distributing trust principal. Answer (b) is incorrect because there are no investment restrictions imposed on a complex trust. Answer (d) is incorrect because an income tax is imposed on a trust’s taxable income.

34. (a) The requirement is to determine the amount of standard deduction for a trust or an estate in the fiduciary income tax return (Form 1041). No standard deduction is available for a trust or an estate on the fiduciary income tax return. On the other hand, a personal exemption is allowed for an estate or trust on the fiduciary income tax return. The personal exemption is $600 for an estate, $300 for a trust required to distribute all income currently, and $100 for all other trusts.

35. (d) The requirement is to indicate whether estate and trusts are required to use the calendar year as their taxable year. All trusts (except those that are tax exempt) are generally required to use the calendar year for tax purposes. In contrast, an estate may adopt the calendar year, or any fiscal year as its taxable year.

36. (c) The requirement is to determine the proper treatment for ordinary and necessary administrative expenses paid by the fiduciary of an estate. Ordinary and necessary administrative expenses paid by the fiduciary of an estate can be deducted on either the estate’s fiduciary income tax return, or on the estate’s federal estate tax return. Although the expenses cannot be deducted twice, they can be allocated between the two returns in any manner that the fiduciary sees fit. If the administrative expenses are to be deducted on the fiduciary income tax return, the potential estate tax deduction must be waived for these expenses.

37. (c) The requirement is to determine when a fiduciary income tax return for a decedent’s estate must be filed. The executor of a decedent’s estate that has only US citizens as beneficiaries is required to file a fiduciary income tax return (Form 1041) if the estate’s gross income is $600 or more. The return is due on or before the 15th day of the fourth month following the close of the estate’s taxable year.

38. (c) The requirement is to determine the correct statement regarding the charitable contribution deduction on an estate’s fiduciary income tax return (Form 1041). An estate is allowed a deduction for a contribution to a charitable organization if (1) the decedent’s will specifically provides for the contribution, and (2) the recipient is a qualified charitable organization. The amount allowed as a charitable deduction is not subject to any percentage limitations, but must be paid from amounts included in the estate’s gross income for the year of contribution.

39. (c) The requirement is to determine who will be taxed on the trust’s 2013 income. During 2013, Carlt created a trust providing a lifetime income interest for his mother, with a remainder interest to go to his son, but he expressly retained the power to revoke both the income interest and remainder interest at any time. When the grantor of a trust retains substantial control over the trust, such as the power to revoke the income and remainder interests, the trust income will be taxed to the grantor and not to the trust or beneficiaries.

40. (b) The requirement is to determine the estate’s distributable net income (DNI). An estate’s DNI generally is its taxable income before the income distribution deduction, increased by its personal exemption, any net capital loss deduction, and tax-exempt income (reduced by related expenses), and decreased by any net capital gain allocable to corpus. Here, the estate’s DNI is the $65,000 of taxable interest, reduced by the $14,000 of administrative expenses attributable to taxable income and the $9,000 of charitable contributions. Charitable contributions are allowed as a deduction if made under the terms of the decedent’s will and are paid to qualified charitable organizations from amounts included in the estate’s gross income.

41. (a) The requirement is to determine the correct statement for income tax purposes regarding the initial taxable period for the estate of a decedent who died on October 24. For income tax purposes, a decedent’s estate is allowed to adopt a calendar year or any fiscal year beginning on the date of the decedent’s death. Answer (b) is incorrect because an estate may adopt a calendar year and is not restricted to a fiscal year. Answer (c) is incorrect because the estate’s first tax year would begin on October 24, not October 1. Answer (d) is incorrect because an estate is not restricted to a calendar year, and if it adopted a calendar year, its initial year would begin with the date of the decedent’s death (October 24).

42. (a) The requirement is to determine what will terminate the private foundation status of an exempt organization. The private foundation status of an exempt organization will terminate if it becomes a public charity. Answer (b) is incorrect because a private foundation can be organized as a foreign corporation. Answer (c) is incorrect because private foundations are not required to distribute their assets to public charities. Answer (d) is incorrect because a private foundation’s exempt purposes are already severely restricted by the Code.

43. (c) The requirement is to determine which exempt organization would be eligible to satisfy its annual filing requirement by filing Form 990-N (e-Postcard). Small exempt organizations whose gross receipts are $50,000 or less are generally eligible to annually file an electronic form 990-N (e-Postcard) listing the organization’s legal name, mailing address, and employer identification number. Exceptions apply to churches and exempt organizations that are required to file a different form. Churches do not have to file an annual information return. A private foundation must annually file Form 990-PF Return of Private Foundation. An exempt organization having gross income of $1,000 or more from an unrelated business must file Form 990-T Exempt Organization Business Income Tax Return.

44. (d) Organizations that can qualify as exempt organizations are listed in Sec. 501 of the Internal Revenue Code, and can take the form of a trust or corporation. To receive exempt status, the organization must file a written application with the IRS. In no event will exempt status be conferred upon an organization unless the organization is one of those types of organizations specifically listed in the Code. A fraternal benefit society must operate under the lodge system. An organization operating under the lodge system carries on its activities under a form of organization that comprises local branches chartered by a parent organization and can be established to provide its members with sick benefits.

45. (d) The requirement is to determine the correct statement regarding qualification as an exempt organization. To qualify as an exempt organization, the applicant must not be a private foundation organized and operated exclusively to influence legislation pertaining to protection of the environment. Exempt status is specifically denied to organizations if a substantial part of their activities consists of “carrying on propaganda, or otherwise attempting, to influence legislation,” if expenditures exceed certain amounts. Answer (a) is incorrect because an exempt organization cannot be organized for the primary purpose of carrying on a business for profit. Answer (b) is incorrect because an organization must be one of those classes upon which exemption is specifically conferred by the Internal Revenue Code. Answer (c) is incorrect because a social club organized for recreation will qualify for exemption if substantially all of the activities of the club are for such purposes and none of the profits inure to the benefit of any shareholder.

46. (a) The requirement is to determine the proper tax treatment of Carita Fund’s insurance activities. An otherwise qualifying exempt organization will instead be subject to tax if a substantial part of its activities consists of providing commercial-type insurance. Sec. 501(m)(3) provides that “commercial-type insurance” does not include insurance provided at substantially below cost to a class of charitable recipients. Since Carita Fund was organized and operated exclusively for charitable purposes, and provided below cost insurance coverage to exempt organizations involved in the prevention of cruelty to children, its insurance activities are exempt from tax. The insurance activities do not constitute unrelated business income because the insurance activities were substantially related to the performance of the fund’s exempt purpose. Answer (c) is incorrect because Carita Fund qualifies as an exempt organization.

47. (a) The filing of a return covering unrelated business income (Form 990-T) is required of all exempt organizations having at least $1,000 of unrelated business taxable income for the year. However, this does not relieve the organization of having to file a separate information return (Form 990) if it is otherwise required to file. Answer (c) is incorrect because in determining whether income is unrelated business income, the exempt organization’s need for the income or the use it makes of the profits is irrelevant. Answer (d) is incorrect because the tax on unrelated business income of exempt organizations must be paid in full with the return.

48. (d) A condominium management association wishing to be treated as a homeowners association and thereby qualify as an exempt organization for a particular year must file a separate election for each taxable year no later than the due date of the tax return for which the election is to apply.

49. (d) An organization wishing to qualify as an exempt organization must be of a type specifically identified as one of the classes on which exemption is conferred by the Code. In no event will exempt status be conferred upon an organization unless the organization is one of those listed. Furthermore, in order to receive exempt status, the organization must file an application with the Internal Revenue Service. Answer (a) is incorrect since an exempt organization may be organized as a corporation. Answer (b) is incorrect because an exempt organization may lose its exempt status by engaging in any prohibited transaction. Answer (c) is incorrect because non-US citizens may be on an exempt organization’s governing board.

50. (b) The requirement is to determine the correct statement regarding exempt organizations. With the exception chiefly of churches, an exempt organization (other than a private foundation) must nevertheless file an annual information return specifically stating items of gross income, receipts, and disbursements unless its gross receipts are normally not more than $25,000. An exempt organization required to file a return must annually report the total amount of contributions received as well as the identity of substantial contributors.

Answer (a) is incorrect because an organization can only achieve exempt status by filing an application for exemption with the Internal Revenue Service. Answer (c) is incorrect because there is no limitation on the amount of compensation that can be paid to an employee if the compensation is reasonable. Answer (d) is incorrect because exempt status can be retroactively revoked if an organization’s character, purposes, or methods of operation are other than as stated in the application for exemption.

51. (a) The requirement is to determine the correct statement regarding qualification as an exempt organization. To qualify as an exempt organization, the applicant for exemption must fall into one of the specified classes of organizations that are listed in Sec. 501 as being exempt from tax. Answer (d) is incorrect because a social club can be an exempt organization as long as substantially all its activities are for such purposes and no part of its net earnings inures to the benefit of any private shareholder. Answer (c) is incorrect because most exempt organizations are permitted specified levels of lobbying expenditures, and can even elect to be subject to a tax equal to 25% of their excess lobbying expenditures to prevent loss of exempt status. Answer (b) is incorrect because foreign corporations can qualify as exempt organizations.

52. (c) Organizations that can qualify as exempt organizations are listed in Sec. 501 of the Internal Revenue Code. An exempt organization can take the form of a trust or a corporation. In order to receive exempt status, the organization must file an application with the Internal Revenue Service. In no event will exempt status be conferred upon an organization unless the organization is one of those listed in the Code. Answer (b) is incorrect because there is no limitation on the amount of salary that can be paid an employee.

53. (b) The requirement is to determine which of the activities is(are) consistent with Hope’s tax-exempt status as a religious organization. An exempt organization must be operated exclusively for its exempt purpose, and other activities not in furtherance of its exempt purpose must be only an insubstantial part of its activities. A religious organization’s providing traditional burial services that maintain the religious beliefs of its members would be consistent with its tax-exempt status as a religious organization. However, conducting recreational functions such as weekend retreats conducted for business organizations ordinarily would not be consistent with the tax-exempt status of a religious organization unless there were tightly scheduled religious activities and only limited free time for incidental recreation activities.

54. (a) The requirement is to determine which statements are correct in regard to the organizational test to qualify a public service charitable entity as tax-exempt. The term “articles of organization” includes the trust instrument, corporate charter, articles of association, or any other written instruments by which an organization is created. To satisfy the organizational test, the articles of organization (1) must limit the organization’s purposes to one or more exempt purposes described in Sec. 501(c)(3); and, (2) must not expressly empower the organization to engage in activities that are not in furtherance of one or more exempt purposes, except as an insubstantial part of its activities.

55. (d) The requirement is to determine which of two activities (if any) will result in unrelated business income. Unrelated business income (UBI) is income derived from a trade or business, the conduct of which is not substantially related to the exercise or performance of an organization’s exempt purpose. For a trade or business to be related, the conduct of the business activity must have a causal relationship to the achievement of the organization’s exempt purpose. Selling articles made by handicapped persons as part of their rehabilitation would be substantially related to the exempt purpose of an organization exclusively involved in their rehabilitation. Similarly, operating a grocery store almost fully staffed by emotionally handicapped persons as part of a therapeutic program to allow the persons to become involved with society, assume responsibility, and to exercise business judgment, would be substantially related to the rehabilitation purposes of the exempt organization.

56. (c) The operational test requires that an exempt organization be operated exclusively for an exempt purpose. An organization will be considered to be operated exclusively for an exempt purpose only if it engages primarily in activities that accomplish its exempt purpose. An organization will not be so regarded if more than an insubstantial part of its activities is not in furtherance of an exempt purpose. Thus, an organization that engages in insubstantial nonexempt activities will not fail the operational test. In contrast, an organization that operates for the prevention of cruelty to animals will fail the operational test if it directly participates in any political campaign.

57. (b) The requirement is to determine the correct statement with regard to the unrelated business income of an exempt organization. An exempt organization is not taxed on unrelated business income of less than $1,000. Answer (a) is incorrect because the amount of unrelated business income will not cause the loss of exempt status. Answer (c) is incorrect because the tax will not apply to a business activity that is not regularly carried on. Answer (d) is incorrect because a loss from an unrelated trade or business activity is allowed in computing unrelated business taxable income.

58. (d) The requirement is to determine which one of the listed activities will not result in unrelated business income. Unrelated business income (UBI) is income derived from any trade or business, the conduct of which is not substantially related to the exercise or performance of an organization’s exempt purpose. For a trade or business to be “related,” the conduct of the business activity must have a causal relationship to the achievement of the exempt purpose. A business activity will be “substantially related” only if the causal relationship is a substantial one. Assuming that the development and improvement of its members is one of the purposes for which a trade association is granted an exemption, the sale of publications used as course materials for the association’s seminars for its members would be substantially related.

Answer (a) is incorrect because even though a special rule permits an exempt hospital to perform services at cost for other hospitals with facilities to serve not more than 100 inpatients, the permitted services are limited to data processing, purchasing, warehousing, billing and collection, food, clinical, industrial engineering, laboratory, printing, communications, record center, and personnel services. Answer (b) is incorrect because even though an exempt senior citizen’s center may operate a beauty parlor and barber shop for its members, selling major appliances to its members has been held to generate unrelated business income. Answer (c) is incorrect because the performance of accounting and tax services for its members would be unrelated to the exempt purpose of a labor union.

59. (a) The requirement is to determine the correct statement with regard to an exempt organization’s unrelated business taxable income when the exempt organization is a corporation. An exempt organization’s unrelated business income in excess of $1,000 is taxed at regular corporate income tax rates if the organization is a corporation. An exempt organization must be a trust in order for its unrelated business income to be taxed at the rates applicable to trusts.

60. (b) The requirement is to determine the correct statement regarding an exempt organization’s income of $15,000 derived from conducting bingo games. If an exempt organization derives income from conducting bingo games, in a locality where such activity is legal, and in a state that confines such activity to nonprofit organizations, then such income is exempt from the tax on unrelated business income. Answer (d) is incorrect because unrelated business income will not cause the revocation or forfeiture of an organization’s exempt status.

61. (c) The requirement is to determine the correct statement regarding the unrelated business income of exempt organizations. A tax-exempt organization may be subject to tax on its unrelated business income if the organization conducts a trade or business that is not substantially related to the exempt purpose of the organization, and the trade or business is regularly carried on by the organization. For an exempt organization, an unrelated business does not include any activity where all the work is performed for the organization by unpaid volunteers. Answer (a) is incorrect because although unrelated business income may result in a tax, it will not result in the loss of the organization’s exempt status. Answer (b) is incorrect because the term “business” is broadly defined to include any activity conducted for the production of income through the sale of merchandise or the performance of services. Answer (d) is incorrect because using a trade or business to provide financial support for the organization’s exempt purpose will not prevent an activity from being classified as an unrelated trade or business and being subject to the tax on unrelated business income.

62. (b) The requirement is to determine the correct statement regarding an exempt organization’s payment of estimated taxes on its unrelated business income. An exempt organization subject to tax on its unrelated business income must comply with the Code provisions regarding installment payments of estimated income tax by corporations. This means that an exempt organization must make quarterly estimated tax payments if it expects its estimated tax on its unrelated business income to be $500 or more. Answers (c) and (d) are incorrect because any tax on unrelated business income must be paid in full by the due date of the exempt organization’s return.

63. (d) The requirement is to determine the correct statement regarding the taxability of unrelated business income (UBI) to an exempt organization that is a charitable trust. Answer (c) is incorrect because an exempt organization that is a charitable trust is subject to tax on its UBI only to the extent that its UBI exceeds $1,000. Answers (a) and (b) are incorrect because an exempt organization with UBI in excess of $1,000 is subject to tax at rates applicable to trusts if it is organized as a charitable trust.

64. (c) Unrelated business income (UBI) is gross income derived from any trade or business the conduct of which is not substantially related to the exercise or performance of an organization’s exempt purpose. Although dividends and interest are generally excluded from UBI, they will be included if they result from debt-financed investments. Answer (d) is incorrect because it states that dividends and interest are always excluded from UBI. Answer (a) is incorrect because the Code only imposes a tax on UBI, it does not revoke an organization’s exempt status. Answer (b) is incorrect because a net operating loss is allowed in computing unrelated business taxable income. Answer (c) is correct because Code Sec. 513(f) specifically excludes from UBI an exempt organization’s conducting bingo games where such activity is legal.

65. (c) The requirement is to determine Miramar’s UDITPA State XY apportionment factor and State XY business income. UDITPA recommends an apportionment formula that equally weighs sales, payroll, and property. Business income is then apportioned to a state by adding the three factors and then dividing by 3 to average the factors. Here the apportionment factor would be (60% + 50% + 49%) /3 = 53%, and would result in the apportionment of $530,000 of business income to State XY.

66. (b) The requirement is to determine Miramar’s State XY apportionment factor if State XY used an apportionment formula in which the property factor was double-weighted. This means that the property factor would be counted twice and then the total would be divided by 4 to determine the average. The apportionment factor would then be (60% + 50% + 49% + 49%)/4 = 52%.

67. (d) The requirement is to determine the correct statement regarding the foreign operations of Glencoe Corporation. Glencoe’s foreign earnings are subject to US income tax. Since Glencoe may have already paid an income tax on those earnings to a foreign country, Glencoe may take either a deduction or a tax credit for the foreign income taxes paid which mitigates the double taxation of Glencoe’s foreign-source earnings.

68. (b) The requirement is to determine Crocker’s maximum foreign tax credit for the current year. Since US taxpayers are subject to US income tax on their worldwide income, they are allowed a credit for the income taxes paid to foreign countries. However, the amount of credit that can be currently used cannot exceed the amount of US tax that is attributable to the foreign income. This foreign tax credit limitation can be expressed as follows:

image

In this case, the credit for the $40,000 of foreign income taxes paid is limited to the amount of US tax attributable to the foreign income, $30,000.

image

69. (b) The requirement is to determine the correct statement concerning Crocker Corp.’s unused foreign tax credit. The $40,000−$30,000 = $10,000 of unused foreign tax credit resulting from the application of the limitation can be carried back one year and forward ten years and used to the extent that the taxpayer is below the limitation in those years.

70. (b) The requirement is to determine the amount of foreign tax credit that Raubolt Corporation may claim for the current year. Since US taxpayers are subject to US income tax on their worldwide income, they are allowed a credit for the income taxes paid to foreign countries. However, the amount of credit that can be currently used cannot exceed the amount of US tax that is attributable to the foreign income. This foreign tax credit limitation can be expressed as follows:

image

One limitation must be computed for foreign passive category income (e.g., interest, dividends, royalties, rents, annuities), with a separate limitation computed for foreign general category income. In this case, the foreign income taxes paid on passive category income of $7,500 is fully usable as a credit because it is less than the applicable limitation amount of ($30,000/$300,000) × $96,000 = $9,600 (i.e., the amount of US tax attributable to the income).

On the other hand, the credit for the $32,000 of foreign income taxes paid on general category income is limited to the amount of US tax attributable to the foreign general category income of ($90,000/$300,000) × $96,000 = $28,800. Thus, Raubolt’s foreign tax credit for the current year totals $28,800 + $7,500 = $36,300.

Simulations

Task-Based Simulation 1

image

During 2013, various clients went to Rowe, CPA, for tax advice concerning possible gift tax liability on transfers they made throughout 2013. For each client, indicate whether the transfer of cash, the income interest, or the remainder interest is a gift of a present interest, a gift of a future interest, or not a completed gift.

Answer List
P. Present Interest
F. Future Interest
N. Not Completed

Assume the following facts:

Cobb created a $500,000 trust that provided his mother with an income interest for her life and the remainder interest to go to his sister at the death of his mother. Cobb expressly retained the power to revoke both the income interest and the remainder interest at any time.

Items to be answered

image

Kane created a $100,000 trust that provided her nephew with the income interest until he reached forty-five years of age. When the trust was created, Kane’s nephew was twenty-five. The income distribution is to start when Kane’s nephew is twenty-nine. After Kane’s nephew reaches the age of forty-five, the remainder interest is to go to Kane’s niece.

image

During 2013, Hall, an unmarried taxpayer, made a $10,000 cash gift to his son in May and a further $12,000 cash gift to him in August.

image

During 2013, Yeats transferred property worth $20,000 to a trust with the income to be paid to her twenty-two-year-old niece Jane. After Jane reaches the age of thirty, the remainder interest is to be distributed to Yeats’ brother. The income interest is valued at $9,700 and the remainder interest at $10,300.

image

Tom and Ann Curry, US citizens, were married for the entire 2013 calendar year. Tom gave a $40,000 cash gift to his uncle, Grant. The Currys made no other gifts to Grant in 2013. Tom and Ann each signed a timely election stating that each made one-half of the $40,000 gift.

image

Murry created a $1,000,000 trust that provided his brother with an income interest for ten years, after which the remainder interest passes to Murry’s sister. Murry retained the power to revoke the remainder interest at any time. The income interest was valued at $600,000.

image

Task-Based Simulation 2

image

Determine whether the transfer is subject to the generation skipping tax, the gift tax, or both taxes. Disregard the use of any exclusions and the unified credit.

Answer List
A. Generation-Skipping Tax
B. Gift Tax
C. Both Taxes
image

Task-Based Simulation 3

image

Situation

Before his death, Remsen, a US citizen, made cash gifts of $7,000 each to his four sisters. In 2013 Remsen also paid $20,000 in tuition directly to his grandchild’s university on the grandchild’s behalf. Remsen made no other lifetime transfers. Remsen died on January 9, 2013, and was survived by his wife and only child, both of whom were US citizens. The Remsens did not live in a community property state.

At his death Remsen owned

Cash $ 650,000
Marketable securities (fair market value) 1,900,000
Life insurance policy with Remsen’s wife named as the beneficiary (fair market value) 2,500,000

For items 1 through 5, identify the federal estate tax treatment for each item. A response may be selected once, more than once, or not at all.

Answer List
F. Fully includible in Remsen’s gross estate.
P. Partially includible in Remsen’s gross estate.
N. Not includible in Remsen’s gross estate.
image

Task-Based Simulation 4

image

Situation

Remsen died on January 9, 2013, and was survived by his wife and only child, both of whom were US citizens. The Remsens did not live in a community property state.

At his death Remsen owned

Cash $ 650,000
Marketable securities (fair market value) 1,900,000
Life insurance policy with Remsen’s wife named as the beneficiary (fair market value) 2,500,000

Under the provisions of Remsen’s will, the net cash, after payment of executor’s fees and medical and funeral expenses, was bequeathed to Remsen’s son. The marketable securities were bequeathed to Remsen’s spouse. During 2013 Remsen’s estate paid

Executor fees to distribute the decedent’s property (deducted on the fiduciary tax return) $50,000
Decedent’s funeral expenses 12,000

The estate’s executor extended the time to file the estate tax return.

On December 3, 2013, the estate’s executor paid the decedent’s outstanding $10,000 medical expenses and filed the extended estate tax return.

For items 1 through 5, identify the federal estate tax treatment for each item. A response may be selected once, more than once, or not at all.

Answer List
G. Deductible from Remsen’s gross estate to arrive at Remsen’s taxable estate.
I. Deductible on Remsen’s 2013 individual income tax return.
E. Deductible on either Remsen’s estate tax return or Remsen’s 2013 individual income tax return.
N. Not deductible on either Remsen’s estate tax return or Remsen’s 2013 individual income tax return.
image

Task-Based Simulation 5

image

Situation

Scott Lane, an unmarried US citizen, made no lifetime transfers prior to 2013. During 2013, Lane made the following transfers:

  • Gave a $14,000 cash gift to Kamp, a close friend.
  • Made two separate $10,000 cash gifts to his only child.
  • Created an irrevocable trust beginning in 2013 that provided his aunt with an income interest to be paid for the next five years. The remainder interest is to pass to Lane’s sole cousin. The income interest is valued at $26,000 and the remainder interest is valued at $74,000.
  • Paid $25,000 tuition directly to his grandchild’s university on his grandchild’s behalf.
  • Created an irrevocable trust that provided his brother with a lifetime income interest beginning in 2015, after which a remainder interest passes to their sister.
  • Created a revocable trust with his niece as the sole beneficiary. During 2013, the niece received $15,000 interest income from the trust.

For items 1 through 7, determine whether the tax transactions are fully taxable, partially taxable, or not taxable to Lane in 2013 for gift tax purposes after considering the gift tax annual exclusion. Ignore the transfer tax credit when answering the items. An answer may be selected once, more than once, or not at all.

Gift Tax Treatments
F. Fully taxable to Lane in 2013 for gift tax purposes.
P. Partially taxable to Lane in 2013 for gift tax purposes.
N. Not taxable to Lane in 2013 for gift tax purposes.
image

Task-Based Simulation 6

image

Situation

Glen Moore inherited stock from his mother, Ruth. She had died on February 1, 2013, when the stock had a fair market value of $150,000. Ruth had acquired the stock on May 15, 2011, at a cost of $120,000. Ruth’s estate was too small to require the filing of a federal estate tax return. Moore wants to know how much gross income he must report because of the receipt of his inheritance in 2013. Which code section and subsection provides the rule for determining whether Moore’s inheritance must be included in his gross income? Indicate the reference to that citation in the shaded boxes below.

image

Simulation Solutions

Task-Based Simulation 1

image

For items 1 through 9, candidates were asked to determine whether the transfer of cash, an income interest, or a remainder interest represents a gift of a present interest (P), a gift of a future interest (F), or not a completed gift (N).

image

Explanations

1. (N) Since Cobb expressly retained the power to revoke the income interest transferred to his mother at any time, he has not relinquished dominion and control and the transfer of the income interest is not a completed gift.

2. (N) Since Cobb expressly retained the power to revoke the remainder interest transferred to his sister at any time, he has not relinquished dominion and control and the transfer of the remainder interest is not a completed gift.

3. (F) Kane’s transfer of an income interest to a nephew and a remainder interest to a niece are completed gifts because Kane has relinquished dominion and control. Since Kane’s nephew was twenty-five years of age when the trust was created, but income distributions will not begin until the nephew is age twenty-nine, the transfer of the income interest is a gift of future interest and does not qualify for the annual exclusion.

4. (P) Since Hall’s gifts of cash to his son were outright gifts, they are gifts of a present interest and qualify for the annual exclusion.

5. (P) Yeats’ gift of the income interest to her twenty-two-year-old niece is a gift of a present interest qualifying for the annual exclusion since Jane has the unrestricted right to immediate enjoyment of the income. The fact that the value of the income interest does not exceed $14,000 does not affect its nature (i.e., completed gift of a present interest).

6. (F) Yeats’ gift of the remainder interest to her brother is a completed gift of a future interest since the brother cannot enjoy the property or any of the income until Jane reaches age thirty.

7. (P) Tom’s gift of $40,000 cash to his uncle is an outright gift of a present interest and qualifies for the annual exclusion. Since gift-splitting was elected and Tom and Ann would each receive a $14,000 annual exclusion, Tom and Ann each made a taxable gift of $20,000−$14,000 exclusion = $6,000.

8. (P) Murry’s gift of the income interest to his brother is a completed gift because Murry has relinquished dominion and control. It is a gift of a present interest qualifying for the annual exclusion since his brother has the unrestricted right to immediate enjoyment of the income.

9. (N) Since Murry retained the right to revoke the remainder interest transferred to his sister at any time, the transfer of the remainder interest does not result in a completed gift.

Task-Based Simulation 2

image

For this item, candidates were asked to determine whether the transfer is subject to the generation-skipping tax (A), the gift tax (B), or both taxes (C).

image

Explanation

(C) Since Martin made an outright gift of $6,000,000 to Dale, the transfer is a gift of a present interest and is subject to the gift tax. Since Dale happens to be Martin’s grandchild, the gift also is subject to the generation-skipping tax. The generation-skipping tax on the transfer of property is imposed in addition to federal gift and estates taxes and is designed to prevent individuals from escaping an entire generation of gift and estate taxes by transferring property to, or in trust for the benefit of, a person that is two or more generations younger than the donor or transferor. The tax approximates the transfer tax that would be imposed if the property were actually transferred to each successive generation.

Task-Based Simulation 3

image

For items 1 through 5, candidates were asked to identify the federal tax treatment for each item by indicating whether the item was fully includible in Remsen’s gross estate (F), partially includible in Remsen’s gross estate (P), or not includible in Remsen’s gross estate (N).

image

Explanations

1. (N) Generally, gifts made before death are not includible in the decedent’s gross estate, even though the gifts were made within three years of death.

2. (F) The gross estate includes the value of all property in which the decedent had a beneficial interest at time of death. Here, the life insurance proceeds must be included in Remsen’s gross estate because the problem indicates that Remsen was the owner of the policy.

3. (F) The fair market value of the marketable securities must be included in Remsen’s gross estate because Remsen was the owner of the securities at the time of his death.

4. (N) Generally, gifts made before death are not includible in the decedent’s gross estate.

5. (F) The $650,000 cash that Remsen owned must be included in Remsen’s gross estate.

Task-Based Simulation 4

image

For items 1 through 5, candidates were asked to identify the federal tax treatment for each item by indicating whether the item was deductible from Remsen’s gross estate to arrive at Remsen’s taxable estate (G), deductible on Remsen’s 2013 individual income tax return (I), deductible on either Remsen’s estate tax return or Remsen’s 2013 individual income tax return (E), or not deductible on either Remsen’s estate tax return or Remsen’s 2013 individual income tax return (N).

image

Explanations

1. (N) The $50,000 of executor’s fees to distribute the decedent’s property are deductible on either the federal estate tax return (Form 706) or the estate’s fiduciary income tax return (Form 1041). Such expenses cannot be deducted twice. Since the problem indicates that these expenses were deducted on the fiduciary tax return (Form 1041), they cannot be deducted on the estate tax return.

2. (N) A decedent’s gross estate is reduced by funeral and administrative expenses, debts and mortgages, casualty and theft losses, charitable bequests, and a marital deduction for the value of property passing to the decedent’s surviving spouse. There is no deduction for bequests to beneficiaries other than the decedent’s surviving spouse.

3. (G) Generally, property included in a decedent’s gross estate will be eligible for an unlimited marital deduction if the property passes to the decedent’s surviving spouse. Here, the life insurance proceeds paid to Remsen’s spouse were included in Remsen’s gross estate because Remsen owned the policy, and are deductible from Remsen’s gross estate as part of the marital deduction in arriving at Remsen’s taxable estate.

4. (G) Funeral expenses are deductible only on the estate tax return and include a reasonable allowance for a tombstone, monument, mausoleum, or burial lot.

5. (E) The executor of a decedent’s estate may elect to treat medical expenses paid by the estate for the decedent’s medical care as paid by the decedent at the time the medical services were provided. To qualify for this election, the medical expenses must be paid within the one-year period after the decedent’s death, and the executor must attach a waiver to the decedent’s Form 1040 indicating that the expenses will not be claimed as a deduction on the decedent’s estate tax return. In this case, the medical expenses qualify for the election because Remsen died on January 9, 2013, and the expenses were paid on December 3, 2013.

Task-Based Simulation 5

image

For items 1 through 7, candidates were asked to identify the federal gift tax treatment for each item by indicating whether the item is fully taxable (F), partially taxable (P), or not taxable (N) to Lane in 2013 for gift tax purposes after considering the gift tax annual exclusion.

image

Explanations

1. (N) There is no taxable gift because the $14,000 cash gift is a gift of a present interest and is fully offset by a $14,000 annual exclusion.

2. (P) The $20,000 of cash gifts given to his child would be partially offset by a $14,000 annual exclusion, resulting in a taxable gift of $6,000.

3. (P) The gift of the income interest valued at $26,000 to his aunt is a gift of a present interest and would be partially offset by a $14,000 annual exclusion, resulting in a taxable gift of $12,000.

4. (F) Since the remainder interest will pass to Lane’s cousin after the expiration of five years, the gift of the remainder interest is a gift of a future interest and is not eligible for an annual exclusion. As a result, the $74,000 value of the remainder interest is fully taxable.

5. (N) An unlimited exclusion is available for medical expenses and tuition paid on behalf of a donee. Since Lane paid the $25,000 of tuition directly to his grandchild’s university on his grandchild’s behalf, the gift is fully excluded and not subject to gift tax.

6. (F) Since Lane created the irrevocable trust in 2013 but his brother will not begin receiving the income until 2015, the gift of the income interest to his brother is a gift of a future interest and cannot be offset by an annual exclusion. As a result, the gift is fully taxable for gift tax purposes.

7. (P) The creation of a revocable trust is not a completed gift and trust income is taxable to the grantor (Lane). As a result, a gift occurs only as the trust income is actually paid to the beneficiary. Here, the $15,000 of interest income received by the niece during 2013 is a gift of a present interest and would be partially offset by a $14,000 annual exclusion.

Task-Based Simulation 6

image

Internal Revenue Code Sec. 102, subsection (a) provides that gross income does not include the value of property acquired by gift, bequest, devise, or inheritance.

image
..................Content has been hidden....................

You can't read the all page of ebook, please click here login for view all page.
Reset
18.189.180.43