Forest Service

Southern Forest

Experiment Station

New Orleans,

Louisiana

General Technical Report

so-97

September 1993

Estate Planning for

Forest Landowners

What will Become of Your Timberland?

Harry L. Haney, Jr., and William C. Siegel
Summary

Funding f~ this book was provided by the USDA Forest Service’s

Cooperatii,e Forestry Staff. S:ate and Private Forestry. Dr. Karen LIU,

Fmnce and Tax Specialist in the Washington, DC, Cooperative Forestry

Office, administered the project, Dr. Wil!im-~ 1,. Howe: of Purdue

Lniversity prwided rechnical review.
Estate Planning

For

Forest Landowners

What Will Become of Your Timberland?

Harry L. Haney, Jr., and William C. Siegel

Harry L. Haney, Jr., is professor and extension specialist, Forest Management-Economics, Department

of Forestry, Virginia Polytechnic Institute and State University, Blacksburg, VA 24061-0324; William

C. Siegel is volunteer chief economist, Forest Resource Law and Economics, U.S. Department of

Agriculture, Forest Service, Southern Forest Experiment Station, New Orleans, LA 70113 and a member

of the Louisiana Bar.

CONTENTS

PARTI. INTRODUCTION ................................................. . 1

Chapter 1. The Importance of Forestry Estate Planning ............................... 3

Forest Ownership .................................................... 3

BookPolicy ....................................................... . 3

Readiness Questionnaire ................................................ 4

Chapter 2. Estate Planning Considerations and Objectives ............................. 7

The High Cost of Dying Unprepared ........................................ 7

Estate Planning Considerations Peculiar to Forestry ............................... 8

A Forest Management Plan as Part of the Estate Plan .............................. 15

Specific Objectives ................................................... 16

Estate Planning Team for Forest Landowners ................................... 17

Chapter 3. The Federal Estate and Gift Tax Process ................................. 19

Background ....................................................... . 19

UnifiedRates ...................................................... . 19

UnifiedCredit ..................................................... . 19

Determination of Gross and Taxable Estate .................................... 19

Chapter 4. Valuation of Assets for Estate and Gift Purposes ............................ 23

General Considerations ................................................. 23

Special Considerations ................................................. 24

Forest Land and Timber ................................................ 24

Discounting for Minority and Undivided Interests ................................ 29

Chapter 5. The Legal Process .............................................. 33

Basis of the Law ...................................................... 33

Wills ........................................................... . 34

Power of Attorney .................................................... 34

Probate .......................................................... . 35

PART II. APPLICATION OF GENERAL ESTATE PLANNING TOOLS TO FORESTRY .......... 37

Chapter 6. Use of the Marital Deduction in Estate Planning ............................ 39

Overview ........................................................ . 39

Qualifying for the Marital Deduction ........................................ 39

Exceptions to Terminal Interest Rule ........................................ 39

Qualified Terminal Interest Property and the Marital Deduction ........................ 40

To What Extent Should the Marital Deduction be Used? ............................ 40

How to Make a Marital Deduction Bequest .................................... 42

Chapter 7. Disclaimers, Settlements, and Elections To Take Against the Will ................. 45

General Considerations ................................................. 45

Disclaimers ....................................................... . 45

Charitable Disclaimers ................................................. 46

Will Settlements ..................................................... 46

Election Against the Will ............................................... 46

Chapter 8. Gifts of Forestry Assets i .......................................... 47

Overview ........................................................ . 47

Gifting Tax Considerations .............................................. 47

Basic Gifting Strategies ................................................. 49

GiftstoMinors ..................................................... . 50

Gifts Within 3 Years of Death ............................................ 52

Charitable Gifts ..................................................... 53

i
Chapter 9. Generation-skipping Transfers ....................................... 59

General Provisions ...................................................

Chapter 10. Role of Trusts ................................................

zy

Overview ........................................................ .

61

Basic Considerations .................................................. 61

Tax Treatment of Trusts ................................................ 62

Types of Trusts and Applications ...........................................

Use of Trusts in Marital Deduction Planning ...................................

“63

Trustees ......................................................... .

69

Trust Applications for Forestry ............................................

Chapter 11. Life Insurance ................................................

‘77

Role of Life Insurance ................................................. 75

Types of Insurance ...................................................

Estate and Gift Tax Considerations .........................................

‘77

Choice of Beneficiaries (Including Contingencies) ................................ 78

Other Considerations ..................................................

How Much Insurance is Enough? ..........................................

‘7;

Chapter 12. Installment Contracts ............................................ 81

General Provisions ...................................................

Estate Planning Considerations ............................................

“8:

Installment Obligation Dispositions at Death .................................... 83

Installment Sales by the Estate ............................................ 84

PART III. APPLICATION OF FORESTRY-SPECIFIC ESTATE PLANNING TOOLS ............. 85

Chapter 13. Special Use Valuation ............................................ 87

Reduction in Value ...................................................

Qualifying Conditions ..................................................

f33

Election and Agreement ................................................ 91

Valuation ........................................................ . 92

Postdeath Requirements ................................................ 93

The Election Decision ................................................. 95

Chapter 14. Deferral and Extension of Estate Tax Payments ............................ 97

Overview of the Estate Tax ..............................................

Estate Tax Option for Closely Held Business Interests ..............................

!Y$

PART IV. FORM OF TIMBERLAND OWNERSHIP AND BUSINESS ORGANIZATION .......... 103

Chapter 15. Sole and Joint Ownership Considerations

Sole Ownership

:C_lz

. ... ........

.........................................................................

Joint Ownership Between Spouses

.........................................................................................................................................

105

Chapter 16. Partnerships ..

Definition of a Partnership

:(I;

Partnership Attributes 109

Estate Planning with Partnerships

Chapter 17. Corporations ... ....

..................................................................................................................................................................................................................

: ii

Corporate Formation and Management 113

Income Tax Implications of Incorporation 114

Estate Planning Considerations

................................................................................... Chapter 18. Limited Liability Companies

: :z

Overview . . . .

Organization and Operation

........

........................................................................................................................................................................................

f;;

Tax Considerations

Implications for Timber Properties

t;y

ii
Chapter 19. State Death Tax Considerations ...................................... 123

Types of State Death Taxes .............................................. 123

Combined Federal-State Tax Ljability ........................................ 123

Appendixes ......................................................... . 127

Appendix I. Glossary ................................................. 129

Appendix II. Additional Readings .......................................... 133

Appendix III. State Death Tax Credit Table ................................... 135

Appendix IV. Form 706. United States Estate (and Generation-Skipping Transfer) Tax Return .... 137

Appendix V. Form 709. United States Gift (and Generation-Skipping Transfer) Tax Return ..... 182

. . .

111

PART I

INTRODUCTION

Chapter 1

The Importance of Forestry Estate Planning

FOREST OWNERSHIP

Forests comprise one-third of the Nation’s land.

Almost three-fourths of this woodland--about 350

million acres--is privately owned. Most of the

private holdings, some 283 million acres, belong to

nonindustrial owners. A nonindustrial private owner

is one who does not have a primary wood-processing

plant, that is, an owner who is not classified as a

forest industry. Nonindustrial private owners control

60 percent of the total commercial forest lands in the

United States.

A Diverse Group

There are nearly 8 million nonindustrial private

forest landowners. More than 6 million hold their

forest properties either as sole proprietors or in

nonformal family ownerships. These two categories

account for 55 percent of the nation’s private woodland acreage. The remainder of the nonindustrial

forest is owned by family corporations, family partnerships, or various other types of ownership entities.

The typical nonindustrial owner is over 50 years old.

Nearly one in five is retired. Almost half of the

private forests in the United States are in ownerships

of more than 500 acres, with an additional 31 percent

in ownerships of 100 to 500 acres.

Forest land and timber values have been rising

rapidly in many parts of the country in recent years.

Often market values reflect factors other than commercial timber production. At the present time,

normal estate valuation rules pose a real danger for

many estates with substantial woodland holdings.

Without proper estate planning, forced liquidation of

family forests or severe disruption of management

regimes is a distinct possibility.

What Can Happen?

Have you thought of retiring soon to try the

projects that you have always wanted to do on your

tree farm while you still have good health and

energy? Are the thinnings, timber stand improvements, hiking trails, and the cabin by the creek still

feasible? But, can you afford to retire and still enjoy

a satisfactory lifestyle? Are the children educated

3

and independent? How will the retirement affect your

timber investments?

Going one step further, if you die today, what will

happen to the timberland that you and your spouse

perhaps have worked a lifetime for? Will your forest

management program be disrupted in order to adequately provide for your spouse and children in an

equitable manner? Will the woodland continue to

function efficiently and will your spouse have adequate

control? Are your forestry investments structured so

that they will not lose value at your death? Will the

timber management plan continue to function as an

effective tool for your spouse to follow? Have steps

been taken to minimize death taxes, or will timber or

land or both have to be sold to pay debts?

Examples abound of forested estates that were profitable during the decedent’s lifetime, but had to be partially or entirely liquidated to settle estate debts and

pay death taxes. Also, in unplanned situations, the

heirs may quarrel over the settlement of the estate and

dissipate valuable forest resources.

BOOK POLICY

Purpose

This book has been written to assist nonindustrial

private landowners in addressing the considerations

enumerated above. It is designed to provide a

working knowledge of the Federal estate and gift tax

law as it relates to estate planning for timberland

owners. The unique character of timber assets is

addressed in terms of the estate planning goals of a

woodland owner. The purpose is to enhance, not

replace, communication with estate planning advisors,

and to make estate planning more efficient through

understanding the process as an informed timberland

owner. In all cases, well-qualified professional

advisors are essential.

Educational, Not Legal, Advice

The discussion and examples presented here should

be regarded as educational, not legal, advice. The

facts and circumstances of one’s personal situation--

goals, financial portfolio, land and timber inventory,
and special considerations--should be carefully

reviewed with an attorney ‘and estate planning

advisor. The applicable laws and regulations, which

are often both complex and dynamic, must be applied

in the context of a specific situation and economic

circumstances before making legal and financial

decisions. The book is written within the framework

of Federal law, but an understanding of the applicable

State law that affects the ownership, management,

and transfer of timberland assets should also be

incorporated into estate planning deliberations.

Because State law varies widely among the 50 States,

much of it is beyond the scope of this publication.

Structure

This book has four major parts plus an appendix

with a glossary, selected Internal Revenue Service

(IRS) tables, selected tax forms, and a list of selected

additional readings on estate planning. The foundation for estate planning is developed in part I. Estate

planning considerations and objectives, the planning

process, and valuation principles are discussed. In

addition, the Federal estate and gift tax process, and

the legal basis for estate planning, are addressed.

The general estate planning tools are explained in

part II and integrated with forestry examples. These

include use of the marital deduction, disclaimers, and

strategies for gifting forestry assets. The role of

trusts, life insurance, and installment contracts in

estate planning are also discussed.

Part III is concerned with forestry-specific estate

planning tools. The planning and requirements necessary to qualify for and effectively utilize special

use valuation, and the deferral and extension of

Federal estate tax provisions is covered in detail.

The various forms of timberland ownership and

their relationship to forestry estate planning are

discussed in part IV. Alternative business structures

for timber estates, including the advantages and

disadvantages of each, are also addressed.

In part IV, chapter 19, State death taxes are treated.

The basic features of the statutes in each State are

discussed.

Forestry examples are used throughout the text to

explain the use of various estate planning tools. The

case examples draw from several regions of the United

States and incorporate combinations of strategies from

which to choose, depending on particular goals.

READINESS QUESTIONNAIRE.

As indicated above, effective estate planning is an

ongoing process consisting of three major components.

The first concerns effective management of the estate

assets during the decedent’s lifetime. The second

component, building on the first, is concerned with

ensuring that the transfer of estate assets at death will

be made in accordance with the decedent’s wishes,

with a minimum of problems and with minimum tax

liability. The third encompasses nontax situations that

only the decedent can address during his (her) lifetime

through personal understanding of family circumstances and their interaction with effective planning.

At this time, take a few minutes to complete the

Readiness Questionnaire on the following page (fig.

1.1).

4
YtS No

1. I have discussed the requirements for cash in the event of my spouse’s death. I have knowledge of the

estimated Federal and State death taxes, as welI as the debts and other costs, payable at that time.

2. Specific plans exist to satisfy immediate financial needs in the event of my spouse’s death.

3. I know what estate planning can accomplish, have set the objectives for my own estate plan, and have

discussed with my spouse a plan for continued management of the family’s timberland.

4. Both my spouse and I have complete and up-to-date wills.

5. I understand the reason for probate and how it functions.

6. I know how to use trusts as an estate-planning tool for saving taxes, lessening probate costs, and

managing my assets.

7. My spouse and I know how to use the marital deduction for Federal estate tax saving.

8. I am aware of the tax savings available by using the gift provisions of the tax law.

9.

10.

11,

12.

13.

I understand the importance of life insurance in my estate planning.

I am aware of my spouse’s life insurance policies and how to shelter policy proceeds from Federal

estate tax.

I understand the different ways to hold timber property in my estate and the advantages and

disadvantages of each.

I know how much family income will be received from retirement plans, social security, annuities, and

other sources.

Both my spouse and 1 know how to contact our attorney, accountant, banking officer, and life

insurance agent. We both know where important documents are stored.

Check the appropriate blank to the left of each statement.

Figure 1.1 .--Estate Planning Readiness Questionnaire.

5

Chapter 2

Estate Planning Considerations and Objectives

THE HIGH COST

OF DYING UNPREPARED

Do you have an estate plan? The answer is “yes”!

Even if a person has not expressed his (her) desires

by writing a will, the State in which a person is

legally domiciled has a plan for disposing of his (her)

property. In fact, all States have laws of descent and

distribution. If an individual has not exercised the

right to specify who will receive his (her) property at

death, State law provides a general plan of rules that

apply. The major exceptions are joint tenancies

where property passes to the surviving tenant and life

insurance contracts where the proceeds pass to the

named beneficiary. Generally, the State’s plan can

be improved upon because there are a number of considerations that State law does not address. Simply

stated, the rules are specific as to who gets the

residue of the estate after the “transfer costs” have

been paid.

Unexpected Heirs

When a person dies intestate (without a will), the

State laws of descent and distribution determine what

happens to his (her) property. The surviving spouse,

children, parents, brothers and sisters, and other

relatives are considered in more or less that general

order. State law does vary in this regard, however,

and becomes more complicated where second and

third marriages are involved--especially when there

are minor children. State statutes rarely consider the

needs of the heirs, their contributions to the estate, or

the tax consequences of the distribution.

Unexpected Values

The fair market value (FMV) of appreciated real

estate, closely held stock, jointly held property, and

other low current return interests may greatly exceed

the value attributable to such property from current

cash flows. Fair market value also exceeds valuations based on the use value of the assets (discussed

in chapter 13). The Internal Revenue Service (IRS)

focuses estimates of value on the “highest and best

use” of the property, preferring market transactions

7

evidence of value wherever possible. Therefore, IRS

valuations may be much higher than the values

ascribed to estate assets by the executor.

Transfer Costs

Transfer costs include Federal and State death

taxes, and probate and estate administration expenses.

Fede ral and State Death Taxes.- -Th e Federal death

tax law encompasses a unified transfer tax on taxable

lifetime gifts, combined with property passing at

death, in calculating tax liability. The gift and estate

tax rates effectively begin at 37 percent on taxable

values in excess of the $600,000 exemption equivalent.

They increase progressively to 55 percent on amounts

over $3 million (the Federal estate and gift tax process

is discussed in more detail in chapter 3). Many States

have an estate or inheritance tax law that imposes

additional death taxes. These can amount to as much

as 20 percent of the Federal tax cost. Other States

have adopted what is commonly called a “pick-up

tax,” which makes the State tax equal to the credit for

State death taxes allowed on the Federal estate tax

return. In this case, no additional tax is owed; thus,

it is important to know State law for planning purposes. State death taxes are discussed more completely in chapter 19.

Probate and Adm inistration Expenses.- -The cost of

probate (see chapter 5) and estate administration

expenses comprise the other so-called “transfer costs.”

At least some States have statutory limits for probate

costs that are associated with small estates.

Thresholds for the applicable amounts under small

estate laws vary from approximately $5,000 to

$100,000. On estates exceeding the threshold, probate

expenses may amount to as much as 8 to 9 percent of

the gross value of the estate. Generally, these costs

gradually fall to approximately 5 percent of the gross

estate value as estate size increases to $1 million.

Wide variations within these parameters are possible,

however, depending on State law and the complexity

of the estate. On larger estates, the charges should

drop even more as a percentage of value if no undue

problems are encountered. Administration and related

costs incurred by the executor will be in addition to

the cost of probate. Of course, major problems can
sharply escalate legal costs--for example, a legal

challenge to the will.

On a $1 ,OOO,OOO taxable estate (gross estate minus

all permitted deductions as explained on page 21)

the total average settlement costs (Federal estate tax

plus administration expenses equal to 5 percent of

the estate) would be $203,000 (see table 2.1). This

amount increases to $688,000 on a taxable estate of

$2,000,000. Note that on a $10 million estate the

total transfer cost has risen to over 54 percent of the

taxable value. State death taxes are not included in

these estimates.

Loss of Leadership and Income

The owner’s leadership and skill may be indispensable in successfully managing the timber property.

Knowing boundary locations; having good relationships with neighbors, consultant foresters, loggers,

and reforestation contractors; having an understanding of silviculture; and having timber marketing

experience are all part of a knowledge base often

built up over a long period of time. This experience

may be difficult or impossible to replace in the short

run. At the owner’s death this leadership will be

lost.

Nonindustrial forest owners are typically in an age

group where they are at the peak of their earning

power. At death these earnings will be missed.

Shrinkage Because of Liquidation

When business assets have to be sold to pay taxes

and administration expenses or to retire indebtedness,

shrinkage losses can often amount to 40 percent or

more of the estate. These losses can result from poor

market timing, breakup of efficient working units,

premature disposition of assets and unfavorable financial arrangements. Partitioning the resources of an

estate among the heirs may also have unfavorable

consequences both in terms of valuation and management.

Ancillary Probate

Ancillary probate proceedings are generally

required when real property is held in more than one

State. The additional legal costs increase the estate’s

overall administrative expenses.

ESTATE PLANNING CONSIDERATIONS

PECULIAR TO FORESTRY

Estates with substantial timber values often have

many of the problems described above. They also

may have additional problems that arise from the

unique nature of the timberland asset and the economic

climate in which the timber owner operates. The

financial returns to timber investments are driven by

three primary factors: timber growth (site productivity), timber markets (stumpage price), and the cost of

capital (interest rate). Landowner investment and

harvest decisions interact in complex ways with these

factors which in turn are substantially influenced by

Federal and State income and death tax considerations.

Illiquidity of Land and Timber Assets

Land “dedicated” to timber production is characterized by a very long investment horizon. Timely and

appropriate management decisions are important in

order to establish and maintain the necessary level of

timber growing stock to match earning potential. This

importance is illustrated in the value growth curves for

loblolly pine shown in figure 2.1. Here land has a

constant price of $300 per acre with no inflation or

real price appreciation. Timber value growth is based

on site 60 yields (base age 25) without thinning. Site

60 is an average site for much of the south. Stumpage

prices are constant and are shown at three levels--high,

medium and low--taken from Timber-Mart South.’

Note that timber income becomes possible only after

age 15. Values then increase rapidly until approximately age 30, but thereafter increase at a declining

rate.

The effects of the price level are shown by the three

curves and illustrate the importance of developing strategies that make it possible to obtain the higher price.

Because value is a function of price and volume, these

curves serve as a proxy for both site quality and stocking level. As stocking levels fall, the value growth

curve will shift downward reflecting the reduced

potential of forestry’s financial returns over time as a

result of inadequate investment in growing stock.

Similarly, poor land will result in lower position

curves that reflect the reduced production potential.

Thus, combinations of low price, poor stocking,

and/or poor site serve to reduce the responsiveness

‘Timber-Mart South is a timber price reporting service for the

Southern States that is published quarterly by Timber-Mart South,

Inc., P.O. 1278, Highlands, NC 28741.
Table 2.1.-- Th e high cost of dying--average settlement costs at death based on Federal estate tar after 1992, plus an

average administration cost of 5 percent.

Taxable

e s tate

Fede ral

estate tax

Adm inistration

e xpense

Total

settlemen t

cost

--_________---______--___

100,000 0

200,000 0

300,000 0

400,000 0

500,000 0

600,000 0

700,000 37,000

800,000 75,000

900,000 114,000

1 ,ooo,ooo 153,000

1,250,000 255,500

1,500,000 363,000

1,750,000 475,500

2,000,000 588,000

2,250,ooo 710,500

2,500,000 833,000

3,000,000 1,098,OOO

3,500,000 1,373,ooo

4,000,000 1,648,OOO

5,000,000 2,198,OOO

6,000,OOO 2,748,OOO

7,000,000 3,298,OOO

8,000,OOO 3,848,OOO

9 ,000,000 4,398,OOO

10,000,000 4,948,OOO

._DOl~~S______________

5,000

10,000

15,000

20,000

25,000

30,000

35,000

40,000

45,000

50,000

62,500

75,000

87,500

100,000

112,500

125,000

150,000

175,000

200,000

250,000

300,000

350,000

400,000

450,000

500,000

5,000

10,000

15,000

20,000

25,000

30,000

72,000

115,000

159,000

203,000

318,000

438,000

563,000

688,000

823,000

958,000

1,248,OOO

1,548,OOO

1,848,OOO

2,448,OOO

3,048,OOO

3,648,OOO

4,248,OOO

4,848,OOO

5,448,OOO

9
G-T - -- - - Low Pric e

:“-

Med. Pric e

j -

High Price

0 -

04

:

3--

: -

0 -

:2-

0 5 10 15 2 0 2 5 3 0 3 5 4 0 4 5 5 0 5 5

TIME (YEARS )

Figure 2.1.-- Land and timber values per acre for loblolfy pine plantations at constant

prices on site 60, base age 25 (average site for the South). Timber value

equals volume @ieM) times price.

of timber investments by lowering revenues and

lengthening the rotation, which in turn increases

illiquidity.

Uncertainty caused by long time horizons limits the

potential number of buyers in the market for timber

property. Consequently, marketing skills, timing,

and luck are usually all necessary in order to obtain

top prices when selling timberland. As tract size and

value increase, the number of potential buyers may

be further restricted simply by the financial

limitations.

The example just discussed is for southern pine

timberland. However, the basic principles that are

illustrated should apply for most species in most parts

of the United States.

While the biological process of stand value growth

is regular and predictable, timber stumpage prices

behave is a much less predictable fashion, sometimes

with wide fluctuations over relatively short periods of

time. Volatile prices often follow sharp, irregular

price cycles (see fig. 2.2). For example, the average

price of Douglas-fir rose from $169.50 per thousand

board feet (MBF) in 1975 to $432.20 per MBF in

1980--an increase of 155 percent in 5 years. It then

dropped precipitously by 73 percent to $118.20 per

MBF in 1982. Six years later, in 1988, the price had

10

risen to $256.00 per MBF. As further evidence of

price volatility, the stumpage price of export grade

Douglas-fir was approximately $700 per MBF during

the summer of 1992, and some observers predict a

price of $1,000 per MBF by 1994 because of courtmandated withdrawals from the timber supply base in

spotted owl habitats.

In other regions, stumpage price fluctuations have

been less dramatic but, nevertheless, important to

landowner marketing strategies. In the South, for

example, southern pine prices increased gradually

from $57 per MBF in 1975 to $172 in 1981--an

increase of 202 percent over 6 years. In 1982, the

price dropped to $127.00 per MBF and ultimately to

$90.70 by 1985--a decline of 47 percent in 4 years.

By 1993, prices in many parts of the South had

increased dramatically to between $250 and $300 per

MBF. Of course, changes such as these do not matter

unless timber is actually sold when prices are high.

Generally, however, volume and quality will continue

to increase throughout the investment period.

The cost of capital, or the interest rate, is a critical

input because forestry is a capital intensive investment.

Land committed to growing trees has an “opportunity

cost,” because it could be sold and the income invested
- - Pin e

Douglas-fi r

Hardwoo d /’

I \

I \

1 9 6 0 1 9 6 5 1 9 7 0 1 9 7 5 1 9 8 0 1 9 8 5 198 8

TIME (YEARS )

Figure 2.2.-- Stumpage price series: 1960-88 (Source: Ulrich, Alice H. 1989. U.S.

h’mber production, trade, consumption andpn’ce staristics 195G87. Misc.

Pub. 1471. Washington, DC U.S. Department of Agn’culture, Forest

Service. 77p.)

elsewhere. Similarly, a reforestation investment must land and timber. The value growth curve is identical

be carried for the length of the rotation. Annual to the medium price curve in figure 2.1. An optimum

operating and management costs also accumulate and investment length for the assumed inputs--site prepincrease the direct burden of holding young timber aration and planting, $150 per acre; annual manuntil it becomes merchantable or of holding mer- agement costs and property taxes, $5 per acre; a nochantable trees for additional growth. Any increase thin management regime with stumpage prices of $15

in the interest cost will discourage holding growing per cord for pulpwood, $35 per cord for chip-n-saw

stock and shorten the rotation. This is illustrated in logs, and $135 per MBF for sawtimber--is approxifigure 2.3 with an 8.24-percent compound interest mately 25 years at a cost of capital of 6 percent.

curve--cost/income curve--that begins with the cost of There is a decision window of plus or minus approxireforestation in year zero and includes the mately 3 years, which causes little change in the

intermediate annual expenses of property taxes and potential income to be received if the stand is

management costs (the cost aspect of the curve). The harvested prior to the optimum rotation curve or

8.24-percent rate is the internal rate of return (IRR). carried beyond that point. The decision window

It is found by setting the sum of dis-counted costs shows one of the key advantages of a timber investequal to the sum of discounted revenues for this ment (that is, trees store well and continue growing).

investment and solving for the interest rate that makes First, the owner has the flexibility to take timber

them equal. An example of this calculation is shown income when it fits best with other ownership goals.

in the valuation section of chapter 4. The Second, the owner can try to maximize income by

cost/income curve not only represents the accum- marketing when he (she) feels that it will bring the

ulating cost of carrying the investment in refores- highest stumpage price. Any combination of prompt

tation and annual expenses, but it also shows the reforestation (to minimize costs), low interest rates,

income potential of expected returns from its point of and low annual costs that hold down the cost curve

tangency with the value growth (liquidation) curve of will increase the rotation length and the maximum

11
5

_ _ _ . . Lan d

- - - - Liquidatio n

5. Cost/Incom e

a4

+_______ . . . . . . . . .._.. _ ._....

II“0, ’ ”I ‘I n n 1 (‘I’I I I ‘I 1 n c 1 r 1 r I”

0 5 10 1 5 2 0 2 5 30 35

TIME (YEARS )

Figure 2.3.-- Timing of timber investment and harvest decisions based on cost/income

and liquidation values (loblolly pine on an average site with a net present

value at 6.00 percent and an internal rate of return at 8.24 percent).

price that can be paid for land to grow trees. Similarly, any combination of increased price, higher

value products, and higher yields shifts the value

growth curve upward, shortens the rotation, and also

increases the maximum price that can be bid for land.

This is another way of saying that costs, prices, and

land productivity are logically connected. The lower

the costs--such as land, reforestation, taxes, and

interest charges--and the higher the returns--such as

timber sale prices, hunting leases, and incentive

payments, if any--the higher will be the rate of return

on the tree farm investment and its asset value, and

vice versa.

Low, Irregular Income

Low Zncome.--Low or inadequate returns on forestry assets often result from premature harvesting,

overcutting, and underinvesting in reforestation and

maintenance of timber growing stock. The result is

that the potential of the timberland is not realized.

This condition has basically the same effect as

shifting the value growth curve down (see fig. 2.1).

Thus the rotation becomes longer, and there is less

timber to harvest.

Irregular Income.--Irregular income occurs for

similar reasons because most nonindustrial private

timber properties are not managed to provide an even

flow of income. The average tenure of nonindustrial

woodland holdings is approximately 10 years, whereas

a timber rotation may vary from 25 to 50 years. Then

too, the average owner’s age is well over 50 years.

This combination of age and relatively short tenure

suggests that sporadic cash flows will be the usual

case. Even in all-aged stands, excess cutting or high

grading (cutting the best trees without regard for the

future stand) will invariably disturb the cutting

schedule and contribute to irregular income.

There are four revenue zones in even-aged forest

stands that further illustrate the potential for low,

irregular income (see fig. 2.4) under various circumstances. The revenue zones vary by species, site, age,

and condition of the growing stock. The following

southern and western management regimes illustrate

the point.

1. Southern regime--even-aged loblolly pine stands

on average sites (site index 60, base age 25).

a. The income potential for premerchantable

trees of 1 to 12 years of age, if liquidated

12
b.

I II III

-- Lan d

- - Liquidatio n

Cost/l ncome

Net Present Valu e

0

Figu re 2.4.--

5 1 0 1 5 2 0 2 5

TIME (YEARS )

Timber income liquidity Zones on a per acre basis and the decision window

for jinal harvest based on cost/income and liquidation values (loblolb

pine on an average site with a net present value at 6.00 percent and an

internal rate of return at 8.24 percent).

severed from the or land (zone I) is the unit cost for handling each product

practically zero (see fig. 2.4). Note, decreases, and as timber volumes per acre

however, that the cost/income curve shows increase, the harvesting cost per acre

that land and timber is an appreciating asset decreases. Both situations contribute to an

that begins increasing in value from the time increase in the net value of stumpage for the

of reforestation. From a practical point of landowner. However, note that a harvest in

view, there is some evidence that actual zone II will result in a sacrifice in total net

prices in zone I may be more heavily revenue as illustrated by the gap (vertical

discounted by the market than the internal distance) between the liquidation curve for

rate of return reflected by the cost/income land and timber and the cost/income curve for

curve in figure 2.4 would suggest.’ land and timber values (see fig. 2.4).

In zone II, the income potential improves c. An optimum financial rotation occurs in zone

with opportunities to thin for pulpwood or to III. This is the harvest timing that gives the

liquidate chip-n-saw logs (small sawtimber) highest rate of return or the greatest increase

in stands aged 13 to 18 years. This is a in owner wealth. It is shown in figure 2.3 as

period of very high rates of value the point where the slope of the liquidation

appreciation as trees increase in merchant- (value growth) curve equals the slope of the

able size. The increase in size yields a cost/income curve. The stand value conproduct mix that crosses the threshold tinues to increase, but at a decreasing rate,

between pulp fiber and solid wood products whereas the cost/income curve is geometricand contributes to the rise in value. This ally increasing. This zone includes timber

potential increase is greatest where sharp from 19 to 28 years of age, depending on site

differentials exist among different classes of quality, silvicultural practices, and the

products--pulpwood, chip-n-saw, and saw- discount rate. The decision window for a

timber. As individual tree volumes increase, final harvest extends to 3 or 4 years on either

13
2

side of an optimum rotation for a particular

set of assumptions so that the potential for

loss of income is minimized. Landowner

goals, estate goals, and the market hold the

key to optimum harvest decisions for

particular sets of circumstances.

d. The final zone (zone IV) extends beyond a

stand’s economic maturity (30 to 40 years).

Here income losses occur from a deceleration of the rate of value appreciation because

of insect and disease losses and decreased

vigor. Such losses reduce the actual rate of

return far below the opportunity for a higher

rate of return from a new stand. Many

factors may influence a landowner’s decision

to hold onto timber until it enters this zone.

For example, it is often said, “That (timber)

is my insurance policy! It is like money in

the bank.” Some owners are also reluctant

to pay the income tax on harvest profits

from highly appreciated stands, or they

value esthetics or let other considerations

influence their decisions.

Western regime--primarily Douglas-fir stands

on average sites. The same landowner considerations come into play, but other factors

such as growth rates, scale of operations, land

use history, the influence of public timber

ownership, and regulations produce a vastly

different management environment that affects

landowner decisions. Thresholds between the

zones are constantly changing as utilization

standards, timber prices, and other inputs vary.

Increased demand and the resulting higher

prices have altered the economics of growing

private timber in the West in the last decade.

a. The zone of limited income from mostly

premerchantable trees occurs from ages 1 to

25 years if they have to be liquidated or

severed from the land (zone I). Value

appreciation rises at increasing rates over

time, but actual values may be heavily

discounted by the market.

b. Limited income potential is possible for

thinning in pulpwood and small sawtimber

stands of 26 to 35 years of age (zone II).

These stands are also in the zone of very

high rates of value appreciation from

ingrowth as increases in timber size cross

the threshold from pulp fiber to solid wood

products (zone II).

Excellent income potential is possible as timber matures into sawlogs, peelers for plywood, and export material within plus or

minus 5 years of an optimum rotation in the

range of 36 to 50 years of age (zone III).

The rate of financial return declines as timber

is held beyond its economic maturity

(approximately 51 years plus) due to losses

from insects, diseases, decreased vigor, and

the opportunity cost of a new stand (zone IV).

Continuity of Management

Continuous long-term management under a welldefined set of goals is the most effective way to insure

efficient timber production from forest holdings. This

goal is clearly desirable from a societal point of view.

From an owner’s perspective, its primary importance

is from the standpoint of keeping timber assets productive. Continuity of management, however, for all its

public and private benefits, is often at variance with an

owner’s immediate goals and personal situation. Many

variables affect an owner’s particular management and

harvest decisions that may interrupt the continuity of

management associated with an optimum return as

depicted in figure 2.3. As noted above, the average

tenure of nonindustrial private timberland owners is a

relatively short 10 years. Even with larger holdings

that have longer average tenure, the holding period

rarely approaches a typical rotation cycle of 25 to 40

years in the South, and longer in the North and West.

Within these short time frames, Federal tax laws

further complicate the intergenerational transfer of

timber property, thus contributing to the liquidation of

growing stock and disrupting management continuity.

Partitioning the estate often produces similar results.

Careful planning is required to insure continuity of

management and the attendant benefits.

Unitary Nature of the Forest

Economies of scale in management, harvesting, and

reforestation are generally achieved only on holdings

of perhaps 1,000 acres or more. The exact size will

depend on site quality, species mix, markets, and other

variables. There is a rather well-defined inverse

relationship between tract size and the unit cost of

14
production. That is, as woodland size increases the

cost per acre of reforestation, harvesting, and

management operations will decrease.

An even flow of timber and other outputs can be

achieved only on holdings large enough to have a

diversity of timber stands, age classes, and species.

For example, if one assumes a 40-year rotation,

defines the minimum operable stand size as 20 acres

for cultural treatments, and wants income every 5

years, a 160 acre [(40 years/5 years) x 20 acres]

minimum of operable land stocked with age classes at

5 year intervals is required. If annual income is

desired, an 800 acre minimum holding would be

required (clearcut management with no thinnings is

assumed). The problem, however, is that age classes

are rarely uniformly distributed, and the distributions

that do exist are upset as family changes or estate

proceedings require liquidation to raise cash. A

management plan can help to solve some of these

difficulties.

Fragmentation of timberland holdings is encouraged by real estate practices and estate tax policies.

Consider a 1,000 acre timber property with four parcels of approximately equal size, which have age

classes that differ by 10 years per parcel. In the

aggregate, an even flow of income and low cost management is possible. At the owner’s death, however,

one parcel each passes to the surviving spouse and

three children (the values were equalized externally

to account for the different levels of growing stock

on each parcel). In the absence of a family agreement to the contrary, the death will disrupt the flow

of timber income, and the cost of management operations will increase. A forest management plan will

not prevent this outcome if the respective parties do

not reach an agreement that encompasses continuity

of management for the entire acreage.

Example 2.1. Consider the 1,000 acre property

noted above, which is located on four parcels of

approximately equal size. The timber corresponds

roughly to the four zones of figure 2.4. A timber

management plan will include an inventory of the

tree farm’s timber stands by species, age, and

condition. An operational plan will project and

treat each stand based on the owner’s goals

(including the estate plan, if desired). The options

for a 40-year rotation (investment period from seed

to harvest) are illustrated by the cutting cycle:

(1) harvest 25 acres per year from mature timber

in zone IV for an even flow of wood products, (2)

harvest 250 acres in every lo-year period when the

highest prices are expected, (3) harvest the growth

from all merchantable timber on a 5-year cutting

cycle, (4) cut timber when the family needs money,

and (5) many combinations of the above. The plan

will depend on the timber market, family needs for

income, and the biological condition of the forest.

A forester can transform the tree farm inventory

into the most effective operational plan to meet

owner goals and to utilize the maximum potential of

the forest.

Diffkulty in Obtaining Credit

Forests are unimproved real estate and largely

unproductive in zones I and II (see fig. 2.4). A

timberland owner, typically over 50 years of age, with

standing in the community and with forestry experience, should have excellent credit. It may be more

difficult initially for surviving spouses to obtain credit,

if they do not have a proven credit record of their

own. It may be even more difficult for the children.

The loss of income and family leadership exacerbate

the problem of credit worthiness when coupled with

liquidity needs of the family to cope with estate transfer costs. This is an important issue to address in the

planning process.

A FOREST MANAGEMENT PLAN

AS PART OF THE ESTATE PLAN

The primary goal of estate planning is the accumulation and conservation of wealth, including its transfer

to heirs or other beneficiaries. With respect to timberland in the estate, a forest management plan is essential to both the goal of producing income and to that of

preserving the land’s inherent productivity. The plan

should have both an operational and a strategic dimension. An operational plan focuses on the production

of net income over a relatively short planning horizon,

typically 5 years. Beginning with the current inventory, all forestry operations during this period,

together with their related costs and revenues, are

scheduled. These would include such activities as thinnings, harvest/reforestation decisions, timber stand

improvement work, and wildlife management practices. Annual budgets within this plan are developed

to meet owner objectives, subject to the constraints

imposed by the timber inventory and the market

environment.

15
A good plan has the flexibility to make adjustments: (1) in revenues as owner needs and/or market

conditions fluctuate, (2) on expenditures as liquidity

and the cost of capital vary, and (3) as unexpected

external factors such as changes in public policies and

casualty losses interject themselves.

The short-term operational plan functions logically

within the context of a strategic plan, which is

developed to meet long-term forest management goals

for the timberland. Species selection, stocking levels,

and rotations are addressed in the strategic plan, as

well as the relationships among timber, wildlife,

esthetics, and other goals.

In developing a forest management plan, the scope

and sophistication will depend on the particular facts

and circumstances of each situation as noted above.

For limited acreage and modest timber values, a relatively simple plan may enable an owner to achieve

his (h e r) timberland objectives. As the acreage and

timber values increase, however, the attention

devoted to the plan should increasingly reflect the

investment in the resource and its potential earning

capacity.

SPECIFIC OBJECTIVES

The members of the family perhaps will have some

,difficulty in agreeing on the planning objectives for

the estate and its timber property. It may not be easy

to do, but it is necessary for development of the

estate plan. Problems arise because most estate plans

have multiple objectives. Invariably, conflicts arise

among the competing objectives that must be solved

before progress on the plan can be made. It is rarely

possible to satisfy all objectives completely, so

priorities have to be established for allocation of the

two primary estate resources--income and property.

Timing, equity, organization, and tax strategies are

among the more common considerations to be

addressed in the planning process. Timing deals with

the choices between current and future consumption

(that is, enjoyment by this generation or the next).

Equity deals with the shares of inheritance among the

heirs, special needs of certain family members, and

contributions by various family members in building

the estate. The form of ownership or business organization often must be decided in terms of who will be

in control and whose philosophy of management will

prevail. Tax saving strategies must be integrated

with the other goals in a way that retains a balanced

plan. Maximum tax savings may not always be the

most desirable end. Finally, there is the element of

trust. If members of the immediate family and the inlaws do not have respect and trust among themselves,

the planning effort becomes more difficult.

Pre- and Postretirement Security

Adequate resources should be allocated for the

financial security and well-being of the estate owner

before and during retirement. Involvement in management activities and professional interests may be

important in retirement. Planning for continuity of

business activities is discussed below.

Security and Compassion for Family

The financial security, comfort, and happiness of the

surviving spouse, either husband or wife, should

perhaps be the highest priority for most plans. The

ability of the survivor to care for the children, manage

daily affairs, and deal with grief due to the decedent’s

death must be considered. With most estates, the husband and wife have worked together for many years to

accumulate the estate assets and often at considerable

sacrifice. The death of either spouse is usually followed by a period of adjustment with respect to both

personal and business affairs. Arranging for the survivor’s comfort and happiness during this time will

depend greatly on the amount and types of assets

received from the estate, and on the control that the

survivor has over his (her) resources.

State law usually provides for a surviving spouse to

have certain minimum rights in the real and personal

property “solely owned” by the deceased spouse,

regardless of what may be stipulated in a will. The

further implications of property ownership will be

developed in part IV. Proper planning can determine

if the amount to be left to the survivor in the event of

either spouse’s death will be adequate. Specific

adjustments can then be made, if necessary, by means

of a will--subject to State law. Wills are discussed in

more detail in chapter 5.

Equitable Treatment of Children

State laws of descent and distribution generally

provide for equal distribution of property among

children. Although equal distribution is desirable in

principle, it may not be satisfactory in terms of the

specific needs of disadvantaged children, nor does it

16
necessarily reflect a particular child’s contribution to

building the estate or caring for the parents during

their aging years. Other considerations include: (1)

a large investment in a particular child’s education,

(2) an extra investment in one child’s business or

purchase of a home, (3) a financial contribution from

a child to the parents in money or in kind, (4) care

for children with physical or mental handicaps, and

(5) differing contributions in managing the woodland.

Equitable adjustments for these types of situations can

be specifically addressed by the will and other planning techniques. A realistic assessment of working

relationships among children and in-laws is essential.

In the absence of a will, State law will control the

distribution of the decedent’s property.

Continuity of Timber Enterprise

The time required to settle an estate will generally

vary between several months and several years,

depending on the complexity of the settlement. Plans

should be made for continuity of management of the

woodland, or assets and opportunities can quickly

disappear. It is essential to take advantage of

favorable timber markets within the context of the

forest management plan and to make timely investments in reforestation and cultural practices that keep

the assets productive. Protection from timber trespass, theft, and natural hazards (insects, diseases, and

wildfire) is also important. Proper planning will

insure that an operational timber management plan

continues in force. The will or other instrument

should direct that business operations of the estate

continue during the critical transition period.

The long-term plan must recognize the needs and

contributions of both spouses, as well as those of the

children. It should also be structured to the greatest

extent possible to insure continued operations after

the death of the decedent.

Minimize Transfer Costs

Generally, one of the principal goals of estate

planning is to minimize the impact of transfer costs

at death. As discussed earlier, transfer costs include

Federal and State death taxes, probate expenses, and

the costs of administering the estate.

Minimizing Ta Liabilities.--Careful attention to the

tax consequences of property disposal is required.

Gifts made during the decedent’s lifetime may be

subject to gift taxes. Gifts have specific advantages

and disadvantages that are discussed in chapter 8.

Property given to the spouse during the decedent’s life

or at death is shielded from tax by the marital

deduction, but this only defers the ultimate payment of

the tax as discussed in chapter 6. State death taxes,

which vary greatly in scope among States, must also

be considered. Careful planning is required to

minimize taxes without jeopardizing other objectives.

This requires that a husband and wife make a fundamental choice: (1) minimize taxes at both deaths and

pass the maximum value to the children, or (2) minimize taxes and other costs at the death of the first

spouse, leaving the surviving spouse with the maximum possible wealth and control over estate assets.

The latter approach will ultimately cost the children

more in estate taxes and administrative costs.

Minimizing Administrative Costs.--Certain steps can

be taken to reduce administrative costs, and even to

avoid probate, but at the cost of flexibility and perhaps

additional taxes. Because all choices have advantages

and disadvantages, they should be carefully considered

in terms of the overall objectives.

Provide Flexibility and Durability of Plan

There are always tradeoffs in saving estate taxes.

Rigid plans rarely work well over long periods of time

because of changes in the law and the economy. It is

generally best to choose an executor who can be

trusted to make decisions that benefit all concerned to

the maximum extent possible and to provide the flexibility to do so. However, where necessary to protect

the interests of a specific heir, the desired outcome

should take precedence over flexibility.

ESTATE PLANNING TEAM

FOR FOREST LANDOWNERS

Attorney

The family attorney usually has the primary responsibility for coordinating the estate planning process.

If he (she) lacks sufficient knowledge of the Federal

and State laws affecting the transfer of real and personal estate assets, an attorney specializing in estate

planning should be engaged. When particular complications exist or difficulties in the business operations

warrant, expert help is well advised. The attorney

guides the formation and articulation of owner

17
objectives, supervises the inventory of personal data

and estate assets, and works with other professionals

to evaluate alternative estate planning strategies. The

attorney drafts the will and other legal documents that

are required to execute the completed estate plan,

including supervision of changes in property titles

and insurance beneficiaries to conform them to the

plan.

Certified Public Accountant (CPA)

A CPA understands the complex interplay among

the estate, gift, and income tax laws, and prepares

and files the appropriate tax returns and other tax

documents. Because he (she) typically has access to

the client’s financial and tax records, the CPA can

discuss appropriate estate-planning opportunities.

Banker

A banker, who may be both lender and corporate

trustee, often has an awareness of the financial needs

of the estate. The banker can help explain the financial and tax aspects of alternative planning choices.

He (she) has expertise in the trust department that can

be utilized during the decedent’s lifetime and also

later by the survivors and has knowledge of how

various types of trusts can help meet specific estate

planning objectives. The role of trusts in estate

planning is covered in chapter 10.

Chartered Life Underwriter (CLU)

A CLU can develop an insurance program that will

provide the kind and amount of life insurance

required to meet the estate’s estimated financial

needs. The purchase of life insurance can provide

the liquidity necessary to cover the estate’s transfer

costs, insure protection of estate assets, and build

estate assets at critical times. In some States,

insurance consultants offer professional estate planning evaluations for a fee that is dependent only on

the service provided rather than on the sale of a

particular insurance package. The recommended

insurance coverage can then be purchased from the

company of choice, with consideration being given to

price as well as to the company’s strength and rating.

Forester

A forester is not a member of the traditional estate

planning groups; nevertheless, he (she) provides an

invaluable service if there are substantial timber assets

in the estate. A forester can prepare a forest management plan that specifically addresses estate-planning

goals and functions as an integral part of the overall

estate plan. The forest management plan will include

projections of capital expenditures and management

expenses on the cost side, and projected timber revenues on the income side. These projections are then

worked into operational plans that meet net revenue

targets specified by the owner’s estate plan objectives.

Operational plans are typically prepared for 5-year

intervals as part of the longer range strategic management plans. The strategic plan is designed to provide

a long-range view of cash flow levels that are consistent with the amount and distribution of the timber

assets. The forester routinely brings management,

marketing, and harvesting skills to the planning process, but often has knowledge of timber tax issues and

how they interact with other estate considerations.

Inventory

Consultations with professional advisors should be

preceded by a personal fact-finding process that

includes an analysis of the family situation, and current and projected lifestyle desires and financial needs.

The fact-finding process also includes an inventory

encompassing the description, form of ownership, and

value of all estate assets. Legal descriptions of all real

property, locations of deeds and other important documents, and all indebtedness should also be listed.

Projected values for all assets should be made for the

next 5 years. The forest management plan will provide the basis for timber volume and value projections.

Insurance policies, beneficiary designations, and policy

options need to be reviewed.

18
Chapter 3

The Federal Estate and Gift Tax Process

BACKGROUND

Since 1916, the Federal government has imposed

a tax (the estate tax) on the transfer of a decedent’s

estate, and since 1932, a tax (the gift tax) on the

intervivos (lifetime) transfer of property by

individuals. Over the years, the two taxes have

undergone many changes; prior to 1977 they were

independent of one another. Since that year,

however, the two levies have been companion taxes

that must be considered together in the context of

estate planning.

UNIFIED RATES

Federal estate and gift tax rates were unified into

one rate schedule by the 1976 Tax Reform Act. The

rate brackets for both gifts and estates became

identical at the time. As shown in table 3.1, the rates

in the unified schedule range from a low of 18 to a

high of 55 percent on transfers over $3 million. An

additional 5-percent surtax was imposed through 1992

on transfers in excess of $10,000,000 but not

exceeding $21,040,000. After 1992, the top amount

for the 5percent surtax dropped to $18,340,000.

UNIFIED CREDIT

The 1976 Act also established a unified estate and

gift tax credit to offset taxes owed. The credit has

been increased in steps; it reached its current maximum of $192,800 in 1987. This amount effectively

shields $600,000 (the exemption equivalent) of estate

and/or gift assets from Federal taxes. As can be seen

by examining the rate schedule in table 3.1, the lowest effective estate/gift tax rate is now 37 percent

because of the fully phased in credit.

The use of the credit begins with taxable gifts

made during the decedent’s lifetime. It is mandatory

that the credit be applied to such gifts--no tax is

actually paid on a taxable gift until the credit is

completely used up. Thus, some or all of the credit

may be exhausted during a decedent’s lifetime and,

therefore, not be available for use by his (her) estate.

Gifts are discussed in greater detail in chapter 8,

including what does and does not constitute a taxable

gift. The value of a gift for gift tax purposes is its fair

market value on the date of the gift. .

DETERMINATION OF GROSS

AND TAKABLE ESTATE

Gross Estate

The gross estate is defined as the value of all

property, both real and personal and both tangible and

intangible, owned by the decedent on the date of

death, or in which he (she) had an ownership interest

on the date of death. Thus, the first step in the estate

settlement process is a complete inventory of the estate

assets.

Valuation.--Once property interests have been established, they must be valued. Valuation of both timber

and nontimber assets is discussed in detail in the next

chapter. The general rule, however, is that property

comprising the gross estate must be valued at fair market value either as of the date of death or as of the

alternate valuation date. Special use valuation is also

possible for timber property and certain other types of

estate assets as discussed extensively in chapter 13.

Fair market value is defined as the price at which the

property would change hands between a willing buyer

and a willing seller, neither being under any compulsion to buy or to sell and both having reasonable

knowledge of all of the relevant facts.

The estate assets may be valued as of the date

falling 6 months after the decedent’s death (alternate

valuation date) if two tests are met: (1) alternate

valuation decreases the value of the gross estate, and

(2) it results in a decrease in the net Federal estate tax

payable. The alternate valuation election must be

made on the first estate tax return filed and applies to

all property in the gross estate. The executor may not

alternately value some assets and not others. The

return may be filed late without invalidating the election if it is filed no later than 1 year after its due date.

The election is also irrevocable--at least after the time

for filing has expired.

19
Table 3.1-- Federal unzjied estate and gQi tax rate sch edule

Amount on Which Tentative

Tax is Computed

Tentative Tax

Not over $10,000 18 % of such amount

Over $10,000 but not over $20,000

Over $20,000 but not over $40,000

Over $40,000 but not over $60,000

Over $60,000 but not over $80,000

Over $80,000 but not over $100,000

Over $100,000 but not over $150,000

Over $150,000 but not over $250,000

Over $250,000 but not over $500,000

Over $500,000 but not over $750,000

Over $750,000 but not over $1 ,OOO,OOO

Over $l,OOO,OOO but not over $1,250,000

Over $1,250,000 but not over $1,500,000

Over $1,500,000 but not over $2,000,000

Over $2,000,000 but not over $2,500,000

Over $2,500,000 but not over $3,000,000

Over $3,000,000

$1,800 plus 20% of the excess of such amount over $10,000

$3,800 plus 22% of the excess of such amount over $20,000

$8,200 plus 24% of the excess of such amount over $40,000

$13,000 plus 26% of the excess of such amount over $60,000

$18,200 plus 28% of the excess of such amount over $80,000

$23,800 plus 30% of the excess of such amount over $100,000

$38,800 plus 32% of the excess of such amount over $150,000

$70,800 plus 34% of the excess of such amount over $250,000

$155,800 plus 37% of the excess of such amount over $500,000

$248,300 plus 39 % of the excess of such amount over $750,000

$345,800 plus 41% of the excess of such amount over $1 ,OOO,OOO

$448,300 plus 43 % of the excess of such amount over $1,250,000

$555,800 plus 45 % of the excess of such amount over $1,500,000

$780,800 plus 49% of the excess of such amount over $2,000,000

$1,025,800 plus 53 % of the excess over $2,500,000

$1,290,800 plus 55% of the excess over $3,000,000

20
Taxable Estate

The definition of taxable estate is the value of the

gross estate less all permitted deductions. These

are six in number: funeral expenses, estate

administration expenses, debts, casualty and theft

losses, the charitable deduction, and the marital

deduction.

Fune ral Expenses.- -Th ese include the costs of

interment, the burial lot or vault, grave marker,

future care of the grave site, and transportation to

bring the body to the burial place. Funeral expenses

must be reduced by any reimbursement from the

Veterans Administration for funeral expenses and any

funeral expense benefit payable to other than the

decedent’s spouse by the Social Security

Administration. The Internal Revenue Service (IRS)

takes the position that, if a decedent’s estate is not

primarily liable for payment of the funeral expenses,

no deduction is allowed for Federal estate tax

purposes unless the decedent’s will directs that the

funeral expenses be paid out of the decedent’s estate.

Adm inistration Expenses.- -Th ese include costs

incurred for collection and preservation of estate

property, payment of estate debts, and distribution of

estate assets. The IRS considers only those

administration expenses “actually and necessarily”

incurred for such purposes to be deductible.

De&.--These are personal obligations of the

decedent that exist at the time of death, including

interest accrued to the date of death. They

encompass such obligations as mortgages, liens,

unpaid income taxes on income includable on a return

of a decedent for the period prior to his (her) death,

unpaid gift taxes, unpaid property taxes accrued prior

to death, and unpaid medical expenses as of the date

of death. Medical expenses incurred by the decedent

that are paid within 1 year of death may be deducted

either on the estate tax return or on the decedent’s

final income tax return. Interest expenses accruing

after death on debts incurred prior to death generally

are not allowed as a deduction. Several courts,

however, have not always followed the IRS position

on this and have allowed such interest to be deducted

if reasonable and necessary for administration of the

estate.

Casualty and Th e ft Losses. - -Th ese may be deducted

if they occur during estate settlement and prior to

distribution of the asset in question to the beneficiary.

The deduction is reduced to the extent that the loss is

offset by insurance or other compensation and to the

extent that it is reflected in alternate valuation if such

valuation is elected. A casualty or theft loss may be

deducted on either the estate tax return or the estate’s

income tax return--but not on both.

Ch aritable Deduction.--A deduction is allowed for

estate assets that are transferred by the decedent’s will

to specified public or charitable entities or uses.

These include: the Federal government, a State

government, and State political subdivision entities if

the transferred assets are used exclusively for public

purposes; corporations organized and operated (not

necessarily in the United States) exclusively for

religious, charitable, scientific, literary, or educational

purposes; and veterans organizations incorporated by

an act of Congress. There is no limitation on the

amount of the charitable deduction, but it cannot

exceed the net value of the property that passes to

charity as reflected in the gross estate.

M arital Deduction.- -Th e value of certain property

interests passing from the decedent to his (her)

surviving spouse is permitted to be deducted from the

decedent’s gross estate. Treasury Regulation

20:2056(e)-2(e) provides that in case of simultaneous

death, a presumption (whether by local law, will, or

otherwise) that one spouse or the other was the first to

die will be recognized.

Determination of Tax Due

The next step is to compute the tentative tax on the

sum of the taxable estate plus adjusted taxable gifts.

Adjusted taxable gifts are defined as the total amount

of taxable gifts made by the decedent after December

3 1, 1976, other than those gifts includable in the gross

estate. Life-time gifts that must be included in the

gross estate are discussed in chapter 8. The rate

schedule is then applied to this total, resulting in the

tentative tax.

Once the tentative tax is determined, it is reduced by

the gift taxes (those previously paid plus those not yet

paid) on gifts made after December 31, 1976. The

result is the gross estate tax. The tax payable on a

post-1976 lifetime gift is the amount owed on that gift

after the gift tax otherwise payable is reduced by the

unified credit. The estate tax reduction for gift taxes

paid on such gifts is based on the rate schedule in

effect on the date of death, not on the rate schedule in

effect at the time of the gift, if the two are different.

21
Credit Reductions

Once the gross estate tax is determined, it is

reduced by certain credits to determine the net tax

due. There are five such credits: the unified credit

discussed earlier, the State death tax credit, the credit

for Federal gift taxes on pre-1977 transfers, the

foreign death tax credit, and the credit for Federal

estate taxes on prior transfers.

Unified Credit.--The amount of the unified credit

available at the decedent’s death ($192,800 minus any

credit used for lifetime gifts) will be reduced if the

decedent made a taxable gift at any time after

September 8, 1976, and before January 1, 1977.

Prior to unification of estate and gift taxes in 1977,

a specific life-time gift exemption of $30,000 was

permitted. The unified credit must be reduced by 20

percent of the exemption allowed for a gift made

during this period. For example, if the decedent had

made a gift on October 15, 1976, and used his (her)

entire lifetime exemption of $30,000, the unified

credit would be reduced by $6,000 (20 percent of

$30,000).

State De ath Taxes.--A limited credit for State death

taxes is allowed (see appendix page 134). It is

determined by applying a rate schedule to the value

of the taxable estate reduced by $60,000.

GiftTax Cre dit.--Th is credit is determined by first

computing the tax on the cumulative total of lifetime

and death taxable transfers. The tax previously paid

(or payable) on the lifetime transfers is then

deducted.

Estate Tar Cre dit.--A credit is allowed for the

Federal estate tax paid on transfers to the decedent of

property from a transferor who died within 10 years

before or 2 years after the decedent’s death. The

credit is the smaller of: (1) the amount of the Federal

estate tax attributable to the transferred property in

the prior decedent’s estate or (2) the amount of the

Federal estate tax attributable to the transferred

property in the present decedent’s estate. If the

transferor dies within 2 years before or 2 years after

the decedent’s death, full credit is allowed. If the

transferor dies more than 2 years before the decedent,

the credit is reduced by 2 percent for each 2-year

period.

Foreign De ath Tax Cre dit.--A credit is allowed for

foreign death taxes paid with respect to property in the

decedent’s estate if the property is actually situated in

a foreign country. The credit is the lesser of the

foreign death tax or the Federal estate tax attributable

to the property.

Estate Tax Computation

Example 3.1. Assume that the decedent died in

1988 with a gross estate valued at $607,800. In 1979,

the decedent had made a lifetime gift of property

valued at $253,000 to his daughter. He had filed a

gift tax return and paid a net gift tax of $34,800

(tentative gift tax of $70,800 minus the unified credit

available at that time of $38,000). There were no

other lifetime gifts.

The decedent’s gross estate includes the gift taxes

paid but not the value of the gift. The taxable portion

of the gift, however, is added to the taxable estate to

determine the tentative tax, as discussed above,

because the gift is not included in the gross estate.

The net estate tax is computed as follows:

Gross estate

Minus debts and

administrative expenses

Taxable estate

$607,800

f107,800)

500,000

Add ad’usted taxable

gifts ($$53,000 minus

the $3,000 annual exclusion that prevailed in

1979)

Taxable amount

Tentative tax

Minus gift tax paid (or

payable)

Gross estate tax

Minus unified credit

Subtotal

Minus State death tax

credit

Net estate tax due

250,000

750,000

248,300

.

( 34,800)

213,500

(192,800)

20,700

f10,000~

$ 10,700

22
Chapter 4

Valuation of Assets for Estate and Gift Purposes

GENERAL CONSIDERATIONS

The unified estate and gift tax is an excise tax that

is generally levied on the fair market value (FMV)

of property that is gratuitously transferred. The

Treasury regulations define FMV as:

. . .the price at which property would change

hands between a willing buyer and a willing

seller, neither being under any compulsion to

buy or to sell and both having reasonable

knowledge of the relevant facts.

Valuation of estate and gift assets is thus a critical

component of estate planning. In arriving at the

taxable base on the date of transfer, FMV is determined on the basis of “highest and best use” rather

than on the use to which the property is actually

being put at the time of the transfer. Although the

two uses may be the same, often they are not. An

exception to the FMV rule permits certain property

to sometimes be valued on the basis of actual use if

such value is lower than fair market value. The

applicability of this rule to timber properties is

discussed in chapter 13.

Establishment of FMV for certain estate assets is

sometimes an elusive process. The estate planner

must, therefore, anticipate disagreements over valuations of some types of property. If the value of an

item on the estate tax return is challenged, the law

permits an executor to require the Internal Revenue

Service (IRS) to furnish, within 45 days of the

request, a statement indicating: (1) the basis for the

IRS’s conflicting valuation; (2) any computations

used by the IRS in arriving at value; and (3) a copy

of any expert appraisal made for the IRS.

Undervaluation

A “valuation understatement,” resulting in penalties, occurs if the value of any property listed on an

estate or gift tax return is two-thirds or less of the

amount determined to be the correct valuation. A

graduated penalty, as follows, applies:

(1) for claimed valuations between 66 2/3 and 50

percent of the correct value, 10 percent of the tax

liability understatement;

(2) for claimed valuations between 50 and 40 percent of the correct value, 20 percent of the tax

liability understatement; and

(3) for claimed valuations less than 40 percent of

the correct value, 30 percent of the tax liability

understatement.

The penalty does not apply if the understated tax

liability is less than $1,000. The IRS may waive all or

part of the penalty if it can be shown that there was a

reasonable basis for the valuation claimed and that it

was made in good faith.

Interaction between Stepped-up Basis

and Estate Tax

In some cases, undervaluation, even though it may

save estate taxes if unchallenged, could be detrimental

from an income tax standpoint, particularly for timber

properties. The timber (as does all other estate property) receives a stepped-up basis for income tax purposes equal to its valuation on the estate tax return. In

the event the timber is subsequently sold by either the

estate or the heirs, the higher the basis, the less

income tax due. The basis is deducted from the sale

proceeds to determine taxable gain. The taxpayer’s

combined income tax marginal rate (State plus

Federal) could, in some instances, be higher than the

marginal death tax rate (Federal estate tax plus State

death tax). Undervaluation on the Federal return in

such a case would result in a higher total tax bill

(death taxes plus income taxes) than would otherwise

be the case with no undervaluation.

State Death Tax Considerations

If the estate is not large enough to require filing a

Federal estate tax return, the same caution applies.

The State death tax marginal rate always will be less

than the Federal and State combined marginal income

tax rate. Undervaluation of timber on the State death

tax return in such a case will mean a higher income

tax bill than would otherwise be the case, when the

timber is subsequently sold.

23
SPECIAL CONSIDERATIONS

Closely Held Corporate Stock

Many nonindustrial timber ownerships are part of

closely held family corporations. The decedent’s

stock in such a business is usually an illiquid asset.

For estate and gift tax purposes, it can present difflcult valuation problems. Because there is no established market, what valuation criteria should be used?

Sales within the family are not reliable. And, as discussed earlier, a penalty may be imposed if the value

reported is two-thirds or less of real value.

Factors to Consider.--Although many factors

should be considered in valuing closely held corporate stock, a number are common to most situations.

(1)

(2)

(3)

(4)

(5)

(6)

(7)

(8)

These include:

the nature and history of the business--such as

the degree of risk, products produced, services provided, operating assets, and capital

structure;

the economic outlook and conditions for the

specific industry in question;

the book value of the stock and the financial

condition of the business;

earning capacity (usually considered the most

important factor);

dividend-paying capacity;

good will or other intangible value;

prior arm’s_length (on an objective and

impersonal basis) sale of stock; and

the market price of stock of similar

corporations.

Depending on the circumstances, some of these factors carry more weight than others. Generally, in a

family-owned timber corporation, the greatest weight

is accorded to the underlying timber assets. The

courts have allowed discounts of 10 to 50 percent

because of the difficulty of selling closely held stock,

especially for minority interests.

Partnership Capital Accounts

Many nonindustrial timber properties are also held

in family or nonfamily partnership form. A partner’s

capital account in the partnership is initially equal to

the value of money and property that he (she) contributed to the partnership. It subsequently also

reflects the partner’s share of profits minus any losses

or distributions. Under State law, unless the partnership agreement provides otherwise, the death of a

partner terminates the partnership and requires a distribution of the partnership assets in proportion to the

respective capital accounts. From an estate tax point

of view, it might be argued that, on dissolution, only

the net asset value of the decedent’s capital account

should be valued. But the IRS also considers the value

of the business as a going concern--the price a willing

buyer would pay and a willing seller accept for the

assets, goodwill, and demonstrated earning capacity.

This valuation would particularly be true if the partnership continues rather than is dissolved.

Life Insurance

The value of a life insurance policy owned by the

decedent, on the life of a person other than the

decedent, is generally the amount the company would

charge for a comparable policy on the date of the

decedent’s death. An insurance policy on the life of

the decedent that is includable in his (her) gross estate

has a value equal to the proceeds payable by the

policy. Chapter 11 discusses in more detail under

what circumstances life insurance proceeds are includable in an estate and when they are not.

Future Interests

The value of property transferred by gift, which

becomes effective at the donor’s death or at some

other future time, is determined by reference to

government valuation tables that provide the actuarial

value of the interest The same procedure applies to

a property interest transferred at death but which does

not become effective until a designated future date.

The tables apply to such things as annuities, life

estates, term interests, remainder interests, and

reversions--all of which will be discussed in more

detail later.

FOREST LAND AND TIMBER

Timberland values reflect the general state of

business in the economy that affects the demand and

supply of timber products. The demand for timber is

affected by many factors such as overall income

levels, employment, supply of mortgage funds, and

interest rates. The supply of timber in the market is

affected by such things as population changes, rate of

family formation, the building cycle, and the general

availability of land.

24
Methods of Valuation

There are three principal methods used to value

real estate including timberland. These are the market

transactions (comparison), income, and cost

approaches. One of these methods is usually selected

as the primary procedure, but a second or even a

third approach may be used as a check for accuracy

if the other methods are applicable and appropriate

data are available. In practice, all methods are

ultimately related to the market.

M ark et Transactions.--Fair market value based on

a comparison of the “subject property” to similar

properties (that is, comparable sales) is generally

regarded as the most reliable method of valuation.

Value is based on the price for which similar assets

were sold under comparable conditions at or near the

same time.

The price paid for property is an expression of the

property’s fair market value in terms of dollars at that

point in time. This expression of value must be verified with respect to the relationship of the parties, the

terms of sale, date of sale, and the effect of inflation.

For price to equal value, buyers and sellers must deal

on an objective and impersonal basis. Transactions

among family members or business associates are

always suspect. When terms other than cash are

involved (that is, mortgages, long-term contracts,

etc.), they must also reflect current market conditions

for the value-to-price relationship to hold. Favorable

terms of sale may reflect hidden benefits. For

example, a lower than market interest rate will cause

the price in question to understate the property’s true

value. Similarly, undisclosed terms that are unfavorable could also cause the price to mask the true

value.

The timing of a transaction is also an important

factor in estimating an asset’s value. Here the

important date is the actual “meeting of the minds” of

the buyer and seller rather than the date of recording

the deed or other paperwork for the record. The sale

value is then adjusted to reflect the interval that has

elapsed between the sale date and the present. The

adjustment, of course, is to the extent possible a

determination of fact and not necessarily easy information to obtain.

Finally, the effect of inflation on the purchasing

power of the dollar is a critically important factor

with respect to transactions that occur at different

times. Contracts that do not adjust for inflation may

distort estimates of value, if not properly accounted

for in the appraisal process. Transfers in which the

assets are encumbered by a mortgage or by contract

terms that prevent the price from reflecting true value

should be avoided for comparison purposes.

Income Approach .- -The income method of valuation

is based on the discounted net present value of future

income expected from the property plus the present

value of the property remaining at the end of the

income period. The future values are discounted to

the present using a chosen interest (discount) rate.

Reasonable estimates of future revenues and future

costs may be obtained for many business situations

based on past experience. Future values cannot be

known with certainty, but the discounting process

weighs the near term cash flows more heavily than

those that will occur in the more distant future. This

makes the choice of the discount rate very critical. It

should reflect the opportunity cost of the resources

committed to the project as opposed to an alternative

use. One problem is that prior experience does not

account for future technological change.

It is essential that the components in an income

approach calculation of net value be expressed in the

same terms with respect to inflation, taxes, and depreciation.

Cost Approach .- -Th e cost approach to valuation is

based on the estimated cost of replacing an asset with

an item of similar quality and utility. The cost and the

value of an asset, however, are not necessarily the

same. Cost equals value only if the asset is new or to

be purchased. Caution must be exercised in estimating

depreciation when adjusting for obsolescence.

Furthermore, cost equals value only when the property in question is being utilized in its “highest and

best” use. Many properties have been over-improved

or under-improved. For example, the excessive cost

for bridge standards higher than necessary for efficient

management will not be reflected in value. Finally,

cost must be economically warranted. Cost reflects

the commitment of material and labor resources,

which have an opportunity cost for other uses, but

whose value represents the right to the present value

of the future net income stream. Replacement cost is

limited by the market to the cost of an item of comparable quality to that being replaced. This is frequently different from reproduction cost due to

improvements in both materials and management

methods, whether for trees or other properties.

25
Valuation of Bare Land

In valuing forest land, the market transactions

approach is generally the most reliable. However, if

appropriate data are available, the income approach

may also be used as a check for accuracy. The cost

approach, is inappropriate for bare land because no

additional supply of land can be created. Obsolescence, a key component of the cost approach, is a

valid consideration only with respect to improvements

to property--such as bridges, fences, and buildings--

but not with respect to the land itself or to trees,

which are an appreciating asset. Similarly, an excessive cost for mechanical site preparation, versus

chemical use at a lower cost and to obtain the same

results, will not be reflected in land values.

M ark et Approach to Value.- -Th e most reliable

method of estimating land value compares the property to sales of similar properties in comparable

locations within the same time period. This is the

method preferred by the IRS. If the market is active

and there are a sufficient number of valid comparable

sales, the market approach will give a satisfactory

estimate of the land’s value.

The most important requirement with respect to the

market approach is access to current sources of land

sale data. Land sale information can be found in title

insurance company records, the local tax assessor’s

and county clerk’s records, appraisers’ and consulting

foresters’ tiles, and real estate brokers’ sales files.

Several sources may be used to obtain a sufficient

volume of transactions to evaluate the level of

economic activity, price trends, and shifts in timber

industry growth patterns.

The price and terms of a sale used for valuation

purposes should be verified with either the buyer or

seller or both. Sales of timberland have traditionally

been private, and the public may not receive a true

picture of the factual circumstances of the transaction.

The price paid may differ from a price paid in the

open market due to financing terms, relationship of

the parties, or other collateral factors. The time of

the comparable transfer should also be accurately

determined in order to make economic adjustments

for the time value of money, inflation, and other

price influences. If these cannot be determined with

confidence for a particular transaction, the transaction

should not be included in the sample for comparative

purposes.

With respect to timberland, there are many variables that should be taken into account in order for

sale transfers to be comparable. These include site

productivity, operability and accessibility of the

property, the proportion of the tract that is productive,

parcel size, location with regard to markets, and regulatory constraints. Because land is characterized by its

unitary quality, immobility, indestructibility, and nonhomogeneity, the timberland market tends to be highly

local in character. Even the assumption of indestructibility must sometimes be altered for the effects of

erosion, soil compaction, and chemical pollution that

may alter productivity and ultimately value. Most

comparable sales include both land and timber, and

many reflect alternative uses of the land.

Incom e Approach to Value.- - W ith this method, the

value of land is based on its income-producing

capacity (productivity) in its “highest and best use.”

This approach is used when market transactions are

limited or nonexistent for comparisons with the property of interest. The income from the land during an

investment cycle is what is left after all the costs of

production--labor, management, maintenance, and the

opportunity cost of capital-are deducted. If this

amount is capitalized (discounted to the present) at an

appropriate interest rate, the result is an estimate of

the present value of the property. Generally, an individual investor’s interest rate is his (her) highest

“alternative rate of return” if the funds were to be

invested elsewhere. Discounted revenue minus discounted costs for one investment period is known as

net present value. Net present value calculated for an

infinite investment horizon of timber rotations is

known as land expectation value. It is the maximum

bid price for land suitablie for growing timber with the

assumed cash flows.

Determining the “highest and best use” is a critical

assumption of the income approach to valuation of

bare land. Again, the unitary nature of land must be

considered. For example, a timber property with good

road frontage may have a higher value for the areas

near the road for strip real estate development than for

timber growing. The negative impact on the balance

of the property would have to be considered if forest

management operations were restricted in the higher

valued areas. All such negative impacts should be

netted against development revenues in determination

of the “highest and best use” for such properties.

Valuation of Merchantable Timber

Timberland in an estate is frequently valued as a

unit; that is, separate valuations are not determined for

26
land and timber. This is a mistake that should not be

made. Serious income tax consequences could result,

due to the lack of an identifiable timber basis, when

timber is subsequently sold.

M ark e t Transactions Approach .- -The market value

of merchantable timber is what the trees would sell

for under the utilization standards used in the

particular market area of the timber property. The

value will be influenced by many factors, such as

species, tree size, product class, quality, total volume

on the tract, and accessibility. Timber markets, like

land markets, are highly localized. Because logs are

bulky and transportation is expensive, the market area

for most products is constrained. The higher the per

unit value of a timber product, the greater the scope

of its market area. For stumpage used for fiber, that

is firewood, pulpwood, and chipped wood products,

the truck haul radius is usually 100 miles or less.

Poles, piling, and veneer quality logs, on the other

hand, may be transported much greater distances.

If timber must be cut to realize income, it is the

liquidation value today rather than the timber’s

potential value that counts. This is the value shown

by the liquidation curve in figure 2.3. Although

many comparable sales include the value of the land,

the timber value alone can be readily established by

a timber cruise.

Incom e Approach .- -The value of merchantable timber below rotation age in even-aged stands can be

estimated by the income method. This approach

presumes an optimum rotation cycle, or at least an

assumed management regime where the expected

value of the future harvest and the management costs

can be estimated. The expected timber revenue less

discounted costs and the discounted terminal value

(land expectation value as discussed above) incomes

are discounted to the present. This residual value is

the income value of the timber stand at the intermediate age (see fig. 2.3). Such values are illustrated

by the cost/income curve as shown in figure 2.3.

The vertical distance between the cost/income curve

and the liquidation curve also represents the foregone

income that will result if timber is cut either prior to

an optimum rotation or if the timber is held longer

than an optimum rotation. As has been previously

discussed, however, these curves are very flat on

either side of the optimum harvest (that is, there is

only a small loss of potential income within approximately 3 years on either side of the best harvest age).

This provides a “decision window” for scheduling

harvests. They may be timed for maximum revenue

by taking advantage of price fluctuations (see fig. 2.3),

smoothing income flows, or other specified landowner

goals.

Cost Approach .- -To use the cost approach to obtain

estimates of value, the same assumptions discussed

under the income approach will hold. In this case, the

procedure is used to compound the establishment cost

and the intermediate cost flows forward to the present

at an appropriate rate of interest.

The cost and the income approaches will provide

estimates of value that will differ, based on the interest

rate chosen, with one exception. That exception is the

special case where the interest rate is equal to the

internal rate of return (IRR) for the assumed management regime. In that situation, the cost/income

curve showing values compounded forward and the

cost/income curve showing values discounted backward from the harvest will be identical (see fig. 2.3).

This suggests a method for determining intermediate

values for standing timber that has been called the

hybrid approach. First, an IRR is computed from all

costs and revenues for the investment cycle. Second,

the IRR is used as the discount rate to calculate the

cost value and/or the income value for the timber

investment period. An example of the hybrid

approach is found on page 28 under valuation of premerchantable timber.

The income valuation approach is the more practical

method for merchantable timber simply because the

length of time for the projection period (harvest value

discounted to intermediate timber value) will normally

be shorter than the projected period for compounding

establishment costs forward. Thus, with other things

being equal, the shorter the period of uncertainty, the

less the variance will be in the expected results.

Valuation of Premerchantable Timber

Satisfactory market transactions for use in valuing

premerchantable timber rarely exist. Valuations often

must be based on either the income or cost approach.

The problems of choosing an appropriate interest rate

can be avoided by solving for the IRR for the assumed

level of management. The IRR is the compound interest rate that equalizes the present values (PV) of the

discounted revenues and the discounted costs, or

stated another way, the net present values (NPV) of

discounted costs and revenues are equal to zero. For

example, assume that net revenue of $2,075 per acre

is received in year 30. Per acre costs include $150 for

site preparation and planting in year 0 and annual

27
management expenses of $3.00 per acre. The IRR is

calculated by trial and error as follows:

Item Yeat Value PV Q 9.0% PV Q 8.5%

Site preparation 0 $-150.00 $-150.00 $-150.00

Management cost l-30 -3 .OO -30.82 -32.24

Harvest revenue 30 2,075.OO 156.40 179.53

Net present value $ -24.42 $ -2.71

PV @ 8.4% PV @ 8.45% PV @ 8.44%

Site preparation 0 $-150.00 $-150.00 $-150.00

Management cost l-30 -32.54 -32.39 -32.49

Harvest revenue 30 184.56 182.03 182.53

Net present value $ 2.02 $ -0.36 $ 0.0 4

Thus, the IRR that makes NPV equal to zero is

approximately 8.44 percent.

Income Approach.--When using the income

approach, only future costs and returns are considered. Past costs are not included because they are

“sunk” and have no bearing on future income. With

the IRR calculated to be 8.44 percent, the income

value for the stand in the example above can be calculated. To solve for the income value at age 9, for

example, the interest calculation is as follows:

Harvest revenue =

$2,075 x 0.18240 = $378.48

(present value of a single sum discounted at 8.44 % for

21 years)

Management cost =

$3.00 x 9.68723 = -29.06

(present value of a terminating annual annuity

at 8.44% for 21 years)

Income value = $349.42

Cost Approach.--Again, with the IRR known, the

cost approach to value works like the income

approach except that the establishment cost, including

intermediate costs and revenues, are compounded forward to the intermediate age of the premerchantable

timber. In the example, the age is 9 years and the

calculation is as follows:

Site preparation and planting =

$150.00 x 2.07351 = $311.03

(future value of a single sum at 8.44% for 9 years)

Management cost =

$3.00 x 12.71928 = 38.16

(future value of terminating annual annuity at 8.44 % for 9

Yew

Cost value = $349.19

Note that both the income and the cost approaches

give the same estimate of premerchantable value

except for rounding error ($0.43). Note also that the

opportunity cost of land is not included in the

calculation because it is common to both cases and,

therefore, can be excluded.

The hybrid approach has the distinct advantage of

eliminating one of the most critical assumptions in

financial analysis, namely, that of estimating a discount rate. The use of the IRR for compounding and

discounting the cash flows associated with both the

cost approach and the income approach will give the

identical answer (ignoring the rounding error). This,

of course, is not the case when a discount rate other

than the IRR is used.

Court Decisions--Gift Tax

Saunders v. U.S., 81-2 U.S. Tex Gzs. (CCH)

P13,419; 48 A.F.T.R. 2d (P-H) 6279 (1981).--Here

the court held that the value of gifted timberland subject to a long-term lease was the present value (using

a discount rate that reflected the illiquidity of the

property) of the anticipated annual income from the

property for the remainder of the lease plus the

residual value of the property at the end of the contract period. Nevertheless, the valuation was technically flawed because real cash flows (without inflation) and a current discount rate (with inflation) were

used in the discounting formula. This procedure is

inconsistent and resulted in undervaluation of the

assets.

J. A. Hipp et al. v. Commissioner of Internal

Revenue 47 CCH Tax Ct Memo 623 (1983).--The Tax

Court determined the fair market value of timberland

for gift tax purposes by relying on appraisal reports

and expert witness testimony and then adjusting the

sum to reflect changed market conditions at the time

of the gift of the same acreage 1 year later. Evidence

relating to comparable sales, measurement of soil quality, volume of timber (summation of assets), and

accessibility was found to be relevant and was considered by the court.

Court Decisions--Estate Tax

Estate of Sturgis v. Commissioner of Internal

Revenue i? C. Memo. 1987-41X--The Tax Court set

the value of 11,299 acres of timberland at an amount

between those offered by the estate and by the government. The court considered the testimony of four

28
experts, each of whom valued the property using the

same methodology. First, the volume of timber on

the property was determined with a separate value

given to each species. Then, the land was valued as

a separate component and added to the timber values.

After considering the testimony of the four experts,

the court also applied a 20-percent discount factor

because of the estate’s minority interests in the

timberland which comprised 91 separate tracts. (For

a comprehensive discussion of discounting, see pages

29-31.)

William M. Oettmeier, Jr., Personal

Representative of The Estate of Russell L. Carter,

Deceased, v. United States, U.S. D istrict Court for

th e Mid dle District of Georgia, No. CW 7- 49 -

VAL(WDO ), M arch 16, 19 89 .--A so-called “common

sense” method was used by the court to value a decedent’s interest in leased timberlands for Federal estate

tax purposes. Although the value of the reversionary

interest was undisputed, the experts for the estate and

for the IRS differed greatly on the value of the future

lease payments. The disagreement was based on two

items: the choice of an appropriate discount rate and

the appropriate discounting formula. The court

rejected the valuations offered by both the estate and

the IRS because it held that neither would have been

an acceptable price to both a willing buyer and a

willing seller. The court determined the value using

its own approach; that is, it basically split the

difference but curiously used two discounts rates to

arrive at its value.

DISCOUNTING FOR MINORITY

AND UNDIVIDED INTERESTS

General Considerations

There is no authority for discounting fractional

interests in either the Internal Revenue Code or the

regulations, except the statement in Regulation 9

20.2031-1(b) that “all relevant facts and elements of

value as of the applicable valuation date shall be

considered in every case. ” Nevertheless, an

undivided fee ownership in timberland, particularly if

it is a minority ownership, is typically discounted

below its fractional proportion of the value of the

tract as a whole. Minority interests in closely held

timber-owning corporations and partnerships are

similarly discounted. Other situations that may

contribute to discounting are lack of marketability of

the ownership interest, transfer restrictions, expenses

of partition suits, and combinations of these factors.

Expe rt Testimony.--Determination of the amount of

the discount is generally more art than science. In

disagreements with the IRS, heavy reliance is often

placed on expert witness testimony. Among the factors typically addressed by expert witnesses are the

following: (1) the difficulty of owners of fractional

interests securing purchasers except at substantial

discounts; (2) the limits of owners of fractional

interests in their control, management, and operation

of the property; (3) the inconvenience of dealing with

several owners; (4) the possibility of complications

caused by owners of very small fractions; and (5) the

danger of partition suits.

Corporate Stock

Among the most important considerations in valuing

the stock of a closely held company are the legal and

operating rights embodied in the stock ownership.

Among the most significant of these rights is the

ability of certain stockholders to control a company.

Conversely, the lack of control is commonly adjusted

for by applying a minority discount. The minority

interest discount is embodied in the concept that the

perceived risk is relatively less when a person has the

right to control a company’s course of action. As a

result of this element of control, a minority stock

interest in a closely held corporation, owned by a

decedent not related to the majority stockholders, will

normally be valued at substantially less per share than

stock that represents a controlling interest (Revenue

Ruling 59-60).

R e lative Size and Ow ne rsh ip Concentration.- -In

addition to control privileges, two equally important

factors are the relative size of the block of stock being

valued and the concentration of ownership. A 20-

percent minority interest in one instance may have

relatively little to say with respect to operations when

only one shareholder controls the other 80 percent.

However, the 20-percent shareholder could exist with

two others each holding 40 percent, with a shareholder’s agreement that at least 5 l-percent approval be

required for certain decisions. The first case would

warrant a higher discount.

Luck of M ark & ability.- -The minority discount concept is separate and distinct from a lack of marketability discount. In fact, a discount for lack of marketability may exist regardless of whether a controlling

or minority interest is being valued. The two types of

29
discounts can exist together or one without the other.

In a recently conducted study, the average discount

for a minority interest was found to be 30 percent

and that for lack of marketability, 42 percent. The

lack of marketability discount recognizes that, compared to the broad spectrum of potential purchasers

of publicly traded securities, the value of closely held

interests is reduced due to a relatively small market.

This concept can also apply to majority holdings.

The IRS “Valuation Guide for Income, Estate and

Gift Taxes” recognizes that the absence of a readily

available market for closely held stock interests may

justify a discount for lack of marketability. It states

that such a discount is suitable for holdings of less

than 50 percent of the voting power.

Intere sts Controlled by Mem bers of Sam e Fam ily. --

In the past, the ownership of the fractional interests

other than the interest in question have had a significant influence on whether a discount could be

allowed. The courts in many instances have chosen

not to discount the interest in question when all the

other interests were owned by members of the same

family--for example, see H orace K. Faw cett, 64 TC

889 (19 75). One major exception to this judicial

trend was the Fifth Circuit Court of Appeal’s

decision in Estate of Brigh t v. U.S., 658 F2d 999

(5th Cir. 1981). Here the decedent’s undivided

community property interest in shares of stock,

together with the corresponding undivided community

property interests of the decedent’s surviving spouse,

constituted a control block of 55 percent of the shares

of a corporation. The court held that, because the

community-held shares were subject to a right of partition, the decedent’s own interest was equivalent to

27.5 percent of the outstanding shares and, therefore,

should be valued as a minority interest, even though

the shares were to be held by the decedent’s surviving spouse as trustee of a testamentary trust.

Following the Brigh t decision, the IRS issued

Revenue Ruling 81-253, which held that, ordinarily,

no minority shareholder discount was to be allowed

with respect to transfers of shares of stock between

family members if, based on a composite of the

family members’ interests at the time of the transfer,

control (either majority voting control or de facto

control through family relationships) of the corporation exists in the family unit. The ruling also stated

that the IRS would not follow the Brigh t decision.

In early 1993, however, the IRS issued Revenue

Ruling 93-12, revoking Revenue Ruling 81-253, and

stated that it would subsequently follow the Brigh t

and several similar decisions in not assuming that all

voting power held by family members may be aggregated for purposes of determining whether the transferred shares should be valued as part of a controlling

interest. Stock shares transferred should henceforth be

valued without regard to the family relationship of the

donee to other shareholders.

Partnership Interests

The principles of Revenue Ruling 59-60 as discussed above (on page 29 pertaining to minority discounts for closely held corporate stock) are applicable

also to valuation of minority partnership interests (see

Revenue Ruling 68-609). This is illustrated in the

W atts decision [Estate of W atts, TC Memo 1985-595,

51 TCM 60 (1985)]. Here the Tax Court agreed with

the taxpayer that a partnership operating as an active

business should be valued as a going business and that

a partnership interest discount was appropriate. The

partnership was engaged in the management of timberland, manufacture of plywood, and sale of lumber.

By terms of the decedent’s will, the partnership was to

continue as a going business. The court considered

the liquidation value, asset by asset, to be inappropriate. It adopted the valuation method of the taxpayer’s appraisers and discounted the decedent’s

minority interest by 35 percent. The decision was

affirmed by the Fifth Circuit Court of Appeals [Estate

of W atts v. Com m issioner, 87-2 USTC 13,726 (1 lth

Circuit, 1987)].

In the H arw ood decision [82 TC 239, 267 (1980)],

the Tax Court allowed a 50-percent discount based on

liquidity and marketability factors for a minority

interest in a limited partnership engaged in the timber

business.

Fee Interests

In the Sels decision [Estate of Sels v. Com m issioner

(TC # 12,642(M ) (19 84)], the Tax Court compared the

in fee financial interests of the decedent to minority

corporate and partnership interests, citing Estate of

Gzm panari [(5 TC 488, (1945)] and Estate of Andrew s

[79 TC 938 (1982)]. Here the value of the decedent’s

undivided interests in 11 tracts of timberland was

determined by using the comparable sales method of

appraisal. The fractional interests ranged from 2.48 to

25.00 percent. The IRS valuation was revised to

reflect differences between the comparison lands and

the decedent’s properties with respect to the quality of

30
timber, accessibility, and timing of the sales. In of a minority interest could expect to encounter a

addition, the IRS valuation was further reduced by a significant delay in obtaining the value of the pur60-percent discount to reflect lack of marketability, chased interest and have little income in the meanlack of control, and the costs of potential partitioning. time. The testimony indicated that partition would be

The estate’s expert witness testified that the purchaser expensive and take at least 6 years.

31

Chapter 5

The Legal Process

BASIS OF THE LAW

Statutory Basis

The Internal Revenue Code, Title 26 of the United

States Code, is the primary statutory source of the

Federal estate and gift tax law. Known as the

Internal Revenue Code of 1986, because of the vast

changes made by the 1986 Tax Reform Act, the Code

is continually being amended by Congress. The tax

component of the estate and gift tax planning process

is in a constant state of flux. In every year since

1981, with the exception of 1985, Congress has

passed substantial changes. For example, the

Revenue Act of 1987 made significant changes in the

estate and financial planning area. The 1988

Technical and Miscellaneous Revenue Act, the 1989

Revenue Reconciliation Act, and the 1990 Revenue

Reconciliation Act, although billed as technical

corrections legislation, also included many new

substantive provisions.

Administrative Basis

Regulations. --Th e Internal Revenue Service (IRS)

is empowered to administer the Code. It does this by

issuing regulations that interpret the law according to

perceived Congressional intent. Other regulations are

statutory in nature, dealing with subject matter that

Congress failed to legislate in detail. The regulations

also serve as an enforcement mechanism. Regulations must be issued in proposed form subject to public comment before being published by the IRS in

final form. Both statutory and interpretive regulations have the force of law; they may be overturned

only by the courts.

Revenue Rulings.--Revenue rulings are interpretive

rulings published by the IRS to apply the tax law to

specific factual situations. Although they sometimes

have significant general application, the rulings

generally have less force than do regulations because

of their limitation to specific sets of facts. Therefore,

they provide valid precedent only if a second taxpayer’s facts are substantially identical to those

outlined in the ruling.

Private Letter Rulings.--Th ese comprise another

IRS interpretive tool to apply the tax law to specific

33

situations. Letter rulings are generally official replies

given by the IRS to taxpayer inquires concerning the

tax consequences of proposed transactions. They are

limited in application to the taxpayer who made the

request; they may not be used as precedent by other

taxpayers. Letter rulings are available to the public

under the Freedom of Information Act. Although not

comprising general precedent, they are nevertheless

often quite useful as an indication of the IRS position

on a certain point.

Tech nical A dvice Mem oran da--A technical advice

memorandum (TAM) is a special after-the-fact ruling

issued by the IRS upon request from either a taxpayer

or the IRS auditing agent during the course of an

audit. As with letter rulings, a TAM is limited in

application to the taxpayer who made the request; it,

too, may not be used as precedent by other taxpayers.

Also available under the Freedom of Information Act,

TAM’s are often utilized to help interpret IRS positions.

Judicial Basis

If a taxpayer disputes the IRS position in a particular matter and the disagreement is unable to be

settled administratively, the issue may be litigated by

the taxpayer filing suit. There are three courts of

original jurisdiction for estate and gift tax cases. The

Tax Court conducts hearings in most large cities, with

or without a formal trial. To file in the Tax Court, a

taxpayer must have received a notice of tax deficiency

from the IRS and refused to pay. A taxpayer can also

turn to the Federal District Court System or to the

Claims Court. The latter is a single court in

Washington, DC. In both cases, the disputed tax must

have first been paid. The taxpayer then files suit for

a refund. The District Court is the only one of the

three courts in which a taxpayer can request a jury

trial in a tax matter. Decisions of the Tax Court and

the District Courts may be appealed by either the taxpayer or the government to the Circuit Court of

Appeals in whose jurisdiction the taxpayer resides.

Appeals from the Claims Court are taken to the

Appeals Court for the Federal Circuit. All appellate

decisions may be taken to the Supreme Court. As a

practical matter, however, very few estate and gift tax

matters are accepted by the Supreme Court.
WILLS

A will is a legal document that directs the disposition of a decedent’s assets. It takes effect at the

death of the decedent through the probate process. A

will should not be confused with a letter of last

instructions or other nonlegal written statements

relating to the decedent’s last wishes. These are not

legal and binding documents as is a will.

Need for and Advantages of a Will

A person who dies without a will (that is, intestate)

leaves the distribution of his (her) property to be

governed entirely by State law. In some cases, State

law will do exactly what the decedent had in mind; in

other cases it will not. Under State law, all heirs of

the same class (children, siblings, etc.) are treated

equally if there is no will. There is generally no way

the court can alter the distribution of the estate assets.

The advantages of a will are many. With a will,

a person can dispose of his (her) property as he (she)

wishes within the limits of the law, can name the executor of the estate, and can save probate expenses by

waiving (not requiring) bonds and sometimes other

expenses. Guardians for minor children can also be

named in a will, and charitable bequests specified.

Will Preparation and Execution

The exact legal requirements for preparing and

executing a will vary by State and must be followed

for the will to be valid. Even handwritten wills must

meet certain legal specifications. Only dispositions

and other provisions in a will that are permitted by

law are valid; the portions that do not follow the law

are invalid. An attorney should always be consulted

when writing a will. An important point to remember is that, with respect to real property, the law of

the State in which the property is located will govern

its disposition--not the law of the State in which the

owner resides if the two are different. This is an

important consideration for those forest landowners

whose holdings are in a State or States other than

their State of residence. The cost of a will is

generally minimal--usually less than the cost of the

bond that must be posted if there is no will.

Joint, Mutual, and Reciprocal Wills

A joint will is a single will executed by two or

more individuals. A mutual will is one made

pursuant to an agreement between two or more

persons to dispose of their property in a special way.

The will in such a case may be joint, or there may be

separate wills. Reciprocal wills are those in which

each testator names the other as his (her) beneficiary,

either in a joint will or in separate wills. Even when

State law permits, it is generally undesirable for

persons to bind themselves with joint, mutual, or

reciprocal wills; they run the risk of being unable to

deal with changed circumstances upon the death of one

of the parties. If executed by spouses, such wills can

jeopardize the marital deduction (discussed in chapter

6). The safest procedure is for each spouse to execute

a separate will, with no provision that restricts the

survivor’s freedom of disposition.

Changing a Will

A will may be revoked, modified, or changed at any

time before death. All changes, however, must be

made in accordance with State law. Minor changes

can be made by preparing a codicil, a short attachment

to an existing will. In some States, a will may become

invalid if the person making it subsequently has a

child, including an adopted child. In such cases, a

new will would have to be written.

POWER OF ATTORNEY

A power of attorney is a legal document prepared

under State law by which the grantor transfers the

right to legally act for him (her) to another person. A

power of attorney can be limited to only certain acts

or may be a general power of attorney covering all

actions permitted by State law. Powers of attorney

may be revoked at any time by the persons granting

them by executing a written revocation in the format

provided by State law. They are usually automatically

revoked by death or incompetency of the grantor.

Therefore, revocable trusts (see page 60) are

sometimes used instead of powers of attorney. Under

a revocable trust, the trustee can act even if he (she)

is unable to ascertain whether the grantor is still alive

and even if the grantor becomes incompetent.

Durable Power of Attorney

Many States now permit durable powers of attorney,

which survive the incompetency of the grantor. For

34
example, New York law allows a principal to

expressly provide that his (her) subsequent disability

or incompetency shall not automatically revoke or

terminate the authority of an attorney-in-fact who acts

under a power of attorney.

PROBATE

Probate is the legal process designed to protect,

administer, and distribute a decedent’s estate. It

includes proving the validity of a will. Probate

courts exist for the purpose of protecting the rights of

the heirs and/or legatees, supervising the assembling

of the estate assets, and assuring proper and orderly

distribution of the assets, either by terms of the will

or in accordance with State statutes in the absence of

a will. Basically, the probate court performs the

same function in all States although its name may

vary from one State to another.

Probate Administration and Costs

The existence of a will does not necessarily avoid

probate. It is still necessary for the court in most

circumstances to supervise distribution of the estate

assets. Under some circumstances, depending on the

type of property ownership involved and State law, all

assets of an estate need not go through probate. In

many States, for example, property owned jointly

between husband and wife automatically passes to the

survivor upon the death of the other (see chapter 15

for a discussion of joint ownership).

Probate administration includes such matters as the

assembling of estate assets, payment of debts, clearing

title to estate property, payment of taxes, and distribution of the assets to the heirs/legatees. In most

cases, a final income tax return will have to be filed

for the decedent. During administration of the estate,

one or more fiduciary (estate) income tax returns may

also have to be filed. In most cases, the executor

named in the will or the administrator appointed by the

court if there is no will--together with the attorney for

the estate--actually handles these details, but always

under the court’s supervision.

Probate costs vary among States. They depend on

the attorney’s fee schedule, and on the size and complexity of the estate. In addition to the attorney’s fee,

there will be court costs, the administrator’s or executor’s fee unless waived, and the cost of the administrator’s or executor’s bond unless waived. Although

it is difficult to generalize, costs typically range

between 2 and 6 percent of estate value.

35

PAR T II

APPLICATION OF GENERAL ESTATE PLANNING TOOLS TO FORESTRY

37

Chapter 6

Use of the Marital Deduction in Estate Planning

OVERVIEW

The marital deduction is a deduction from the

adjusted gross estate for property passing to the

surviving spouse. It is considered by many to be the

most important estate tax saving device available to

a decedent’s estate. Since 1948, individuals have

been eligible for tax-saving opportunities related to

property passing to a surviving spouse that were

previously available only in community property

States. The law has been liberalized several times

since then. Finally, the 1981 Economic Recovery

Tax Act (ERTA) made deductions for both lifetime

and testamentary transfers to spouses “unlimited.”

Thus, the marital deduction now recognizes the role

of both spouses’ contributions to building the family’s

assets. Wills written before 1982 that contain a

marital deduction clause based on pre-ERTA law

should be reviewed and amended if the clause will

produce an unsatisfactory result based on current law.

Bequests to spouses who are not U.S. citizens do not

qualify for the estate tax marital deduction unless

they are in a qualified domestic trust. In order to be

considered a qualified domestic trust, the trust

instrument must provide that at least one of the

trustees be a U.S. citizen or domestic corporation and

that any distribution from the trust principal be

subject to the U.S. trustee’s right to withhold the

estate tax due on the distribution.

QUALIEYING FOR THE

MARITAL DEDUCTION

The decedent’s estate can claim a deduction--the

marital deduction--for qualifying lifetime and testamentary (by will at death) transfers of property to a

surviving spouse. The deduction for both lifetime

and testamentary transfers is unlimited. However,

the property must actually pass from the decedent to

his (her) spouse. The marital deduction is not

available to the estate of a widow, a widower, or an

unmarried person.

Transfer of Property Interests

To be eligible for the marital deduction the

decedent must have been a citizen or resident of the

United States at his (her) death. The decedent must be

survived by a spouse, and the property must be passed

from the decedent to the surviving spouse. Not only

must the value of the property interest be included in

the decedent’s gross estate, but it must also be of a

type that will be included in the surviving spouse’s

gross estate to the extent that it is not consumed or

given away during the surviving spouse’s lifetime.

Generally, no marital deduction is allowed for

property interests that are terminal interests. A

terminal interest is an interest in property that will

terminate or fail on the lapse of time or on the

occurrence, or failure to occur, of some event or

contingency. Examples include life estates and

annuities. Another example is property given to a

surviving spouse that would revert to the children if

the surviving spouse remarries. The purpose of this

rule is to require that, if property is transferred to the

surviving spouse, it will be included in the surviving

spouse’s estate unless disposed of during the surviving

spouse’s lifetime. Thus, whenever trust between

spouses is lacking and conditions are attached to gifts

or bequests, the use of the marital deduction is on

shaky ground. As explained later, there are, however,

certain exceptions to the terminal interest rule.

Examples of eligible property transfers to the

surviving spouse include: an outright bequest by will;

a power of appointment; life insurance proceeds; joint

tenancy survivorship; transfers by annuity, insurance,

or other contract; and transfers by State laws of

intestate distribution. In summary, any property left

with no strings attached is an absolute interest and

qualifies for the marital deduction.

Property interests passing to a surviving spouse that

are not included in the decedent’s gross estate do not

qualify for the marital deduction. Expenses, indebtedness, taxes, and losses chargeable against property

passing to the surviving spouse will reduce the marital

deduction.

EXCEPTIONS TO

TERMINAL INTEREST RULE

Basically, each spouse must trust the other

implicitly for the marital deduction to work effectively . However, there are five exceptions to the

39
terminal interest rule, which generally stipulate that

the property interests in question will qualify for the

marital deduction if certain requirements are met.

They will, however, also be taxable in the surviving

spouse’s estate if not consumed or given away before

his (her) death.

Qualified Terminal Interest Property

Property under a qualified terminal interest property (QTIP) election is eligible for the Federal estate

tax marital deduction. Under this election, the value

of the property is included in the surviving spouse’s

estate at his (her) death. A more detailed discussion

follows.

The General Power of Appointment

This is the right to determine the ultimate disposition of certain designated property. The survivor

must have a life interest that entitles him (her) to all

the income (payable at least annually) and must have

the power to appoint the property to himself (herself)

or his (her) estate.

Survivorship Condition

A bequest to a spouse may be conditioned on his

(her) survival for a period up to 6 months after the

death of the decedent; or on his (her) survival of a

common disaster, providing the spouse does, in fact,

survive.

Right to the Payment

The surviving spouse must have a right to the

payment of life insurance, endowment, or annuity

proceeds, coupled with a power of appointment for

the survivor or the survivor’s estate. Annuities

payable from a trust and commercial annuities

qualify.

An Income Interest

The survivor must have an income interest in a

charitable remainder unitrust or annuity trust (see

chapter 8) where he (she) is the only noncharitable

beneficiary. These conditions apply automatically;

however, the executor can elect for these provisions

not to apply.

QUALIFIED TERMINAL INTEREST

PROPERTY AND THE MARITAL DEDUCTION

A QTIP is a special form of life estate interest

given to a surviving spouse that qualifies for the

marital deduction. With a QTIP, the estate owner can

control the disposition of the remainder interest after

the surviving spouse’s death. The remainder interest

will, however, be included in the surviving spouse’s

estate. For example, timber property may be put into

a QTIP, with the value qualifying for the marital

deduction. The surviving spouse receives the income

from the timber property for life, with the remainder

interest passing to the children or other designated

beneficiaries at his (her) death.

The amount of the marital deduction resulting from

the QTIP election is the net value of the property

involved, after reduction of indebtedness charged

against it. The debt to be reduced from the property

value includes any estate taxes charged against the

property.

Qualification for the QTIP

The QTIP interest must be specifically elected by

the executor of the estate on the estate tax return.

Once made, it is irrevocable. To qualify, the

following conditions must be met: (1) the surviving

spouse must be entitled to all of the income from the

property payable at least annually for his (her) life, (2)

a QTIP interest in property not placed in trust must

provide the survivor with rights to income that are

sufficient to satisfy the rules applicable to marital

deduction trusts, and (3) there must be no power of

appointment in anyone to appoint any part of the

property to any person other than the spouse during

the spouse’s life. The fact that a marital deduction

formula (as discussed later in this chapter) is used to

determine the amount of property passing to a QTIP

does not jeopardize the QTIP election (Letter Ruling

8814002).

TO WHAT EXTENT SHOULD

THE MARITAL DEDUCTION BE USED?

Because the unlimited marital deduction is such a

powerful planning tool, it should be used carefully in

order to meet both the forest landowner’s objectives

and legal constraints on the transfer of property. The

survivor’s estate, his (her) general state of health, and

40
his (her) ability to manage the additional resources

efficiently are also factors to be considered.

Legal Rights

Legal rights of the surviving spouse to take a

share of the real property and, in some States, a

share of the personal property in the estate must be

taken into account in deciding how much and in what

form property should pass if it is to qualify for the

marital deduction. This, of course, is governed by

State law. These decisions are affected by the presence of children from the current and perhaps

former marriages of either spouse.

Nontax factors

Nontax factors that may affect the marital

deduction’s use include the couple’s personal

relationship, health and age (life expectancy), and

degree of confidence in the spouse’s business ability

because there is always a tradeoff between control

and tax savings. Spousal trust permits equalization of

the estate’s resources and freedom to use all the

planning tools that are available to save taxes. A

lack of trust, fear of a spouse’s remarriage, and

perhaps fear of divorce may force an owner to

maintain maximum control, which complicates the

planning process.

The surviving spouse’s resources and the

possibility of inheritances from other sources should

also be taken into account in projecting tax outcomes.

The needs of young children have to be included here

as well. The current value of both spouses’ estates

and the effects on each other’s estate tax return

should be considered.

Marital Deduction Deferral

If the goal is simply to save the maximum estate

tax at the death of the first to die, the marital

deduction should be used to the fullest extent. A will

that states, “I leave everything to my spouse,” results

in the deferral of all estate tax on the death of the

first to die. This may create a hugh tax problem for

the estate of the second to die, especially if that

person already has a substantial estate of his (her)

own. The marital deduction defers the tax until the

surviving spouse’s death; therefore, the aggregate

estate taxes of both spouses should be considered. If

the survivor’s health is good and normal life

expectancy is long, the deferral gives time for the

survivor to use the additional resources wisely through

additional planning or consumption. A number of tax

factors, as follows, should be considered.

M axim ize Credit.--Maximization of the unified

credit in each spouse’s estate is the key to use of the

marital deduction. The $192,800 credit permits each

spouse to transfer $600,000 in net taxable estate value

to persons other than the other spouse without estate

tax. Thus, together, they can pass $1,200,000 in net

taxable value to the children without estate tax cost.

Example 6.1. Assume a forest landowner husband owns 1,200 homogeneous acres of timberland

with a net value of $1,200,000 after payment of

estate debts and administrative costs. His wife is

without assets. (The analysis works the same with

husband and wife roles reversed.) If he wills her

the entire estate with a marital deduction bequest,

his estate will pay no tax. When the wife dies,

with income earned used to pay funeral expenses

and administrative costs, her estate will face a

Federal estate tax of $235,000 on the value of the

timberland. This equals a 20-percent reduction in

estate value. It may have to be paid by selling part

of the property or utilizing Section 6166 (see chapter 14) and paying the tax from timber sale income

over time. In addition, there is considerable risk

from concentrating the assets in one or the other

spouse’s estates because the spouse without assets

might die first, and the unified credit would be

wasted. This result would be similar to the situation where the survivor inherits all the assets.

Balancing th e Marital Deduction.- -Th e goal is to

balance the expected values in each estate with adjustments for life expectancy, earning power, and ability

to manage the assets.

Example 6.2. Assume the same facts as in example 6.1, but now the husband makes an outright

bequest of $600,000 in timberland value (600

acres) to the children, which is protected from

estate tax by the unified credit. He wills the

balance to his wife with a marital deduction

bequest, and his estate also pays no estate tax on

that portion (600 acres). When the wife dies, her

estate has a $600,000 exemption equivalent so that

no estate tax is owed and the children have saved

$235,000. The disadvantage here, however, is that

the wife did not have control of half of the timberland estate that she had helped the family accumulate and that she may need to maintain the lifestyle

to which she had grown accustomed.

Survivor’s ability.- -Th e survivor’s ability and

willingness to reduce the size of his (her) estate is a

41
key factor. The spouses’ goals with respect to the

welfare of the children must be compatible.

Example 6.3. Assume the same facts as before,

but now the $600,000 bequest to the children is

put into a nonmarital trust from which the wife

has the income for life. She has access to the

same level of income as before. If desired, a

clause can be included for invasion of trust

principal subject to an ascertainable standard of

living (see chapter 10 on “The Role of Trusts”).

The spouse’s ability and willingness to adjust the

size of his (her) estate must be considered. In example 6.1, the wife’s credit will be lost if she dies first,

because she owns no assets. This situation can be

remedied easily with a gift of $600,000, which balances the two estates, permits use of both credits, and

saves $235,000 in taxes after each transfer. This

remedy works if the credit is used by the first spouse

to die by putting the assets in a nonmarital trust, or

by giving it outright to the children. Spousal trust is

essential--as discussed above--for this procedure to

work.

To summarize the optimum marital deduction

strategy: (1) it must be used in conjunction with the

available unified credits, (2) it must be used with

regard to the survivor’s estate, and (3) consideration

must be given to the survivor’s ability, health, and

willingness to reduce the remaining estate to minimize estate tax liability. Generally, the marital

deduction is used to defer the tax at the first spouse’s

death so that additional planning can be done by the

surviving spouse.

HOW TO MAKE

A MARITAL DEDUCTION BEQUEST

Basic Patterns

A bequest that qualifies for the marital deduction

may be made as an outright gift, a direct transfer to

the surviving spouse, or by trust for his (her) benefit

(see chapter 10). In any case, the transfer will

usually fall into one of the following patterns.

Prope rty.--An outright bequest of specific property

may be made in these terms: “I give my wife the

600 acres of timberland that I own in Laidback

County, State (legal description).”

Example 6.4. Assuming the same facts as in

example 6.1, but specifing that the bequest

includes zone IV mature timber and zone III

maturing timber (see chapter 2, for a discussion of

timber zones), will provide liquidity for the surviving spouse’s immediate needs. Alternatively, if

the surviving spouse’s needs for liquidity can be

met from his (her) own resources, the bequest can

be of zone I premerchantable timber and zone II

young timber, both of which are rapidly appreciating assets.

Money.--This is known as a “pecuniary bequest,”

or a gift of money: “I give my husband $600,000.”

That statement alone does not necessarily make it so,

however. The resources have to be in the estate to

generate the cash.

Example 6.5. Assume the same acreage as in

example 6.4, but now the land and timber stands in

zones I through IV are assumed to be distributed as

follows: bare land equals $300,000, which is

equally distributed among the zones; zone I--

premerchantable timber only, $90,000; zone II--

young growth of 30 cords per acre, $210,000; zone

III--young sawtimber, $600,000; and zone IV--

mature sawtimber, $900,000; for a total of

$1,800,000 in timber and $2,100,000 total value.

This situation lets the total value increase reflect

the potential value for the property. The acreage

is equally divided into 250 acres per zone (which

are handled as management units). The timber

stands are as follows: the 8- to lo-year-old pine

plantations in zone I are valued at $360 per acre;

pine pulpwood in zone II is valued at $840 per acre

($28 per cord); the small sawtimber in zone III is

valued at $2,400 per acre and is predominately

chip-n-saw saw-logs; and the mature sawtimber in

zone IV is valued at $3,600 per acre because it is

primarily high quality sawtimber. The bequest can

include the acreage in zone IV, which will provide

sufficient timber that can be sold relatively soon to

generate the necessary cash.

Fractional sh are.- -Th e owner can give a straight

fractional share; that is, “I give one-half of my

residual estate, outright, to my wife.” The “net

estate, ” technically known as the residual estate, is

what remains after payment of debts, administrative

expenses, specific bequests, and other charges.

Example 6.6. Assume the same facts as in example 6.5. The timberland portion of the bequest

would thus amount to $1,050,000, if the expenses,

other bequests, and charges are paid from other

liquid resources. This creates an immediate tax bill

of $173,500, which could have been deferred.

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Formula Marital Deduction Bequests

Other things being equal, the preferable approach

would be to use a formula marital deduction bequest

that sets aside the largest amount that can pass free of

the Federal estate tax by way of the unified credit.

This circumvents the problems generated when the

bequest amounts have appreciated (depreciated in

some cases, but rarely for timber) into an unanticipated tax situation. There are three basic formula

clauses that are normally used.

Pecuniary. --Th e pecuniary marital deduction formula is easy to express and may offer greater opportunity for post mortem planning. The bequest can be

made outright or in a marital deduction trust (see

chapter 10). It directs that the amount to the marital

share for the surviving spouse be the sum that minimizes the Federal estate tax payable. The bequest

can be made outright or in trust. The residual share

corresponding to the exemption equivalent and

Federal credit for State death taxes can be disposed

of outright or in a nonmarital trust (see chapter 10).

Example 6.7. Assume the same facts as in example 6.4. The pecuniary marital deduction share

can include the timber from zones III and IV in

order to provide liquidity. The residual share can

include timber in zones I and II. This places

growth and value appreciation in that portion of

the first spouse’s estate that will not be taxed

again at the second spouse’s death. Amounts in

excess of $600,000 in the marital share can be

consumed or gifted to reduce the second spouse’s

estate value.

Unified Cre dit. - -The pecuniary unified credit formula (see chapter 10) is similar to the pecuniary

marital deduction formula. It directs that an amount

equal to the exemption equivalent, plus Federal credit

for State death taxes, if appropriate, be given outright

or in trust. The residual estate in this case will

constitute the marital deduction amount that can also

be outright or in trust. The results are similar to

example 6.7 with respect to appreciation and

liquidity.

Fractional Residuary M arital Deduction Form ula.

--This directs to the survivor the smallest fraction that

minimizes the Federal estate tax payable. Although

it is harder to calculate than the pecuniary formula--

shares can only be determined after a final accounting

by the executor--appreciation of estate assets is shared

by the spouse and other beneficiaries, and this may

be a desirable outcome in terms of family relationships even if it costs some additional tax.

The Choice of Marital Deduction Formula

The choice as to which marital deduction formula

to use depends on the gain (or loss) potential of estate

assets, the preferences as to whether spouse or children or both should benefit from the appreciation (or

depreciation) in the estate’s timber assets, estate taxes

that may be due at the spouse‘s death, and family relationships. The choice should be made only after an

analysis of the financial and tax considerations, with

emphasis on the personal preferences of the individuals

involved.

7Iimber Assets. - -The treatment should be dictated by

the landowner’s goals as expressed in the timber management plan. These include continuity of management, keeping the forest property intact as a management unit, financial targets, and nonmonetary considerations of the family. Integrating the timber management plan into the overall estate plan can be facilitated if the timber plan has an estimate of current

value by stand or management unit, a projection of net

cash flows over the immediate planning horizon (operational plans are usually for 5 years, but sometimes up

to 10 years), and a projection of the timber value at

the end of the planning period.

Timber assets are dynamic in that they are appreciating assets that respond to weather and markets.

Their current value depends on the distribution of timber stands as affected by volume of merchantable timber and product classes (see chapter 4). Timber assets

usually appreciate but present particular challenges due

to their unitary nature, the fact that only periodic

income is usually available, and illiquidity. The

appreciation, moreover, will vary with market fluctuations and the stage of the growth cycle that stands are

in at a particular time.

Life Insurance.--Life insurance proceeds may qualify for the marital deduction in numerous ways, but

a life insurance specialist should be consulted to insure

both marital deduction qualification and the best financial choice for the heirs. It is imperative that the

policies be carefully coordinated with the overall estate

plan with respect to policy ownership, beneficiaries,

and settlement options. Otherwise the financial advantages of insurance may be dissipated, and the needs of

the beneficiaries left unmet or only partially served

(see chapter 11).

Pe rsonal E& k ts. --Special attention should be given

to their treatment, including value, when using the

marital deduction formulas. Many family heirlooms

are difficult to value and difficult to divide. The

decedent and heirs often have particular attachments to

43
certain effects that should not be ignored but should

be handled separately.

D isclaim e r. --In making a marital deduction

bequest, it may be desirable to provide in the will

that the surviving spouse can refuse to accept any

part of the marital bequest. The opportunity for a

disclaimer provides a second look at the outcomes

(see chapter 7).

State Death Taxes.- -Th e applicable State death

taxes, if any, should be reviewed and included in

drafting the marital deduction formulas and in other

analyses. State death taxes often do not conform to

the Federal estate tax model, and they can upset plans

if not incorporated (see chapter 19).

44
Chapter 7

Disclaimers, Settlements, and Elections To Take Against the Will

GENERAL CONSIDERATIONS

Sometimes a decedent’s best laid plans do not

materialize. Assets may appreciate or depreciate in

value, an unexpected gift may be received, or a loss

may occur. Adjustments may not have kept pace

with fast-moving events. Sometimes the decedent

was merely careless or neglectful, and at death it’s

too late to change his (her) plan for disposing of

property. Nevertheless, the heirs or legatees can

often make certain changes in the plan of disposition

through disclaimers, settlements, and the election to

take against the will.

DISCLAIMERS

No one is forced to take what is due to him (her)

under another person’s will or by virtue of the laws

of inheritance in the absence of a will. The bequest

or legacy can be disclaimed. A disclaimer is defined

as the irrevocable and unqualified refusal by a beneficiary to accept property during probate under

authority of Section 2518 of the Internal Revenue

Code (IRC). Disclaimers can be effectively utilized

to realize certain post mortem estate planning benefits

that were not established prior to the decedent’s

death. If a qualified disclaimer is made by someone

who does not wish to accept an interest in property,

the interest disclaimed will be treated for Federal tax

purposes as if it had never been transferred to that

person. Additionally, the disclaimant will not be

treated as having made a gift, for either estate or gift

tax purposes, to the person to whom the interest

passes by reason of the disclaimer.

Disclaimer Requirements

Section 2518 of the IRC provides a single set of

definitive rules for disclaimers for purposes of the

estate, gift, and generation-skipping transfer taxes.

To be effective, a disclaimer must be qualified.

Four basic requirements must be met:

(1) The refusal must be in writing.

(2) The written refusal must be received by the

transferor, his (her) legal representative, the

estate representative, or the holder of legal

45

title to the property not later than 9 months

after the day on which the transfer is made, or

9 months after the beneficiary becomes 21

years old.

(3) The disclaiming party must not have accepted

the property, any interest in it, or any of its

benefits before making the disclaimer.

(4) The property disclaimed must pass to someone other than the person making the disclaimer without any direction on the part of

the disclaimant. However, a valid disclaimer

may be made by a surviving spouse even

though the interest passes to a trust in which

he (she) has an income interest.

D isclaim e r Provisions in th e W ill.- -In th e absence

of a contrary provision in the will, disclaimed assets

go to those persons who would have received them if

the disclaiming party had predeceased the estate

owner. However, if there is a possibility that a disclaimer might be a useful post mortem tool, it would

be advisable to make provision for disclaimers in the

will. These could include the requirement that a

written statement be delivered to the executor within

the requisite time limits, stipulations for disposition of

disclaimed bequests, and details as to what is required

to assure the effectiveness of a disclaimer for Federal

and State tax purposes (various States have further

requirements of their own in addition to the Federal

requirements listed above). The provision in the will

that disposes of a disclaimed bequest is extremely

important to the one who is going to disclaim. As

noted above, the disclaimant cannot disclaim in favor

of anyone of his (her) choice; all that can be done is

a refusal to accept the bequest and allow it to pass

under the alternate provision in the will.

Disclaimers by the Surviving Spouse

If the surviving spouse’s marital deduction bequest

provides more than he (she) may need or consume, the

additional amount will be includable in his (her) estate.

This could result in the beneficiaries of the surviving

spouse receiving somewhat less than they might otherwise receive. In such a situation, the surviving spouse

might wish to disclaim all or part of the bequest. If

the disclaimer will result in the disclaimed property

passing to those whom it is desired to benefit (that is,
the children), the property in question would never be

included in the surviving spouse’s taxable estate. It

would pass to the intended beneficiaries without gift

tax liability and without any added transfer expenses.

A point to consider is that a disclaimer of a marital

deduction bequest may serve to increase the estate tax

liability of the decedent’s estate unless it is made in

favor of a charity or the unified credit is available to

offset liability. But even if additional estate tax

results for the decedent’s estate, the disclaimer could

possibly reduce the estate tax and administration costs

of the disclaimant’s estate. These factors would all

have to be considered.

Disclaimer in Favor of a Surviving Spouse

If a surviving spouse is to receive a marital

deduction bequest considered to be less than adequate

for his (her) needs and there are bequests to others,

the other beneficiaries may wish to disclaim their

bequests in whole or in part. The effect of this

strategy would be to increase the marital deduction

and thus reduce estate taxes. Internal Revenue Code

Section 2056(a) permits an estate tax marital deduction for property disclaimed by a third person that

passes in favor of the surviving spouse. If the disclaimed assets are not necessary for the surviving

spouse’s needs, gifts in the amount of the disclaimed

bequests could later be made to the original beneficiaries in installments that would minimize or eliminate gift taxes.

CHARITABLE DISCLAIMERS

Internal Revenue Code Section 2055(a) allows a

deduction for a charitable transfer resulting from a

disclaimer. For example, if a decedent’s will provides that a charity would receive a disclaimed

bequest, a disclaimer may reduce estate taxes and, at

the same time, take the bequest out of the disclaimant’s estate. In this situation, however, there are

income tax considerations to be taken into account. If

the bequest is accepted and then given to charity, the

legatee-donor will get an income tax deduction. The

value of that deduction must be weighed against any

higher estate taxes resulting from acceptance of the

bequest.

WILL SETTLEMENTS

A will contest or settlement can result in a shift of

property interests from one beneficiary to another or

from a beneficiary named in the will to a person not

named. If the contest or settlement is bona fide and at

arm’s length, the courts have held that no gift results.

If a

scribed

will does not give a surviving spouse a preshare of the testator’s estate, many States

permit the surviving spouse “to take against the will.”

If the surviving spouse makes this election, he (she)

will get a larger share of the estate. At the same time,

the election may increase the marital deduction, thereby reducing the estate tax.

ELECTION AGAINST THE WILL

46
Chapter 8

Gifts of Forestry Assets

OVERVIEW

Estate planning frequently focuses on the transfer

of property at death; however, gifts also offer a

powerful tool to achieve planning objectives. With a

program of giving, the “ability to afford the gift”

should be the first consideration. Stated another way,

do not give away money or timberland that someday

might be needed. Many gifting objectives are personal and do not involve tax saving, but they are just

as, or perhaps more important than tax and financial

considerations. However, careful attention to the tax

rules permits the donor to stretch the benefits of his

(her) gifting program.

Some Reasons for Gifts

The foremost reason for a program of gifting is to

benefit family members. When most of the assets are

owned by one spouse, a substantial gift equalizing the

family assets is a statement of trust. Other beneficial

effects that follow as a result of gifting are discussed

in chapters 6 (“Use of the Marital Deduction in

Estate Planning”) and 10 (“Role of Trusts”). Gifts to

the adult children, especially of timberland, may help

promote a sense of financial maturity in the donees

and may provide the motivation for them to learn the

business of managing the tree farm. Thus, the donor

can see the responsibilities for managing a going concern transferred to the next generation with efficiency

and effectiveness. It follows that the donor will gain

a general feeling of satisfaction in seeing the timberland used and enjoyed. The process can assist the

donees’ personal growth and, properly done, influence their behavior in favorable directions.

Gifts from senior family members who are in

higher income tax brackets can improve the total

family income tax burden by moving incomeproducing property into the hands of family members

who are in lower tax brackets. Charitable gifts

provide an income tax benefit while at the same time

benefiting organizations that are personally important

to the donor--churches, colleges, museums, and

others. Gifting reduces (thins) the size of the donor’s

gross estate and, in so doing, reduces both Federal

and State death taxes. This also lowers estate settlement costs and avoids the delays and fees of the

probate process with respect to the property gifted.

47

In some cases, the transfers can put the property out

of reach of creditors.

Because of the power of gifting to reshape the

donor’s estate, a program of gifting should be pursued

cautiously because there are also disadvantages. Perhaps the most important is the loss of control. Thus,

important business entities and key parcels of timberland may not be the best candidates for a gift. Gifts

of income-producing assets reduce the donor’s income.

A gift also transfers the donor’s basis to the donee,

with possibly adverse income tax implications that

would not be the case with testamentary transfers.

Additionally, special use valuation (see chapter 13) is

not available for lifetime gifts. Most of these points

will be discussed more fully in the following sections

of this chapter.

GIFTING TAX CONSIDERATIONS

Any transfer of property or an interest in property,

without adequate and full consideration in money or in

kind, may involve a gift. The goal of gift and estate

tax minimization has been made more difficult by

recent changes in the tax laws. For example, Clifford

and spousal remainder trusts can no longer be used as

effective income-splitting devices. These short-term

trusts with reversionary interests of income or principal were formerly used to shift income from the

grantor to beneficiaries in lower tax brackets. Such

income is now taxed to the grantor, effectively nullifying the benefit of these types of trusts. The socalled “kiddie tax” affects gifts to children under age

14 because their unearned income over $1,100 per

year is taxed at the parent’s top rate. Children 14

years and older with unearned income of $550 or more

are taxed at their own rate. This provides a considerable incentive to increase an older child’s income

with income-producing gifts.

Incomplete Gifts

If a donor retains an interest in or power over the

property gifted, it results in the gift being incomplete.

A complete gift requires: a competent donor and

donee, a clear intent to make a gift, an irrevocable

transfer of legal title, the delivery of the gift to the

donee, and the donee’s acceptance.
Gifts with no strings attached are complete gifts.

Incomplete gifts are more likely to occur in transfers

to trusts than in outright transfers (see chapter 10 on

trusts). If provisions are included in a deed to the

effect that “If I outlive you, the property will become

mine again,” the gift is called “the possibility of a

reverter . ” The gift is considered complete, but the

restriction reduces its value. Along similar lines, a

parent who gives the family tree farm to the children,

but tells them, “I plan to live here and hunt and fish

until I die,” has made a gift of a remainder (future)

interest. Again, the gift is considered as being complete, but its value has been reduced, and it is not

eligible for the annual $10,000 exclusion.

Gifts of property are valued as of the date of the

gift. Any appreciation of the property while in the

donee’s hands is excluded from the donor’s estate.

In addition, gift taxes on property transferred more

than 3 years before the donor’s death are excluded

from the donor’s gross estate, probate administration

expenses will be avoided on the value of the gift

property and the gift taxes paid, income from the

gifted property will be excluded from the donor’s

estate, and State death taxes may be reduced in some

States.

Gifts of Land and i’k b er R igh ts.- -Th e Internal

Revenue Service (IRS) will treat the gift of underlying land with retention of the timber rights by the

donor as an incomplete gift. This means that the

value of the land will be included in the donor’s

estate. Revenue Ruling 78-26 held that the entire

value of forest land given to an individual by a donor

who reserved for 10 years all timber rights, which

constituted personal property under the law of the

State in which the timber was located, with the donor

dying during the lo-year period without having

removed any timber, was included in the decedent’s

gross estate. The U.S. Fourth Circuit Court of

Appeals has upheld the IRS position. The court held

that under South Carolina law, when the decedent

transferred her land to a corporation in exchange for

shares of its stock, reserving timber rights on a portion of the land for 2 years, she also reserved an

interest in the soil necessary to nourish the timber

growing on it. The court ruled that to the extent that

the transfer to the corporation was not for an adequate and full consideration, the timberland was

includable in her gross estate as a gift with a retained

life estate (Estate of Grah am v. United States, U.S

Court of Appeals, Fourth Circuit, No. 83-1068, Sept.

30, 1983).

Gift Tax Rates, Credits, and Exclusions

The unified gift and estate tax transfer schedule

applies to all gifts. As discussed in chapter 3, a single

rate schedule exists with respect to both lifetime gifts

and estates of decedents. The marginal tax rate begins

at 37 percent of the taxable amount in excess of

$600,000. The top rate following the passage of the

Revenue Reconciliation Act of 1993 is 55 percent on

gifts and estates in excess of $3 million (see table 3.1).

The amount of gift tax payable in any calendar year is

calculated by taking the cumulative lifetime taxable

transfers and applying the unified transfer tax

schedule. The tax on previous transfers is then

subtracted from this amount, as is whatever has not

previously been used of the $192,800 unified gift and

estate tax credit.

Internal Revenue Code (IRC) Section 2504(c) sets

a 3-year statute of limitations for revaluation of lifetime gifts for gift tax purposes. It does not, however,

bar the revaluation of lifetime gifts for estate tax purposes. Thus, a gift of timberland that does not have

a readily determinable market value should be supported by a qualified appraisal to establish its fair

market value (see chapter 4 for a detailed discussion of

timberland valuation).

Annual Exclusion. --The annual exclusion permits

the first $10,000 in gifts, based on fair market value,

to each donee (other than the donor’s spouse) during

each calendar year to be transferred tax free. The gift

must be of a present interest; that is, it cannot comprise property or a right that cannot be utilized until

some future date by the donee.

Example 8.1. Parents have four adult, married

children. One parent, in this case the father, owns

2,000 acres of timberland in fee simple, which has

an average value of $1,000 per acre. The father

(donor) can give each child (donee) $10,000 in

value each year. That is, he could give each child

either 10 acres or a fractional, undivided joint

interest in the timberland (see chapter 15) worth

$10,000 each, for a total of $40,000 per year for

the family. He could also give each child’s spouse

a similar 10 acres or $10,000 interest in the timberland each year. This could be transferred as 20

acres or $20,000 in joint family ownership to each

child and spouse for a total annual family transfer

of $80,000.

As long as the donor makes the gift outright, the

annual exclusion should not present a problem. However, with timberland, a qualified appraisal is necessary to verify the fair market value of the transfer.

48
In addition to the annual gift tax exclusion of

$10,000, there is an unlimited gift tax exclusion for

qualifying payments of tuition and medical care. The

deduction for tuition is limited to direct tuition costs,

and the payment must be paid directly to the institution. The deduction for medical costs is for those

unreimbursed by insurance as defined in IRC Section

213(d).

M arital Deduction . --The marital gift tax deduction

is unlimited. For gift transfers to a spouse to qualify,

the following requirements must be satisfied: the

man and woman must be married at the time the gift

is made, the donor spouse must be a U.S. citizen or

resident, the donee spouse must be a U.S. citizen,

and the gift cannot be a “nondeductible” terminal

interest except for QTIP’s (see chapter 6 for a

discussion of QTIP’s and terminal interests).

Although an effective planning tool in the right

situation, the question remains as to what extent

should the unlimited gift tax marital deduction be

used? A lifetime transfer saves estate administrative

expenses and probate costs for the donor spouse who

dies first and it may permit full utilization of the

unified credit if the other spouse were to die first.

The QTIP election (see chapter 6) can be utilized if

the donor feels that it is necessary to insure that the

children ultimately receive the property. These

decisions should be carefully analyzed with expert

counsel and with the family’s goals fully in mind.

Reportin g Procedu re s.--A Form 709 gift tax

return (see appendix) is required for transfers of

property greater than $10,000 in fair market value

and for split gifts (see below), regardless of value.

Returns are due on April 15 with the Federal income

tax returns for the tax year, or as extended.

O th er Consideration s. --Approximately one-fourth

of the States have a gift tax on the transfer of

property (see chapter 19). These provisions, if

applicable, should be considered.

Split Gifts

A married person who makes a gift to a child or

any other person can treat that transfer as though

one-half had been made by him (her) and one-half by

his (her) spouse, if the spouse agrees. The gift is

split for the purposes of computing the gift tax.

Thus, the gift is taxed at a lower rate than if the

transfer had been a single gift by one spouse. The

$10,000 annual exclusion and unified credit are

applied jointly, but the actual donor must file the gift

tax return.

Example 8.2. Assume the same facts as in example 8.1, but now the mother (assetless spouse)

agrees to make a split gift to the children. Each

child will now receive a split gift of either $20,000

in undivided value or 20 acres. This can be

increased to $40,000 or 40 acres by making split

gifts to the child and his (her) spouse. In that case,

the total transfer for four children and their spouses

would be $160,000. A practical way to make the

transfer would simply be to draft a deed for each

family member for 40 acres in joint ownership.

Split spousal gifts are allowed only if: (1) each

spouse is a citizen of the United States at the time the

gift is made, (2) the parties are married at the time,

and (3) both spouses agree to split all their gifts for

the calendar year.

BASIC GIFI-ING STRATEGIES

In this section, attention is focused on the question

of the economic impact of giving an asset; the effective use of the unified credit, annual exclusion, marital

deduction, and gift-splitting; and whether cash, or its

equivalent should be the gift property. Timberland is

emphasized, but other assets usually found in timbered

estates are included.

What Type of Property to Give

Choosing the right property for a gift is an important part of the gift plan. A gift may be of personal

property--art, cash, business interests, securities

(stock), personal effects, cars, and other tangible

assets. It could be real estate--rental property, timberland, timber and hunting leases, personal residences, easements, or other rights in real property.

Or, the gift could be of life insurance--cash value,

cash refunds, or other benefits associated with the

policy. Considerations in selecting gifts should, of

course, be meshed with the overall estate planning

goals.

There are some basic considerations to bear in

mind in choosing gift property.

Low Gift Value.--For lifetime gifts, it makes sense

to give property that has a low gift tax cost but a high

potential estate tax cost. Appreciating assets, such as

timberland in zones I and II, fit this category (see

figure 2.4 and the trust example in chapter 10). Timberland with high growth potential is a good candidate

for gifts because it is likely to become an estate tax

problem for the donor if held.

49
Appreciated Prope rty. --Timberland often fits into

the appreciated property category. Assume that a

donor is in the 32-percent marginal income tax

bracket--28 percent Federal and 4 percent State. If

he (she) sells a property for $10,000 net gain, the

income tax will be $3,200. However, if the donor

gives the property to a son or daughter (older than

14) who is in the 15-percent marginal income tax

bracket, the tax on the sale of the same property by

the donee would be only $1,500. This transfer

should also be compared with a gift of cash while

carrying the timberland through the estate for a

stepped-up basis.

H igh - yield Assets.--Senior family members in the

new 36.0- or 39.6-percent brackets may consider

transferring high income-producing assets to children

(over age 14) who are just getting started in their

careers and who are currently in a low marginal tax

bracket. Alternatively, a retired parent in the 15- or

28-percent bracket should consider gifts to children of

low income-producing assets with good growth potential, such as rapidly appreciating young timber

stands.

Keepe r Assets. --Timberland is often low-basis

property that will remain in the family. Many times

senior family members who worry about control of

their tree farm will consider taking the timber income

and parting with the land. If it will cause future

estate problems, the donor could harvest the mature

timber and transfer the cutover, bare land to the

children. This transfer can be coupled with gifts of

some of the liquid assets to cover the cost of reforestation. In such a case, it is important to make sure

that the donees have the resources to handle the management costs and carrying charges associated with

the property while it is unproductive.

Problem Prope rty.- -If timber property will cause

problems for the owner’s estate executor because it is

hard to divide, value, or sell, the owner could give

the property during his (her) lifetime. Sometimes the

family home, the lake property, or the shore cottage

will fit into this category. Art, antique guns and

clocks, and jewelry also fit into this mold.

Jointly H eld Prope rty.- -If timberland is held

jointly, it may be advantageous to retitle the property

to make it easier to handle for testamentary disposition. For example, if a parent and child hold timberland jointly, the parent may wish to gift his (her)

interest to the child. This avoids the problem of

having the property fully valued in the estate of the

first to die due to inadequate records for proof of

proportionate contributions.

Life Insurance.--In order to keep life insurance

proceeds out of the decedent’s estate, it may be beneficial to transfer ownership of the policy to a junior

family member or to a life insurance trust (see chapter

11). The gift tax cost is based on the value of the

policy, but it is likely to be lower than for other assets

with approximately the same expected value at the

decedent’s death because of insurance’s “tax-favored”

status.

Income Tax Basis

The donee’s basis in gifted property is the donor’s

basis plus any gift tax paid on the net appreciated

value of the gift while in the donor’s hands. For this

reason, highly appreciated property should often be

held in order to receive a stepped-up basis on the

death of the owner. This strategy, however, must be

balanced with the further appreciation potential of the

property.

Installment Sales and Gifting of Installment Notes

A strategy of selling property to a son, daughter, or

other related person with installment reporting of gain

and periodic forgiveness of all or part of the payments

as they come due should be used with considerable

caution. This runs the risk of having the sale

recharacterized as a gift. Because the payments under

the installment contract are treated as income to the

seller, a possible solution is to treat the payment as

income and make gifts of cash to the children who

then make the payments from an entirely separate

account (see chapter 12).

GIFI’S TO MINORS

Gifts within families are the most common type of

lifetime gifts, such as from parents to children and

from grandparents to grandchildren. Many are gifts to

minors that are made without much thought being

given to the legal or tax consequences. As long as

such gifts are small, there is generally no serious

problem.

As gifts increase in value, however, the so-called

“kiddie tax” has a major impact on minors under the

age of 14 (see page 47). On the other hand, State law

is often more concerned about protection of the

minors’ rights and the minors’ legal capacity to own,

manage, and sell property. Many States require

guardians for minors who own real property, place

50
restrictions on a minor’s power to make contracts,

and otherwise restrict a minor’s ability to conduct

business on his (her) own behalf. These constraints

complicate gifting to minor children, especially of

real property, such as timberland. Vehicles, such as

trusts, custodianships, and guardianships, are utilized

for protecting minors’ interests. These differ in a

number of important respects and their advantages

and disadvantages should be understood before

embarking on a substantial gifting program involving

minors.

Two pieces of legislation have been widely

adopted that make the process of gifting to minors

more uniform across State boundaries. The Uniform

Gift to Minors Act (UGMA) and more recently the

Uniform Transfer to Minors Act (UTMA) have made

it easier and legally safer to make gifts of all types of

property to minors.

When making gifts to minors, the legal, tax, and

practical management aspects of the transfer all need

to be considered, especially where timberland is concerned. The Revenue Reconciliation Act of 1993

increased the spread between the lowest and highest

noncorporate income tax bracket by more than 50

percent. This in turn has increased the motivation for

tax shifting. State income taxes also have to be considered.

Example 8.3. Assume that a parent who is in the

36-percent income tax bracket gives a child (over

age 14) an interest in timberland that is under a

long-term lease to a forest products company.

The interest transferred provides an income of

$10,000 per year. The lease payment is treated as

ordinary income for income tax purposes. If it is

assumed that the child has enough additional

unearned income from other sources to utilize his

(her) $550 standard deduction, the family has

saved $2,100 in income taxes [($lO,OOO x .36)

versus ($10,000 X .15)].

However, the issue of parental obligations for

legal support must be taken into account. A legal

obligation of support makes the child’s income

attributable to support taxable at the parent’s rate. In

addition, trust income actually applied to the support

of a beneficiary whom the grantor is legally obligated

to support is taxable to the grantor (IRC Section

677). The IRS treats custodial accounts similarly,

and many State laws treat a guardianship as a trust,

which would subject it to treatment under Section

677. State law should be carefully considered with

respect to the definition of support because expenses

for private schools, a college education and, in some

cases, a graduate education may be considered as

required for support.

Custodianship

Under the UGMA and UTMA laws for transferring

property to minors, custodians have the same power

over the property that an unmarried adult could exercise over his (her) own property. These laws permit

all types of property to be transferred, including

timberland. The custodian can enter into business

transactions that are required for managing the property. Such actions, however, are subject to the laws

governing fiduciary obligations.

State statutes should be checked for the specific

requirements concerning transfers, for the exact

responsibilities of the custodian and for the age of

majority. The custodial control of a minor’s property

is usually given over to the full control of the donee at

the age of majority, but the applicable State law should

be reviewed.

Estate Tax.--If the minor child dies before the custodial account is transferred to his (her) control, the

property is includable in his (her) estate. It may be

included in the donor’s estate if the donor is the custodian and dies before the child reaches the age of

majority. Therefore, it is not a good idea for the

donor to also serve as custodian and risk having the

assets included in his (her) estate, especially if the

value is large. Similar problems exist with regard to

the donor’s spouse serving as custodian. These problems suggests that a reliable aunt, uncle, or cousin

would be a safer choice.

Gijl Tax.--Gifts under the UGMA and UTMA qualify for the annual gift tax exclusion of $10,000

($20,000 for split gifts). However, the parent-donors

should not be custodians because there is a risk that

the transfer to the child-donee at majority could be

treated as a release of a general power of appointment

and, therefore, taxable to the parents.

Guardianships

A legal guardian takes custody of and manages a

minor’s property. He (she) has fiduciary responsibilities similar to those of a trustee; however, the

guardian does not hold legal title to the property. The

guardian can be the recipient of gifts to a minor.

Example 8.4. Assume the same facts as in example 8.3. The parent is appointed as the child’s

guardian and, in addition, is also legally obligated

for his (her) support. The $10,000 annual lease

income would continue to be taxed at the parent’s

51
36-percent marginal tax rate, even though it is

now the property of the child, if used for the

child’s support. The portion (if any) not used for

the child’s support, but rather for his (her) benefit, is taxable to the child. The guardian files the

income tax return for the child.

For estate purposes, the property that is given to

the child is removed from the donor’s estate, subject

to the provisions for gifts within 3 years of death that

are discussed below on pages 52 and 53.

A guardianship provides the greatest protection for

the child’s property rights. This includes bonding,

accounting, and court supervision. The price for this

extra measure of security for the child often means

added operating costs and constraints on the flexibility of operations, as compared to a custodial or

trust arrangement. Potential disadvantages include

terminations at majority, which may be earlier than

what is in the best interests of the child’s welfare,

and adverse estate tax consequences if the child dies

within the term of the guardianship.

Trusts for Minors

Trusts can provide a very flexible means of

making larger gifts. The general applicability of

trusts as an estate planning tool is addressed in

chapter 10. Certain specific issues related to gifts to

minors will be discussed here. The grantor has considerable freedom to design a trust instrument that

meets his (her) objectives. It can be established to

distribute income to a minor during its term, accumulate income for the minor, or both. The grantor can

establish the term of the trust, select the trustee (and

successor), specify when and how the principal will

be distributed, and fulfill other functions discussed in

chapter 10. If substantial gifts are involved, this is

probably the most effective method of handling a gift

transfer to minors, assuming that the size of the gift

warrants the expense of setting up and operating a

trust.

Two basic types of trusts are in most common use

as instruments for making gifts to minors. Trusts

written to conform to the provisions of IRC Section

2503(b) make the annual gift tax exclusion possible

because the transfer will be a gift of a present

interest. This type of trust requires the current

distribution of income to the minor but does not

require distribution of the principal when the minor

reaches majority. Trusts written in accordance with

IRC Section 2503(c) also insure the availability of the

annual gift tax exclusion on gift transfers for the

benefit of minors. Current distribution of income is

not required, but the distribution of the principal and

income is required when the minor reaches majority--

or sooner if specified in the trust instrument. The

annual exclusion will additionally be available if the

income “may” be used by the beneficiary before he

(she) reaches age 2 1, with the remaining principal paid

to him (her) at age 21. If the minor dies before

reaching age 21, it will be paid to his (her) estate

(GuU, CA-5 75-USTC 7 13,107, 521 F2d (1975),

aff’g DC Tex., 75-l USTC 1 13,067). With these

types of trusts, the income portion is considered as a

gift of a present interest and the principal portion as a

gift of a future interest. The income tax treatment for

the beneficiary is as discussed above.

A trust written under the provisions of IRC Section

2503(c) is a separate taxable entity. The income tax

treatment of trusts is discussed in chapter JO. The

trust property will generally not be included in the

donor’s estate.

Trusts have considerable flexibility as tools for

making gifts to minors, but they require careful attention to draftsmanship in order to qualify for the annual

gift tax exclusion and also to make practical sense for

management of property such as timberland. A qualified estate planner should be consulted.

GIFTS WITHIN 3 YEARS OF DEATH

The value of gifts made within 3 years of the

donor’s death is generally not includable in his (her)

gross estate. Such gifts are valued on the effective

date of transfer, and the appreciation in value after that

date is not subject to the estate transfer tax.

There are certain exceptions to this rule, however,

which apply whether a gift tax return is required or

not. The value of a life insurance policy transferred

by the decedent within 3 years of death will be

included in the gross estate. In addition, all gift

transfers within 3 years of death will be included in

the calculation of estate value for purposes of determining the estate’s qualification for special use valuation under IRC Section 2032A (see chapter 13),

deferral and extension of tax payments under IRC

Section 6166 (see chapter 14), and qualifications for

special stock redemption (IRC Section 303). Such gift

transfers made within 3 years of death are not effective

for meeting the statutory percentage requirements

under these statutes. In addition, gift taxes paid on

gifts within 3 years of death are includable in the

donor’s estate.

52
In spite of these few restrictions, there are still

good reasons for proceeding with a gifting program

within 3 years of death. As noted above, the appreciation after the gift’s transfer is not taxable to the

donor; therefore, properties with high appreciation

potential, such as young plantations in zones I and II

(see discussion of timber zones in chapter 2), are

good candidates for gifts. Similarly, subsequent

income generated from the gift is not includable in

the donor’s estate although the gift tax paid on the

transfer is included. For spouses the unlimited marital

deduction may be used without incurring a gift tax.

Gifts to donees in lower income tax brackets may

save on income taxes if not subject to the “kiddie

tax. ” In States with a gift tax, the State gift taxes

paid are deductible on the Federal estate tax return.

Certain negative factors must be considered in

making gifts within 3 years of death. One is the

gross-up provision, which takes all previous taxable

transfers into account when computing the transfer

tax. Also, as discussed earlier, the gift does not get

a stepped-up basis as does a testamentary transfer.

This is particularly disadvantageous for timberland

because timber is a long-term investment. The basis

for most timber assets held for long periods of time

is low.

CHARITABLE GIFTS

Overview

With the peace of mind that comes from knowing

that one’s spouse and children will be adequately provided for, a plan for charitable giving of additional

assets may bring great personal satisfaction. A donor

can benefit both his (her) family and the charity in a

variety of ways. The affordability of the gift depends

on its after-tax cost, which is affected by the donor’s

filing status, taxable income, and overall tax rate

(that is, the sum of Federal, State, and local marginal

rates, as adjusted).

FuZ jiZ Z s D ream s. --Charitable gifts can help fulfill

dreams of things that the donor would like to have

done to help others, given different circumstances.

For example, a scholarship could be provided for a

talented young person to help him (her) achieve

things not able to be done directly.

Sets Exam ple. --Giving sets a powerful example of

generosity and humanitarian concern for others--a

message of incentive and motivation to a generation

with sufficient wealth for survival. It also refutes the

mind set that implies, “I have mine and I don’t care

about you! ”

Uses Resources Eflciently. --Gifts permit efficient

uses of resources. For example, churches and scholarships provide large benefits for the community and for

society by combining voluntary labor and a rapid turnover of resources. The gift enables the charity to

leverage its resources.

Pe rm its Ch oice. --Gifts permit a choice of charitable

opportunities, such as churches, forestry research,

youth programs and community efforts. These may be

combined in a number of ways that meet the donor’s

objectives.

Satisfaction. --Gifts should be viewed as a source of

satisfaction rather than a cost. The donor should feel

good because he (she) has contributed to the betterment of one or more persons or organizations that

benefit the community.

Charitable Income Tax Deduction

Taxpayers can deduct amounts contributed to religious, charitable, educational, scientific, and other

organizations for income tax purposes. The tax effects

depend on w h en assets are given, h ow th ey are given,

h ow m uch is given, and to w h om they are given. For

substantial gifts, the donor should understand the different categories of charitable giving and their effects

on deductions. These categories include: (1) public

charities--such as churches, universities, hospitals, and

foundations that have received considerable public support; (2) semipublic charities--such as veterans organizations, nonprofit cemetery associations, and others

that do not fit into the public charity category; (3)

private charities--such as private, nonoperating, or distributing foundations; (4) contributions for the use of

a charity (rather than “to” a charity); and (5) capital

gain property--that is, highly appreciated property.

Churches and subdivisions of government are automatically viewed as charitable, but private charitable

organizations must meet the requirements of Section

501(c)(3) of the IRC and have an exemption letter

from the IRS to prove their status in order to assure a

tax deductible contribution.

The percentage limitations on charitable contribution deductions are based on the charitable category of

the organization and the nature of the gift. The

charitable contribution deduction for the tax year is

limited to a percentage of the donor’s “contribution

base.” The donor’s contribution base is defined as his

(her) adjusted gross income without regard to any net

operating loss carryback.

A 50-percent limitation on charitable contribution

deductions applies jointly to so-called “50-percent”

53
charities, which include a number of organizational

categories, both public and private. It is applied to

public charities first, then to private charities, and

any contributions in excess are carried over for 5

succeeding taxable years. There is a 30-percent limitation on deduction of contributions to private charities classified as so-called “30-percent” charities, as

well as contributions “for the use of” charities.

Examples of the former include fraternal orders and

veterans organizations. Deductions for contributions

of capital gain property to semipublic and private

charities is limited to 20 percent of the donor’s contribution base. There is also a special 30-percent

limit on certain capital gain property given to a public charity, and there are further limitations based on

the ratios among these various categories.

Valuation of the Contributions.--A deduction for

donated property is measured by its fair market

value, subject to certain reductions for appreciated

property as discussed below. No problems exist for

securities that are publicly traded. However, for

large gifts of real estate or timber property a qualified

appraisal must be obtained and a summary must be

attached to the tax return (Section B, Form 8283) if

the value of the property exceeds $5,000 ($10,000

for nonpublicly traded property). The appraisal must

be made within 60 days prior to the date of the gifts.

The appraiser must be qualified to make appraisals of

the type of property being gifted. For example, timberland should be appraised by a person who meets

the federal appraisal standards. The appraiser must

sign the appraisal form, must not be related to the

donor, and must not work on a percentage basis.

There are penalties for overvaluation of property.

If an audit determines the reported value to be 200

percent more than the correct value, a 20-percent

penalty can be imposed. Additional penalties can be

levied for more blatant overvaluation.

Appreciated Proper& --The charitable deduction

depends on the property’s fair market value, the type

of property (real or personal), the holding period, the

character of the charity, and the use of the property.

Capital gains property and ordinary income property

retain their different characters for charitable purposes.

Capital gain property held by the donor for more

than 1 year is given favorable tax treatment. That is,

the donor gets a deduction of fair market value and

does not have to pay tax on the appreciation, subject

to the alternative minimum tax. For real estate,

including timberland, the donor is entitled to a

deduction based on the property’s fair market value

on the date of the contribution. The deduction is

generally limited to 30 percent of the donor’s contribution base, as noted above, if made to a public

charity, such as a church or university. If the contribution is to a semipublic charity the limitation drops

to 20 percent. Contributions of capital gain property

to certain private foundations that do not make distributions may be limited to the property’s basis.

However, there is also a special rule on contributions of appreciated property that permit the donor to

deduct up to 50 percent of his (her) contribution base

if an election is made to reduce the value of the contribution by the amount of the appreciation. The election decision should be based on the amount of the

appreciation (timberland often has a very low or zero

basis and may not be a good choice), the importance

of a deduction greater than the 30-percent limit, and

the donor’s exposure to the alternative minimum tax

(AMT) provision of the Federal income tax. The

appreciation is a preference item that is included in the

base of AMT taxable income.

Charitable Estate Tax Deduction

Lifetime charitable contributions generate not only

an income tax deduction but also an estate tax deduction. In addition to the income tax deduction discussed above, the estate tax deduction depends on the

marginal tax rate. At the estate’s taxable threshold

(that is, just over $600,000 in taxable estate value) the

saving would be 37 percent of the value of the charitable contribution. When the value of the taxable

estate exceeds $3 million, the donor saves 55 percent

of the value of the contribution. If the transfer is a

testamentary bequest or includable in the donor’s

estate by virtue of a retained interest, only the estate

tax deduction will be available.

Gifts with Retained Interests--

Charitable Remainders

A timberland owner may be thinking of giving a

particular property to a charity, but he (she) may feel

that the income from the property is needed for the

present time. The transfer could take effect at death,

but there may be a spouse or other family member

who would need the benefit of the income value after

the donor is gone. For example, there are many

parents who own woodlands in rural, often remote

areas of the country with children who are professionals and live in distant cities, and who often have

little interest in the tree farm. However, the children

54
may feel that they need the income for educating

their children or for some other reason.

Such a landowner can make a present gift to a

charity of a future interest. This is known as a

charitable remainder. If the gift is money or liquid

assets, the transfer should be in trust. For real

property, however, the remainder interest can be

created without using a trust. The remainder can be

constructed to take effect at the end of a set term of

years, at the donor’s death, on the death of the surviving spouse, or perhaps on the death of other persons as well. The donor of the gift gets a current

income tax deduction based on the present value of

the remainder interest. There are, of course, some

strict limitations.

The value of the remainder interest is deductible

for Federal gift tax and income tax purposes, if given

to a qualified charity. The amount of the gift is the

fair market value of the property less the value of the

retained “life interest,” determined from actuarial

tables.

Ch aritable Rem aind e r Trusts.- -Th e donor can get

an income, estate, or gift tax deduction for a charitable contribution to a charitable remainder trust that

has one or more noncharitable beneficiaries only if

the trust qualifies as an annuity trust or a unitrust

under the IRC. The annuity trust provides a “fixed

annuity payment” to the income beneficiaries. A unitrust provides a “variable annuity payment” based on

a percentage of the trust’s earnings. Both trusts can

be established during a donor’s lifetime or by the

donor’s will. The donor is required to set aside certain assets with payments--either fixed or variable--

made for either a fixed term (not to exceed 20 years)

or for the life of the donor-grantor, his (her) spouse,

or other named persons with the remainder to go to

a qualified charity. Distributions to the beneficiaries

must be made at least annually, and the principal

must not be used for the beneficiaries’ benefit except

in accordance with specific payout requirements in

the trust.

Both the annuity trust and the unitrust require a

payment rate of at least 5 percent. The payment

under an annuity trust is calculated on the basis of the

initial fair market value of the trust assets, updated

annually. With a unitrust, the beneficiaries have a

variable annuity. For example, if the assets are

timberland, the payments may fluctuate with the

cyclical nature of the market. With a unitrust, the

instrument may, but is not required, to have a provision permitting use of the principal if the annual

income is insufficient. Furthermore, additional

contributions can be made to a unitrust during the

grantor’s life or by terms of the grantor’s will under

specified terms and conditions [Treasury Regulation Q

1.664-3(b)] and (Revenue Ruling 74- 149). On the

other hand, with an annuity trust, once the payment

schedule is established, the annual payments are made

from principal, if current earnings are insufficient and

no additions to the trust are accepted. In fact, if the

payment rate is set too high for an annuity trust, the

remainderman-the charity--may get a smaller gift than

expected or none at all. This situation has been noted

as an opportunity that invites abuse and thus merits

Congressional attention.

The unitrust may be created with an income-only or

makeup option. Under this arrangement, the trustee

pays the beneficiary only the current income, but as

earnings increase in future years the deficit in previous

payment amounts is made up DRC Section 664(d)(3)].

Tax Conse quences. - -Th e remainder interest under

an annuity trust for tax purposes is the net fair market

value of the trust property less the present value of the

annuity. If two or more beneficiaries are involved,

the computations are based on the life expectancies of

each individual. The present values are computed

using the IRS tables in IRC Section 7520 and are

based on a floating interest rate--120 percent of the

midterm applicable Federal rate. Examples of the procedure can be found in IRS publication 1458.

The annuity trust and the unitrust are exempt from

Federal income taxes except for unrelated business taxable income. The distributions to trust beneficiaries

are taxed as ordinary income first, and then as capital

gains to the extent of the trust’s undistributed capital

gains.

For estate tax purposes, the trust property’s value

will be includable in the grantor’s estate if he (she) is

the sole beneficiary.

Pooled Incom e Fund.--This is an IRS-designed

vehicle for charitable contributions that meets a

donor’s needs and provides him (her) with a tax

deduction. It operates within safe guidelines for valuation of the contributions and for the protection of the

government and the charity. Whereas the annuity trust

and unitrust are private endeavors, pooled income

funds pull together several contributors to benefit both

the charity and the individual contributors. In a word,

a pooled income fund is a public trust that is controlled by the charity. Most of the provisions are

similar to the annuity trust and the unitrust; however,

with pooled income funds, the property of all donors

are commingled. The pooled income trust cannot

receive or invest in tax-exempt securities. The income

55
tax deduction is based on the present value of the

remainder interest to the charity.

A Ch aritable Lead Trust.--This is the reverse of

the charitable remainder annuity trust. Property is

left to create income for the charity, with the

remainder interests passing to the family. It reduces

death tax liability; however, there is a gift tax on the

present value of the remainder interest when the trust

is created.

Ch aritable Rem aind e r in a Pe rsonal Resid ence or

Farm.--Generally, a donor can obtain a charitable

contribution deduction for a gift of a future interest in

property only through a charitable remainder trust or

a pooled income fund. However, the IRC makes an

exception for the gift of a personal residence or farm

[IRC Section 170(f)(3)(B)]. Under these circumstances, a donor can contribute the property to

charity but reserve the right to live on it or use it for

the rest of his (her) life and for that of the surviving

spouse, if applicable. The gift must be irrevocable.

The personal residence can be a second home or

cooperative apartment. A “farm” means land and

improvements used by the donor or tenant to produce

crops, fruits, or other agricultural products or

livestock or poultry [Regulation 8 l.l70A-7(f)(4)].

The regulation does not explicitly include or exclude

a tree farm. But if a taxpayer is considering using

this provision of the IRC for a tree farm, it would be

prudent to obtain a letter ruling (see page 33) from

the IRS. If this fails, other alternatives should be

considered. For example, this type of asset can be

transferred by deed during life or by will at death,

with the surviving spouse having income and right of

possession for life, and the property then passing to

the charitable organization at his (her) death.

Qualified Conservation Contribution

A charitable contribution of any interest in property that is less than the donor’s entire interest does

not qualify for a deduction unless it is an undivided

part of the donor’s entire interest, or a gift of a

partial interest in property that would have been

deducted if it had been in trust.

A charitable contribution of an open space easement in gross and in perpetuity is treated as a contribution of an undivided portion of the entire interest

of the donor in the property [Regulation 8 l.l70A7(b)(l)(ii)]. An easement in gross is defined as a

personal interest in, or right to use, the land of

another. A deduction is allowed for the value of a

restrictive easement gratuitously conveyed to the

United States in perpetuity. Special rules apply to

easements and remainder interests granted for conservation purposes.

Gifts of partial interests in real estate generally do

not qualify for a charitable contribution deduction;

however, a qualified conservation contribution is an

exception [IRC Section 170(f)(3)(B)(iii)]. A qualified

conservation contribution is defined as a qualified real

property interest donated to a qualified conservation

organization exclusively for conservation purposes

[IRC Section 170(h)]. A qualified real property interest is defined as the entire interest of the donor other

than a qualified mineral interest, a remainder interest,

or a restriction granted in perpetuity on the use that

may be made of real property. The term “conservation purpose” is defined to include any one (or more)

of four objectives: (1) the preservation of land areas

for outdoor recreation by the general public or for the

education of the general public; (2) the protection of

a relatively natural habitat of fish, wildlife, or plants,

or similar ecosystem; (3) the preservation of open

space, including farmland and forest land, where such

preservation (a) is for the scenic enjoyment of the general public and will yield a significant public benefit or

(b) is pursuant to a clearly delineated Federal, State or

local conservation policy and will yield a significant

public benefit, and (4) the preservation of a historically important land area or certified historic structure.

The conservation purpose must be protected in perpetuity. Qualified organizations are limited to government and publicly supported charities or organizations

that they control. The value of the conservation easement is based on the sales of similar easements to the

government if such records exist. If such records do

not exist, the conservation easement is based on the

difference between the fair market value of the property before and after the easement [Regulation 8

l.l70A-14(h)(3)]. After the conservation easement is

made, the donor must reduce the basis of the retained

property by the proportional part of the basis allowable

to the easement.

Example 8.5. Talloak owns a 200-acre parcel of

timberland in the path of a suburban leap frog

development. The property has been in the family

since the original land grant from the King, and it

is the owner’s objective to keep the property in the

family and in timber production. The market value

of the property for timberland is $300,000,

including the current growing stock which has been

well managed for timber and wildlife. The fair

market value in the “highest and best use” in 1993

had risen to $900,000. Talloak gave the USDA

56
Forest Service a permanent conservation easement

subject to the restrictions that the property would

be managed on a sustained-yield basis, that no

more than 20 percent of the forest could be harvested in a S-year period, and that it would be

promptly regenerated within 2 years. The

$400,000 charitable deduction is limited by the

income tax contribution rules discussed above.

The income tax deduction is limited to 30 percent

of adjusted gross income because it is appreciated

property given to a public charity. Since

Talloak’s adjusted gross income is $200,000, the

current income tax deduction is $60,000

($200,000 X 30 percent). With a 5year carryover for excess contributions, Talloak’s adjusted

gross income is expected to increase sufficiently to

fully absorb the deduction over this period. The

estate’s value is also reduced by $400,000 due to

the restriction. The appraisal was made by a qualified consulting forestry company that specializes

in forest appraisals.

Examples of Charitable Giving

The following are recent actual case examples,

with the persons’ names changed.’

Example 8.6. Case l--A Gift of Timber.

Mr. Plen T. Trees, a bachelor in his mid-50’s,

was interested in a plan that would save taxes and

pay him income for life.

He owned a stand of timber, deeded to him by

his parents 20 years earlier, and now worth

$300,000 to $350,000. He owned only the timber, not the land.

Working with his CPA and Linfield’s development office, he established a charitable remainder

trust with the timber. This made it possible for

him: (1) to avoid the capital gain on the sale of

the timber,(2) to obtain a charitable income tax

deduction in the year of the gift, (3) receive an

income for life, and (4) to save on estate taxes by

reducing his taxable estate.

A unitrust was chosen because Mr. Trees

wanted a vehicle that would keep up with inflation. A unitrust pays a fluctuating income based

on the value of the assets in trust, revalued

annually. As the trust assets increase/decrease in

value, Mr. Trees receives a higher/lower income.

‘Prepared by Ms. Elizabeth Holden, Director of

Planned Giving, Linfield College, McMinnville, OR, and

used with permission.

The specific unitrust is an “income only with makeup

provisions” instrument. In periods when the trust

assets do not earn enough to pay the agreed upon

percentage, Mr. Trees receives the actual income

earned. The balance will be “made up” and paid to

him later in years when the trust earns more than the

agreed upon percentage

The results are that the trust sold the timber for

$330,000, neither Mr. Trees nor the trust had to

recognize a capital gain on the sale, he was allowed a

charitable income tax deduction in the year of the gift

of $34,000, and he began receiving an annual income

equal to 12 percent (when the trust was established in

1988 interest rates were higher than currently) of the

value of the trust, which will continue throughout his

lifetime. At Mr. Tree’s death, Linfield College will

receive the trust principal that remains as a charitable

gift and will set up an endowed scholarship fund in his

name.

Example 8.7. Case 2--A Gift of Land and Timber.

Mr. Well D. Zerved, a recently retired businessman who had developed a very successful company, wanted to make a major contribution to the

educational programs of Linfield College. He and

his wife, ages 68 and 70, had several children and

many grandchildren for whom they wished to provide in their estate plan. They had sufficient

financial wealth from his work to leave substantial

amounts for their heirs as well as their charitable

interests.

Working with his attorney to determine which

assets to use and the best way to make the contribution, Mr. Zerved established a charitable remainder unitrust and named Linfield College as the

charitable remainderman. He funded the trust with

a large tract of land, timber, and mineral rights that

he had held for many years. The property would

have been subject to a considerable capital gain if

sold directly.

Since Mr. Zerved wanted to make sure that his

wife was well provided for if he should predecease

her, he chose a two-life trust that would make payments throughout both their lifetimes. Specifically,

it is a unitrust with a “net income with makeup

provision. ” The payout rate is set at 10 percent of

the assets of the trust, revalued each year.

The results were that the property, appraised at

$550,000, was sold by the trust for a much higher

price with no tax obligation. Mr. Zerved was

allowed a charitable gift deduction of $96,700 in

the year of the gift, he avoided income tax on the

sale of the appreciated value of the property, and

57
he reduced the taxable value of the estate. Mr.

and Mrs. Zerved are receiving an annual income,

set at a payout rate of 10 percent, until the death

of the survivor beneficiary. At that time, Linfield

College will receive the proceeds of the trust and

establish a named endowment as requested by Mr.

Zerved at the time the trust was created.

Example 8.8. CASE 3--A Gift of Timber with

Timberland Retained.

Mr. and Mrs. Juan A. Travel, farmers

approaching retirement (ages 55 and 53), were

interested in freeing themselves from some of

their farm responsibilities. They wanted to retire,

have their son take over the responsibility of

running the farm, and have as much income as

possible to do a little traveling.

They owned a tract of timber valued at

approximately $150,000 together with the land

they farmed. It had such a low basis that they

would have had to pay what seemed like an

enormous amount of capital gains tax if they sold

it. Mr. Travel had heard about charitable trusts, so

they came to Linfield College to find out more

about this life income arrangement. Because they

wanted to pass the land to their children when they

died, they decided to retain the land, but give the

timber to establish a charitable remainder trust.

The results were that in 1990 the trust sold the

timber tax free to a buyer who logged and

replanted the tract. The Travel’s have a lifetime

income from the two-life unitrust with an annual

payout rate of 7.5 percent of the trust’s assets,

revalued annually. Because they avoided a capital

gain tax, they had $45,000 more invested for

income than they would have had if they had sold

the timber themselves. Their children will receive

the reforested land with growing timber when they

die. Linfield College will receive the principal in

the trust to establish a scholarship fund in the

Travel’s memory.

58
Chapter 9

Generation-skipping Transfers

A detailed discussion of generation-skipping

transfers and the associated generation-skipping tax

imposed by chapter 13 of the Internal Revenue Code

(IRC) is beyond the scope of this book. The procedures involved are complex in nature and often

hazardous to implement.

Nevertheless, generation-skipping transfers, if

properly planned, can be used to provide income free

of Federal estate and gift taxes to one or more

generations of direct heirs. The property itself

eventually passes to a person or persons two or more

generations down the line. The forest estate planner

should therefore be alert to the benefits of generationskipping transfers while at the same time understanding the disadvantages.

GENERAL PROVISIONS

Every individual has a $1 million generationskipping transfer exemption which he (she) can allocate during life by gift or at death by will to any

number of generation-skipping transfers. An allocation, once made, is irrevocable. Married couples can

elect to split the use of the exemptions, thus raising

the amount to $2 million, much like the case of split

gifts discussed in chapter 8.

The generation-skipping transfer tax is imposed at

the time the property is eventually transferred.

Unlike the estate and gift tax, which has a progressive rate structure, the generation-skipping tax is

imposed at a flat rate equal to the maximum Federal

estate tax rate in effect at the time of the eventual

transfer--currently 55 percent plus a possible surtax.

A generation-skipping transfer involves use of a

granted life estate that can either be held in trust or

created outside of a trust. Life estates not held in

trust are referred to as legal life estates. The disclaimer provisions of Federal law discussed in

chapter 7 apply for generation-skipping transfer purposes (see IRS Letter Rulings 8815034 and 8907028).

Advantages

If the family goal is to preserve the woodland

operation intact through more than one generation,

59

minimization of the estate tax in the estates of the

children of the current generation is critical. Preserving the operating property for the lifetime of the

children is consistent with such a family goal, and thus

a generation-skipping transfer may be an ideal arrangement.

Example 9.1. A grandparent (A) might leave by

will a tract of timber property valued at $500,000

to his child (C) for life, with a remainder interest

to a grandchild (G). C, the life tenant, would be

entitled to the income from the property for life.

At C’s death, title to the property would pass to G.

Under current law, an exemption from Federal tax

of $1 million per transferor, as discussed above, is

provided. This means that the property in question

would be subject to Federal estate tax in the estate

of A but not again until the death of G. At G’s

death, the transfer would be subject to a flat rate of

55 percent under current law. The same rule.

would apply if the transfer by A had been made by

deed during his lifetime rather than by will at his

death, with the normal $1 million exemption.

Strategic use of the $1 million exemption will permit particularly large sums to escape taxation. Assets

with the greatest potential for appreciation should be

used to fund generation-skipping transfers.

Disadvantages

A number of disadvantages apply to generationskipping transfers. In specific instances, these may

offset the potential benefits. A careful analysis of each

particular situation is critical in order to avoid costly

mistakes.

Special use valution as discussed in chapter 13

applies only to generation-skipping transfer property as

included in the transferor’s gross estate, not to the

property as included in the eventual transferee’s estate.

The same rule applies to the installment payment of

estate tax under Section 6166 of the IRC as discussed

in chapter 14. As mentioned above, the property will

be taxed in the transferee’s estate at the maximum rate

then in effect, and without benefit of the unified

credit. The credit for previously taxed property (see

page 22) also is not allowed. With respect to life-time

generation-skipping transfers, the $10,000 gift tax
annual exclusion is not available if the transfer is not

of a present interest. (See chapter 8 for a discussion

of the annual exclusion.)

Special Problems with Timber Properties

Problems may arise with legal life estates over the

question of how far the life tenant can go with

respect to certain actions involving the property in

question. This is particularly important with timberland.

For example, what constitutes income from a timber property? Will harvesting be restricted to cutting

only timber volumes equal to the growth that occurs

after creation of the life estate? Or can additional

harvesting be done if part of a professional forest

management plan? What rights do the life tenant have

with respect to making changes on the property where

an expenditure of funds would be needed to return the

land to its previous condition? What about minerals?

State law in many instances controls the answers to

these questions. In some cases, however, depending

on the State in question, there are no clear guidelines.

For these reasons and more, a trust with carefully

drafted powers for the trustee can provide a more

flexible management structure than could a transfer

outside of trust. (See chapter 10 for a more detailed

discussion of trusts.)

60
Chapter 10

Role of Trusts

OVERVIEW

A trust is an arrangement by which a person or

entity called a trustee holds legal title to designated

property in trust. The property in the trust is called

the corpus, and it is managed by the trustee for the

benefit of one or more beneficiaries. The rules

governing trust administration come from Federal

law, State law, and the provisions of the trust instrument itself. Federal law primarily concerns the

Federal tax treatment of income, estate, and gift

transfers associated with trusts. State law generally

governs the conduct and rights of the trustee, controls

on trustee action, and State tax aspects. The trust

instrument contains the rules of operation within the

options permitted by State law.

A trust may be established to do almost anything

the person creating it, called the grantor, might do

for himself (herself) and some things that he (she)

cannot do because of lack of skill, sickness, disability, distance from the timberland, or death. The

ability of the trust to bridge the gap between life and

death is one of its remarkable characteristics. A trust

is recognized as a separate legal entity under both

State and Federal law.

BASIC CONSIDERATIONS

The discussion that follows concerns trusts generally; however, the principles are illustrated in

several examples concerning timberland.

Trust Provisions

Trust law is complex and, as noted above, is based

on both Federal and State law. Because the States do

not have a uniform law of trusts, it is imperative to

have the trust instrument drafted by an attorney who

knows not only the Federal tax rules but also the

applicable State law. The provisions generally

included in a trust are as follows:

Prope rty.- -Th e property transferred to the trust to

be managed--the corpus--is described. If timberland

is being put in trust, the applicable deeds and legal

descriptions should be included.

Trustee.--This is the person or entity who holds

title to the property and signs the trust agreement.

The trustee may be either an individual or an

institution such as a bank and may include cotrustees

as necessary or desired.

Bene$ciaties.--Both primary and contingent beneficiaries may be named. The conditions under which

income and principal will be distributed are spelled

out. With respect to timber, it is particularly important to distinguish between the principal (timber merchantable volume and young growth present at creation

of the trust) and the income (subsequent growth); and

between the trustee’s powers and the beneficiaries’

rights with respect to both.

Pow e rs.- -Th e administrative powers and flexibility

accorded the trustee are enumerated. Flexibility is

especially important as concerns timberland because of

sometimes rapid changes in markets, new technology,

and environmental regulations.

Spendth rift Provision.- -Th is bars transfer of a

beneficiary’s interest and stipulates that it is not

subject to a creditor’s claims, subject to the provisions

of State trust law.

Te rm - -Th e length of the trust is the term. If a

shorter period is not specified, a saving clause against

perpetuities can provide that the trust will end no later

than the period allowed by State law. State law generally limits a trust term to no more than 21 years

longer than the death of the last surviving beneficiary

named in the trust.

Bond .- -Th e trust may specify that the trustee post a

bond, but most trusts normally exempt the trustee

from this requirement and address the conditions for

exemption of successor trustees.

Successor.- -Th e trust instrument should provide for

appointment of a successor trustee in the event the

named trustee dies, becomes incapable, or declines to

serve.

Fees.--Payment of reasonable fees to the trustee is

provided for, or alternatively the trustee serves without

a fee. Institutional trustees always serve for a fee

because that is their business.

Nontax Benefits

Nontax benefits can include professional management of financial and real property assets, including

timberland. A trust can be designed to assure a timber

61
owner or beneficiaries designated by the owner of

both income and protection from creditors. Trusts

are frequently designed to benefit family members--

such as spouses, minor children and grandchildren,

and aged parents--during either the life of the grantor

(living trusts) or after the grantor’s death (testamentary trusts). Th e trust supplies the missing

management and experience elements for the beneficiaries, who may lack ability and training, be in

poor health, be involved in school or a profession, or

be incompetent. It can provide the opportunity to

travel by insuring professional management of timberland and other assets and by freeing the grantor

and/or beneficiaries from management details. A

trust assures continuity of management, provides privacy, and can save probate expenses. In fact, trust

creativity is limited only by the grantor’s imagination

and the applicable law.

TAX TREATMENT OF TRUSTS

Trusts can provide savings in three major tax

areas: income, estate, and gift. These are discussed

here, in general terms. Specific tax considerations

associated with particular types of trusts are

addressed later.

Income Taxes

A trust can either be a separate taxable entity or a

conduit for passing income to beneficiaries, who then

report the income on their own returns, or both.

Moreover, a trust can be set up to accumulate

income, distribute income, or a combination of both.

Thus, the trust income can be split in one more way

than there are beneficiaries. The grantor is taxed on

trust income only to the extent of income actually

received, or income actually used for the support of

someone that the grantor is legally obligated to

support.

The Federal income tax saving benefits associated

with trusts have been severely limited by recent tax

reform changes. Th e rules with respect to shortterm, income-splitting trusts--such as Clifford and

spousal remainder trusts (see chapter 8)--have been

changed so that the income from such trusts is now

taxable to the grantor, thus removing them as an

effective income-splitting device between grantor and

beneficiary. Income from other types of trusts

received by children under age 14 who are eligible to

be claimed as dependents on their parents’ returns is

taxed at the parents’ rate on income in excess of

$1,100 per year. Both trust and estate Federal income

tax rate schedules have been revised to lower the

bracket thresholds far below those of other noncorporate taxpayers. Trusts must also now make estimated

payments on income. The current income tax rules

regarding estimated payments and distributions to

beneficiaries may serve to increase the cost of trust

administration. Generally, trusts must use a calendar

year as their tax year. There still remain a number of

ways for the grantor to retain favorable income tax

treatment, but they require careful analysis by a

specialist in order to conform to all the rules and are

beyond the scope of this book.

fie Trust Tax Return.--A trust is taxed like an individual with certain important exceptions. A limited

exemption--equivalent to a personal exemption--of

$300 for trusts required to distribute all income currently and $100 for others, is allowed. For the 1993

tax year, undistributed income is taxed at 15 percent

on the first $1,500, at 28 percent on amounts from

$1,500 to $3,500, at 31 percent on income from

$3,500 to $5,500, and at 36 percent on amounts over

$5,500. A lo-percent surtax produces an effective

39.6-percent rate on taxable income above $7,500.

These rate thresholds are indexed for inflation.

Deductions and credits for trusts are similar to those

for individuals, with some important differences for

timber. For example, trusts are not eligible for the

reforestation amortization and investment tax credit.

These expenditures must be capitalized and recovered

when the timber is sold or otherwise disposed of. The

opportunity to immediately deduct certain depreciable

costs under Section 179 of the IRC also is not available to trusts. Other differences are covered in

Section 642.

Generally, the conduit principle applies to income

distributed under a simple trust. The income is

reported by the trust on its tax return and is then

allowed as a deduction to the extent distributed or

required to be distributed. Beneficiaries are taxed on

the income required to be distributed to them whether

received or not. Thus, the trust works as a conduit

for income passed through to the beneficiaries. The

distributable net income (DNI) concept limits the

distribution deduction allowed the trustee. It also

limits the amount includable in the beneficiaries’ gross

income. Distributable net income is defined in IRC

Section 643(a).

62
Example 10.1. A simple timber trust requires that

all income be distributed currently to the life

beneficiary. The trust has ordinary income in

1993 of $18,000 from crop and hunting leases,

expenses of $750 chargeable to income, long-term

capital gains of $6,000 from timber sales, and

$2,250 in expenses chargeable to corpus.

The beneficiary would receive $17,250 ($18,000

minus $750). The trust’s DNI would be $15,000

[$18,000 - ($750 + $2,250)], which is the taxable

amount to the beneficiary (capital gains are

excludable from DNI). The trust’s taxable income

is $5,700 ([$18,000 ordinary income + $6,000

capital gain] - [($300 exemption + $3,000

expenses + $15,000 DNI]). The result is that the

trust beneficiary gets deductions that would

ordinarily be charged to trust principal.

Example 10.1 is for a simple trust. Complex

trusts, which may accumulate income or distribute

principal, in addition to distributing income, are

much more intricate and beyond the scope of this

discussion.

The income tax basis for property transferred to a

trust by lifetime gift is the donor’s basis increased by

the gift tax on the unrealized appreciation. On the

other hand, property transferred to a trust from a

decedent that is includable in his (her) estate receives

a stepped-up basis equal to its value for estate tax

purposes. This is an important consideration in

dealing with highly appreciated assets such as is often

the case with timberland. The stepped-up income tax

basis for timber property that is valued in its current

use under IRC Section 2032A (see chapter 13) is its

special use value.

Accum ulated incom e.- -Th e re may be many reasons

for accumulating income in a trust. For example, if

the beneficiary does not need all of the trust income

currently, or if he (she) could not use it wisely, it

could be accumulated if the trust instrument so permits. If the beneficiary’s tax bracket is higher than

that of the trust, the accumulation of income will

produce an immediate tax saving. However, because

the 28-percent tax bracket for trusts begins at $1,500,

the opportunity for this type of savings is limited.

When the trust accumulates income for high

income beneficiaries, certain so-called “throwback

rules” apply to the ultimate distributions. The basic

premise is that distributions will be taxed as they

would have been in the years the income was earned

by the trust. A “short cut” method is now used for

computing the tax, which is still quite complicated.

Estate Taxes

When establishing a trust, the grantor must decide

if he (she) wants the trust corpus included in his (her)

estate. If the situation is such that the estate will be

subject to tax, substantial estate tax benefits will

accrue from exclusion of the property from the estate.

The penalty is loss of control of the property during

the grantor’s lifetime. There are also advantages to be

gained from keeping the property out of probate, such

as continuity of management and probate cost savings,

which will vary by State.

If the grantor is willing to relinquish control of trust

property forever, the property’s value will not be

included in his (her) estate. However, if the property

is an insurance policy on the life of the grantor, he

(she) must transfer it to the trust more than 3 years

before death in order to be excluded from the estate.

Most grantors are reluctant to give up control even if

it means large estate tax savings. Furthermore, tax

problems are often associated with living trusts when

it is not clear how much control or benefit has been

retained by the grantor. There are a number of guidelines in several sections of the IRC that should be

observed if the desired outcome is to prevail for the

heirs.

Power-.--The power to revoke, alter, amend, or terminate a trust should be given up. If such powers are

retained, they will result in the trust assets being

included in the grantor’s estate. Furthermore, the

changes should be made more than 3 years before the

expected date of death (IRC Sections 2035 and 2038).

Life Inte rest.- -If a life interest in the possession,

enjoyment, or right to income from the trust property

or the power to dictate who will enjoy the property is

retained, it will result in the property being included

in the grantor’s estate. For example, reserving the

right to hunt and fish or the right to hunting lease

income from timberland will have the effect of

including the entire property in the decedent’s estate.

This rule also applies to voting rights associated with

stock in a “controlled corporation” (see chapter 17),

which may own timberland in a trust.

R eve rsionary Interest.--Keeping a reversionary

interest increases the possibility that property will

return to the grantor’s estate. If the reversionary

interest is worth more than 5 percent of the total

property value when the decedent dies, it may be

included in his (her) estate (IRC Section 2036).

Gene ral Pow e r of Appointm ent.--Re tention of control to dispose of trust property in the grantor’s favor,

63
or in favor of his (her) estate or creditors, will result

in the inclusion of the property in the estate (IRC

Section 204 1).

Insurance Policy .--If an insurance policy is to be

part of the trust corpus, the estate should not be the

beneficiary, and if someone else is the beneficiary,

the insured should not retain “incidents of ownership

in the policy” (IRC Section 2042) (see chapter 11).

Transfers of any powers with respect to an insurance

policy, within 3 years of death, will result in

inclusion of the policy in the estate.

Gift Taxes

A transfer of property to a trust involves a gift.

The trust beneficiaries are the donees rather than the

trustee. This fact has special significance in applying

the annual gift tax exclusion. That is, there are as

many exclusions available as there are beneficiaries

for either the $10,000 annual exclusion or the

$20,000 split gift tax exclusion (see chapter 8 and the

trust example on page 66).

Transfers of nonincome-producing property to a

trust can also pose a problem in connection with the

annual exclusion. Timberland is generally treated as

being nonproductive when it does not produce current

income. This problem can be overcome by showing

that the timber is an appreciating asset and that it is

producing unrealized income in terms of volume and

value growth. It may be advisable to incorporate

growth projections and recommendations for producing periodic income by thinning and final harvests

into the management plan. The information in the

plan can be refined at anytime to show current annual

increments and a schedule of accumulating values.

Trust benefits can be costly. The advantages

outlined here must be balanced against the costs such

as legal fees, the trustee’s fees, and ongoing timberland management costs.

TYPES OF TRUSTS AND APPLICATIONS

Trusts are flexible tools in estate planning that

generally provide one or more otherwise unavailable

benefits. These include shielding the trust’s assets

from creditor’s claims, accumulating funds for college tuition, and providing necessary financial

support for children or retired parents. Income or

estate tax savings, or both, may also be a goal, as

well as the desire to avoid probate.

Living Trusts

A living trust is created during the grantor’s

lifetime. It can be either revocable or irrevocable

depending on the goals of the grantor.

Irrevocable Living Trust.- -Th e grantor gives up the

trust property permanently, but in return gains supervised management and investment of the assets, and

avoids probate. He (she) may pay gift tax upon establishment (see chapters 3 and S), but the trust corpus is

not includable in his (her) estate, and income is taxable

to the beneficiaries as it is distributed annually. Other

advantages of an irrevocable living trust include the

possible saving of estate taxes in the grantor’s estate

and those of the life beneficiaries, providing protection

for family assets, and perhaps saving income taxes for

the family. Avoiding probate prevents public disclosure of the decedent’s financial affairs, the size of

the assets of the estate, and the listing of the beneficiaries and the property each received. With respect

to timber, it eliminates the necessity of operating the

tree farm as part of an estate while the estate is being

settled. Probate fees and expenses are saved. Estate

tax savings are achieved by keeping the trust assets,

which may have appreciated considerably since the

trust was established, out of the grantor’s estate. This

is accomplished by not retaining a life interest in the

property (IRC Section 2036); not keeping a reversionary interest worth more than 5 percent of the property

value on the date of death (IRC Section 2037); not

keeping the power to alter, terminate, or revoke the

trust (IRC Section 2038); not having a general power

of appointment as defined in chapter 6 (IRC Section

2041); not possessing an incidence of ownership of a

life insurance policy on his (her) life that names the

trust as beneficiary, or not transferring ownership of

the insurance policy on his (her) life within 3 years of

death (IRC Sections 2042 and 2035)--all as discussed

earlier.

The primary disadvantages of an irrevocable living

trust are giving up control of the timber property and

other assets placed in trust, and keeping a hands off

posture forever. There are also, of course, the costs

of distributing the trust corpus upon termination. Gift

taxes will also be due if the transfer to a trust exceeds

the $10,000 ($20,000 for split gifts) annual gift tax

exclusion per beneficiary (donee) plus whatever unified credit equivalent is available.

R e vocable Living Trust.--A revocable living trust

may be changed or terminated by the grantor at any

time. It may be funded or unfunded; it provides an

64
opportunity for the grantor to try certain provisions

and make changes as needed to meet his (her) goals.

Because it is revocable, there are essentially no tax

savings associated with this type of trust. The

income is taxable to the grantor. The fair market

value of the trust assets are taxable in the grantor’s

estate. There is no gift tax, however.

The advantages of a revocable living trust include:

(1) avoiding probate; (2) avoiding interruption of

family income upon either the grantor’s death or

upon his (her) becoming incompetent; (3) providing

a trial period for trust operation and the power to

make subsequent changes based on experience; (4)

consolidating scattered real estate, such as timber

properties, in two or more States by putting the title

in trust and avoiding ancillary probate; (5) enabling

a business or other enterprise, such as a tree farm, to

continue operating; (6) relieving the grantor of an

administrative burden, such as timber management;

(7) having generally less accounting and administration requirements than a testamentary trust; (8) being

possibly less vulnerable to judicial challenge of the

grantor’s capacity as compared to a testamentary

trust; (9) depending on State law, possibly serving to

bar the statutory rights of a surviving spouse to a

share of the decedent’s property and putting the

property beyond the reach of the grantor’s creditors;

and (10) serving as an instrument to accept death

benefits from employee plans and life insurance

proceeds on the grantor’s life. Thus, the revocable

living trust has many advantages, but it is very

important to have the instrument carefully drafted and

coordinated with the grantor’s will.

The disadvantages, as noted above, are that the

income is taxable to the grantor and the trust’s assets

are includable in the grantor’s estate. However, the

trust becomes irrevocable on the grantor’s death

(unless terminated at that time) and then becomes

eligible for tax advantages associated with irrevocable

trusts. The trust may be established to avoid death

taxes upon the death of the beneficiaries, although

this procedure is subject to the generation-skipping

tax (see chapter 9). The trust incurs the costs of

establishment and operation during the grantor’s life

and may incur additional costs at death, such as those

associated with filing Federal estate and State death

tax returns.

Standby Trust.- -The standby trust is generally revocable but may be established to become irrevocable

upon the grantor’s disability. It provides supervised

control and investment management if the grantor is

disabled or absent, but the income is taxable to the

grantor, and the fair market value of the estate property is includable in his (her) estate. There is no gift

tax liability. The standby trust is essentially designed

for the contingency of the grantor becoming mentally

or physically disabled, or having the inability to manage his (her) affairs for any reason. Its primary advantage is prevention of incompetency proceedings under

State law, while at the same time protecting the

grantor’s assets and providing for his (her) financial

needs. The disadvantages are that there are no income

or estate tax savings and it may not be available under

the law in some States.

Pourover Trust.- -Th e pourover trust is a living trust

that may be either revocable or irrevocable, funded or

unfunded. Its purpose is to receive and accumulate

payouts and proceeds from various sources as these

occur over time--such as insurance payments, annuity

checks, and similar receipts. The tax treatment is the

same as for other living trusts discussed above,

depending on revocability. The pourover trust can be

very useful as a means of collecting funds from disparate sources such as individual retirement accounts,

Keogh plans, insurance policies, qualified employee

benefit plans, and assets from estates and other trusts.

The pourover trust can be established to give the

prime beneficiary of a life insurance policy a life

interest in the insurance proceeds, rather than

receiving them outright. The corpus of the proceeds

is then directed to others on the death of the prime

beneficiary and are not part of his (her) estate.

Pourover trusts are relatively new and some technical issues remain unresolved. When used with a will,

the trust should be in existence before the will’s

execution, kept separate, and incorporated by

reference.

Grantor R etained Inte rest Trust.- - W ith the so-called

grantor retained income trust (GRIT), grantor retained

annuity trust (GRAT), and grantor retained unitrust

(GRUT), the grantor reserves a qualified term interest

in the form of either a fixed dollar or fixed percentage

annuity (IRC Section 2702). At the end of the specified term, the principal passes to the remainder persons. The nontax benefits of such trusts are generally

negligible. The trust income is taxable to the grantor.

The value of the corpus is not taxable to the grantor‘s

estate unless he (she) dies within the reserved income

term (period). The gift tax that may be due on establishment of the trust depends on the value of the

remainder interest at the time the trust is created.
The term of GRAT’s and GRUT’s is not limited by

statute but by practical considerations. If the grantor

dies within the term, the principal is taxable in his

(her) estate. Thus, the period of the trust should be

substantially shorter than the grantor’s life expectancy

considering both mortality tables and actual life

expectancy due to health and other factors.

Current rules substantially limit the use of GRIT’s

that provide transfers for the benefit of a family

member. Family members are defined to include

spouses, ancestors of the transferor or transferor’s

spouse, lineal descendants of the transferor or transferor’s spouse, brothers and sisters of the transferor,

and spouses of the above. Family members do not

include nieces and nephews or friends. There are

special rules for the valuation of tangible nondepreciable property, especially undeveloped land that

generates limited or uncertain income. It would seem

that forest land would be included in this category.

The valuation under IRC Section 2702(d) of the term

interest is the amount that the holder of the term

interest establishes as the amount for which the

interest could be sold to an unrelated third party.

Testamentary Trusts

Trusts created in accordance with the instructions

contained in a decedent’s will are known as testamentary trusts. They provide supervised control and

investment management of the trust assets, and trust

income is taxed to the beneficiaries if currently

distributed. The fair market value of the decedent’s

assets that are put into the trust are includable in his

(her) estate, but there is no gift tax liability.

Generally, a testamentary trust is utilized by individuals who are unwilling to give up control of assets

while alive.

The advantage of a testamentary trust is that it can

protect the trust property from successive estate tax

levies as the income is utilized by successive generations, such as surviving spouse, then children, and

then grandchildren. The generation-skipping transfer

tax (see chapter 9) may become applicable upon final

disposition of the property. The nonmarital credit

trust is a good example of an estate tax-saving testamentary trust. Up to $600,000 of the decedent’s

assets, including timber, could be put into trust at the

decedent’s death and qualify for the unified credit.

The trust would then pay the surviving spouse income

for life and permit use of the principal subject to

ascertainable needs, but withhold control from him

(her). The property will thus not be taxed in either

the decedent’s or the surviving spouse’s estate and the

corpus passes to the children or other second

generation beneficiaries estate-tax-free.

Example 10.2. Greentree owned 1,200 acres of

timberland--one-half was a lo-year-old plantation

valued at $600,000 and growing currently at 25

percent per year; the other half was mature timber

valued at $1,500,000. Assume that this constituted

the net taxable estate for his spouse, two married

children, and four grandchildren. None of the unified credit had been previously utilized.

When Greentree died, his will’s marital deduction

formula clause directed the $600,000 exemption

equivalent into the nonmarital-unified credit trust

(see fig. 10.1 on the following page). This transfer

was protected from estate tax by the unified credit

of $192,800. The trustee had the discretion to pay

the surviving spouse the trust income if needed, plus

the option to invade the principal for her benefit if

required, subject to an ascertainable standard of

living. The executor funded this bequest with the

plantation valued at $600,000 so that its rapid

appreciation would accumulate tax free for the

children and their families.

The balance of the estate, $1,500,000 in mature

timber, went into a marital deduction trust for the

surviving Greentree spouse. The estate tax was

deferred by Greentree’s marital deduction, and an

additional $600,000 will pass tax free to the children

and their families at the spouse’s death. In the

meantime, the timber will be harvested and each

family member will be given $10,000 per year plus

tuition while in college and gradate school. Because

the surviving Greentree spouse has a life expectancy

of 22 years and a yen for travel, these procedures

are expected to thin the estate sufficiently to avoid

significant tax problems at the second Greentree

death.

The Importance of Flexibility

Trusts are usually drafted to last for long periods of

time, but many things change over the years that are

difficult to anticipate in advance. With revocable

trusts, these can be addressed by the grantor as

required. With irrevocable trusts, however, it is necessary to build in flexibility so that the trustee has the

power to respond to changed conditions in order to

achieve the grantor’s objectives. Psychologically, this

is difficult to do for many grantors. Nevertheless,

66
Es tate of

Firs t Spous e

To Die

Tax Free iTrans fe r

- $600,000

Exe m ption Eq uivale nt

Surviving Curre nt Incom e Ch ildre n

Spous e

Marital De duction

, , and , , Outrigh brBe q ue s t

Outrigh t Be q ue s t

Invade Principal Unifie d Cre dit

or Trus t Trus t

I

- $600.000

J’

I

Tax Fre e

Exe m ption Eq uivale n/t\, Trans fe r

Ch ildre n

Owne rs or

Be ne ficiarie s

Figure lO.l-- Intergeneratinal transfer of timber assets using the uniJed credit with

either a marital deduction trust or with an outright bequest.

there are a number of features that permit flexibility

and safety for both the family and the trust assets.

Incom e-sprink ling Clause.- -Th is clause permits the

trustee to act as a parental substitute by distributing

income as needed or accumulating it according to

guidelines established by the grantor. When there are

multiple beneficiaries, the guidelines should provide

preferences and priorities with respect to the needs

and purposes to be accomplished. They should

address the treatment of excess income and plans for

distribution as the beneficiaries come of age. This

can be done by a letter outside the trust instrument.

In the case of timber assets, it can be done in the

forest management plan. The grantor may wish to

consider a separate trust for each sibling in order to

avoid conflicts. Income-sprinkling clauses can also

be utilized to provide surviving spouses with fixed

minimum levels of income by giving the trustee the

power to sprinkle the spouse with funds as needed.

It is important that the grantor be distanced from the

decision in order to avoid having the assets revert to

his (her) estate. The choice of the trustee is critical,

and an institutional trustee may need to be accompanied by a cotrustee who knows the needs of the

family members.

67

Invasion of Trust Principal.- -The trustee should have

the discretion to use the trust principal to benefit the

income beneficiaries under an “ascertainable

standard. ” Under IRS regulations, this may include

education (including college), support in reasonable

comfort, and other factors.

Pow e r of Beneficiary to W ith d raw Principal.- -Th e

beneficiary may be given the power to withdraw principal subject to the limitation that the total amount

withdrawn in any 1 year may not exceed $5,000 or 5

percent of the value of the current trust property,

whichever is greater. In this way, the beneficiary is

not totally subject to the trustee’s discretion, and only

the annual right of withdrawal is included in the

beneficiary’s estate.

“Crum m ey” Pow e r.- -Th e beneficiary is given a

limited unilateral power, called the “Crummey”

power, to withdraw income or principal or both from

the trust. The power is generally exercisable only

during a limited period of time, such as 30 days, each

year. Inclusion of the “Crummey” power in a trust

permits gifts made to the trust to qualify as gifts of

present interests. This in turn permits such gifts up to

$10,000 per donee ($20,000 per donee for split gifts)

to qualify for the annual gift tax exclusion (see chapter

8 for discussion of the exclusion).
Other Provisions.--Beneficiaries with disabilities

can be provided for by defining “disability” and

addressing trust distributions for the benefit of such

persons. Spendthrift provisions can expressly reject

assignment of trust income to creditors or others in

anticiaption of income distributions by the trustee.

Efficiency provisions can provide for termination of

the trust by the trustee if trust administration becomes

uneconomical. Although anticipating changes in the

economy is nearly impossible, a sprinkling provision

in the trust can allow beneficiaries’ needs to be

addressed in terms of inflation over time. Unitrust

provisions might be considered (see Chapter 8) so

that the beneficiaries receive a fixed percent of the

trust principal if it is greater than trust income. The

trustee may be given hold-back powers that would

delay or cancel trust distributions upon unacceptable

behavior by a beneficiary--for example, if the

beneficiary is involved with drugs or in a divorce

proceeding. The grantor may wish to designate the

age at which a beneficiary will receive distribution of

trust principal so that he (she) will have time to

mature and become a productive member of society.

USE OF TRUSTS

IN MARITAL DEDUCTION PLANNING

Generally, the goal for married couples with

significant wealth is to eliminate all estate taxes at the

death of the first spouse and to minimize estate taxes

on the death of the surviving spouse. This is usually

done with a marital deduction bequest, which may be

either outright or in trust (see chapter 6). Planning

for a marital deduction trust must be coordinated with

the bequests to the children or other heirs of property

covered by the unified credit if the unified credit is

also utilized. The unified credit portion can also be

outright or in trust. Thus, if professional

management of the tree farm will be in the surviving

spouse’s best interest, trusts can be used for the

marital deduction bequest, the unified credit bequest,

or both. A trust also provides protection against

demands by children and creditors. For the

remainder of this discussion, it is assumed that both

bequests will be in trust.

The unified credit trust (sometimes called

nonmarital credit trust) provides for the surviving

spouse as beneficiary, if he (she) needs the income,

and the trust principal will be exempt from Federal

estate taxation on his (her) death (see figure 10.1 and

example 10.2). It can include sprinkle provisions as

discussed above. The trust can provide that the

income provisions terminate upon remarriage of the

surviving spouse. Perhaps, more importantly, it can

be designed to realize the maximum benefit of estate

appreciation when the grantor desires that the

surviving spouse not benefit from it for whatever

reason.

In addition, several types of marital deduction trusts

may be utilized (see chapter 6 for discussion of the

marital deduction). These include power of appointment trusts, qualified terminal interest property (QTIP)

trusts, and estate trusts. The choice among these

should be made based on accomplishing the grantor’s

goals most effectively.

QTIP Trust

The QTIP trust provides the surviving spouse a life

income interest. The key feature is the ability of the

estate owner to control the disposition of the remainder interest after the spouse’s death while at the same

time utilizing the marital deduction for the trust assets

in his estate. For example, when there are children

from previous marriages, the grantor can be assured

that their wants will be met at the surviving spouse’s

death. The surviving spouse must be given the trust

income payable, at least annually, for life. The QTIP

election must be made by the executor; a full or partial election can be made based on the form of the

bequest and the degree of utilization of the full unified

credit. For a more extensive discussion of QTIP’s,

see chapter 6.

Power of Appointment Trust

The power of appointment trust gives the surviving

spouse a life income interest in the trust property,

which must be paid at least annually. The surviving

spouse or trustee is given the right to use the principal for designated purposes such as making gifts that

qualify for the gift tax annual exclusion. Although it

is not necessary that this right be granted, it is a

means of reducing estate taxes in the surviving

spouse’s estate. A general power of appointment exercisable by will also gives the surviving spouse the

right to provide in his (her) will for the disposition of

the trust assets at his (her) death. The trust provides

that, if the surviving spouse fails to exercise the right

to name the beneficiaries of the trust assets, they will

pass to beneficiaries, if any, named in the trust by the

grantor.

68
Estate Trust

The estate trust is designed for the surviving

spouse who does not need income. The trustee may

be given the discretion to make distributions based on

need, but the surviving spouse does not have a right

to demand them. The trust assets qualify for the

marital deduction as long as the trust ends on the

death of the surviving spouse and the trust assets are

to be paid to the survivor’s estate at that time. Thus,

the survivor’s will controls the disposition of the trust

assets. This type of trust can also eliminate income

distributions on remarriage of the surviving spouse

and accumulate them for the eventual benefit of the

surviving spouse’s heirs. It can also hold nonincomeproducing property with growth potential, such as

timberland, which could pose a problem with a

power of appointment trust.

A Disclaimer

A qualified disclaimer by a surviving spouse (as

discussed in chapter 7) is valid even if the will directs

the property disclaimed to a marital deduction trust in

which the surviving spouse has an income interest.

Similarly, the children can use a disclaimer to

disclaim legacies that will permit the surviving spouse

to receive a larger marital deduction amount. (See

chapter 7 for more on disclaimers.)

TRUSTEES

The selection of and powers given to the trustee(s)

are a critical problem that bedevil many otherwise

sound trust plans. The person or institution chosen

as trustee must, of course, measure up in a practical

sense. If timberland is an important part of the estate

assets, a forester with business experience may be

preferred, if not as sole trustee, perhaps as a

cotrustee. Ability, integrity, judgment and durability

are all important qualities for a trustee. State law

requirements must be satisfied. These are particularly important with respect to the rules regarding

trust property in one State and trustee(s) who reside

in another State.

Tax considerations come into play if the grantor

names himself (herself) as trustee with powers over

income and principal, which can make the income

taxable to the grantor. Similarly, if nongrantor

trustees have the power solely or partially to vest

income or principal in themselves, the trust income

would be taxable to them.

Individual Versus Institutional Trustee

A family member who has all the requisite skills

and experience may be persuaded to be named a

trustee and perhaps serve without a fee. However,

that may not be fair to the trustee because it takes

valuable time to do the job right. The family member

named may resent the imposition of the duties

involved and/or make them a low priority in his (her)

work schedule if uncompensated. On the other hand,

an institutional trustee offers experience, continuity,

and a variety of skills (usually in a department with

several individual specialists). It may not, however,

have the personal interest in the timberland assets or

in the beneficiaries that a family member would have.

Trustee fees should be investigated and negotiated

while the grantor is alive. For institutional trustees,

there are acceptance and termination fees, as well as

minimum annual management fees for handling trust

investments and income distributions. There may be

additional fees for handling timber sales, preparation

of fiduciary income tax returns, and other services that

may be required. These fees will vary by institution

and should be carefully investigated when determining

if an institutional trustee has the ability and the interest

in the tree farm to do the job that the grantor requires.

There is always the element of uncertainty over an

institutional trustee’s acceptance of the trust corpus.

Is the property sufficiently large to be attractive, and

will the trustee have the skill to manage it effectively?

Some trust departments are experienced at managing

timber properties, but others may want to dispose of

the woodland and invest in more liquid investments.

Family Cotrustees

In some, cases a family member may serve as

cotrustee with an institutional trustee. He (she) brings

a common touch to the personal needs of the beneficiaries and a personal, sometimes sentimental, family

attachment to the timber property. However, this will

cost more, even if the cotrustee serves without fee,

because additional time will be required for meetings,

consultations, and resolution of conflicts. The

cotrustee may also deserve a fee, which would be an

additional expense. Thus, there are benefits and

costs for both personal service and financial skills,

which should be carefully considered and balanced.

69
Appropriate language should be included in the trust

instrument to insure that favorable tax treatment will

not be compromised by having beneficiaries as

cotrustees.

Success or Trustees

Naming of alternate trustees should be considered.

Family members age and change, and institutions also

change and may go out of business. Thus, the

original ‘rustee may not or cannot continue to serve

at some point in time. Alternates should be named,

or procedures should be in place, to address this

contingency. Such foresight may save court fees,

bond costs, and valuable time. A grantor can retain

the power to appoint a successor institutional trustee

only if the trustee resigns or is removed by judicial

order (Revenue Ruling 77-182); broader powers to

the grantor will most likely result in the property

being includable in his (her) estate.

Trustee Powers

The trustee should be given sufficient power to

enable him (her) to accomplish the objectives of the

grantor. State law will address any powers omitted

from the trust instrument. With timber assets, special

provisions may be needed to address the distinction

between principal (timber capital and/or growing

stock) and income (growth). Because timberland may

be nonincome producing in some years, the allocation

of value appreciation should be considered. In years

with income, the allocation of timber sale revenue to

capital expenditures, operating expenses, and income

distributions must be addressed. It is often prudent

to include other income-producing assets in the trust

in addition to timber in order to cover expenses in

nonincome years or to permit retention of timber sale

income for that purpose. The trustee needs sufficient

flexibility to respond to changing economic and environmental conditions, market opportunities, and beneficiary needs.

TRUST APPLICATIONS FOR FORESTRY

Timber is a unique asset. In most States, the title

to standing timber can be legally separated from the

title to the land on which it grows. In such a case,

the timber continues to grow after severance of the

title. Because the timber represents both the principal

and income and the land remains dedicated to the

production of the timber, the severance of title

necessarily reduces the value of the land because of

the incumbrance. Therefore, the value of the land can

be reduced for estate purposes without affecting its

ability to produce a timber crop and thus income.

This severance is not without cost, however, and may

result in higher administration and management costs.

Example 10.3. The Irrevocable Living Trust--A

Case Study.

This is an actual case study that illustrates how a

well-planned, well-managed, irrevocable trust

involving timberland has worked over a 3-year

period for a 20-year Washington Farm Forestry

Association small timber landowner.’ The following factors, all discussed in more detail

elsewhere in this book, were considered by the

grantor in establishing this trust.

Once the trust instrument--the guiding document that

controls the trust, its assets, and the functions of the

trustees for the duration of the trust--is completed,

funding of the trust actually starts the business and

management of the trust. This funding is achieved

with property (timberland) and/or securities (stocks,

bonds, or money accounts) and should involve good

financial planning and knowledge of the way income

will be produced, the income tax provisions, the cost

basis of assets gifted to beneficiaries through the trust

vehicle, and the impact of capital gains taxation, if the

trust should sell timber or securities. Certain basic

facts regarding gifts and taxation that are important are

listed below.

(1) Gift taxes are exempt on the first $10,000 gift

per donee per year or on the first $20,000 from

a married couple to each donee. If property is

separately owned by one person with the

$10,000 exemption, the exemption can be

increased to $20,000 if the spouse consents,

even though the spouse does not own the

property. If the person or married couple

decide they wish to exceed the $10,000 or

$20,000 annual exemption, then a gift tax

report must be filed, but no taxes need to be

paid because the excess gifts can carry over to

proportionately use up the unified credit for

estate taxes--a $600,000 estate tax exemption.

‘Used with permission of the author, who, although wishing to

remain anonymous, welcomes any criticisms, comments, or

inquiries by writing to Lori I. Rasor, Editor, “Northwest

Woodlands,” 4033 S.W. Canyon Road, Portland, OR 97221.

70
(2)

(3)

(4)

If the gift donor’s estate assets are above the

Federal estate tax level ($600,000 for one

person or $1,200,000 for a married couple),

astute estate planning will involve gifting

assets into the trust that have the potential of

growing rapidly or that have longer term

growth such as land (a scarce commodity),

timber, which is also becoming scarce and is

experiencing escalating market prices, and

certain securities, namely common stocks in

good investment grade companies over the

long term. Stocks have outperformed most

other investments, according to past history

performance. Mature timber on good site

land can grow 7 percent a year in board feet

volume, compounded; therefore, timber value

can double in 10 years in board feet volume.

The capital gain or loss basis for income taxes

for the trust assets is the cost basis of the

assets gifted of the donor, which is carried

over permanently to the donee. So, if assets

such as timber are sold in the future, capital

gains tax will be paid on the difference

between the donor’s original cost and the

donee’s sale value. The market value of the

gifted asset, at the time of gifting, is used for

the asset value at the time the gift is made,

applicable where considering gift tax exemption calculations.

Consideration should be made by the gift

donor as to the annual income produced by

the asset and the annual needs of the trust to

cover expenses. The needs of the trust

beneficiaries for annual income distributions

for personal family support also should be

considered.

In gifting securities, one would need to gift highdividend or high-interest-producing securities to produce cash flow for the trust. These might be highdividend stocks such as utility, petroleum, or natural

resource stocks. The latter two pay good dividends

and have a good growth record. Bonds have no

growth factor other than high income (8 to 10 percent), which if reinvested, like compound interest,

acts as an asset growth factor.

The following actual case history of a 3-year duration, family-oriented, irrevocable living trust, illustrates the above factors in funding a trust through

gifts and eliminating future estate taxation problems.

The trust is named “XYZ Family Farm Trust.” Its

purpose is to hold, control, manage, and distribute

assets and income from the trust to the children and

grandchildren of the trust grantors, and to create a

vehicle for future gifts of farm and timberland and

nonreal estate assets for the future benefit of the

beneficiaries.

The goal and wishes of the donors, in funding this

trust, is that management through its trustees will

preserve the assets of the trust, help those assets grow

in value and not distribute the capital assets to

beneficiaries without specific needs, such as worthy

economic or business needs or support; housing,

educational, or health needs; or necessary retirement

income.

The trust was funded in the following manner:

12-3 l -86--Initial funding

Real estate (timberland) deed recorded for

first undivided one-third of 80 acres

fully stocked with timber

Stocks-720 shares of Borg Warner

@J 38 l/8

Total 1986

1987--Funding trust

2-4-87--Real estate (timberland) deed

recorded for a second undivided

one-third of above 80 acres

3-4-87--Cash gift to establish a

checking/savings account

Total 1987

1988--Funding trust

3-3-88--Real estate (timberland) deed

recorded deed recorded for a third

undivided one-third of above

80 acres

12-24-88--Stocks (valued at closing of

market Dec. 22)

500 shares of Pacificorp

@? 35 7/S $17,937.50

300 shares of Wash Water

PWR @ 27 l/2 8,250.OO

300 shares of Walgreen

@ 30 S/8 9,187.50

400 shares of Enron

@ 35 112 14,600.OO

Total 1988

$70,000

27,145

$97,145

$70,000

1,000

$71,000

$70,000

49.975

$119,975

71
19 89 --Funding trust 19 87

12-2 l -89 --Real estate (tim be rland )

deed recorded for 22.4 acres,

fully stock ed w ith tim be r $132,670

Total funding of trust, 3 ye ars

th rough 12/3 1189 $420,79 0

The summary of annual income, income

distributions, and taxation are as follows:

19 87--Incom e

Dividends on stock s

Inte rest on bonds

Inte rest on bank accounts

$ 356.00

333.33

1.146.00

Long-te rm capital gains

Less expenses

Net taxable incom e

6.50

$32,9 74.41

19 88--Incom e

Note : Borg W arne r stock m e rge r 4122187 resulted in a

$31,145.58 capital gain. Incom e distribution: 30 pe rcent

retained in trust and taxed at an 11-pe rcent starting rate.

Se venty percent w as distributed to beneficiaries and taxe d

m ainly at 28 pe rcent.

Inte rest on bank accounts

Inte rest on corporate bonds

Inte rest on tax-free bonds

$ 115.73

1,500.00

654 44

2,270.17

Less expenses 165 42

Net incom e 2,104.75

Less tax-free inte rest

Net taxable incom e

‘654 44

$1,450.31

19 89 --Incom e

Dividends on stock s

Inte rest on bank accounts

Inte rest on corporate bonds

Inte rest on tax& e bonds

$3,376.65

170.14

1,500.00

9 50 00

5,9 9 6.79

Less expenses .141 60

Net incom e 5,855.19

Less tax-free inte rest 9 50 00

Net taxable incom e $4,9 05.19

The year-end annual inventory of assets on

December 31 of each year is as follows:

19 86

R e al estate, parcel 1, 80 acres

(first one-th ird value)

Stock

Total 19 86

$140,000.00

3.279 .74

25;374.73

$168,654.47

R e al estate, parcel 1 (tw o

one-th irds value)

Bank accounts

Bond s

Total 19 87

19 88

R e al estate parcel 2 (th re e

one -th irds value)

Bank accounts

Bond s

StOCkS

Total 19 88

$210,000.00

3,375.9 0

25,374.73

49 ,475.oo

$288,654.47

19 89

R e al estate, parcel 1 (th re e

one -th irds value)

R e al estate, parcel 2 (22.4

acres of tim be rland )

$210,000.00

132.670.00

Bank accounts ’ 51073.9 3

Bond s 25.374.73

stocks 71;764.58

Total 19 89 (on 12/20/89 ) $444,883.24

This case history of an irrevocable living trust for a

3 year duration illustrates an example of the original

purpose and goal of the trust as mentioned above:

(1)

(2)

(3)

(4)

Gifts of timberland and/or securities into the

trust ($97,145 initially, cumulative current

value $420,790) removes these assets from the

donor’s estate and future estate and inheritance

taxation.

The goals and wishes of the funding donors of

the trust have been dramatically fulfilled--assets

have grown in value. The current inventory of

timberland is valued at the time of gifting into

the trust and does not indicate current market

prices for timber in parcel 1 nor does it

include the annual compounded 7-percent

growth in board feet volume. Present values

are markedly higher today.

Securities, mainly stocks, had remarkable

growth in value in 1 year--$49,975 at the end

of 1988versus $71,764.58 at the end of 1989--

for an increased value of 43.6 percent,

surpassing the growth in 1989 of the Dow

Jones Industrial Average increase of roughly 20

percent. Note: The 43.6-percent increase

includes income reinvested in the Dividend

Reinvestment Program.

The trust vehicle, under supervision of an

experienced trustee, provides continuity of

control of assets and, hopefully, good

72
management by one entity for the benefit, in

this case history, of seven beneficiaries, of

whom four are minors, and prevents injudicious. expenditures of capital assets by a

spendthrift beneficiary.

The timberland and securities were gifted into the

trust over 13 months (3 tax years) in order to utilize

the annual gift tax exclusions for the seven beneficiaries. Only one timberland appraisal was necessary

because the assets were transferred into the trust over

a span of 13 calendar months, which, by using the

end of 1 tax year and the beginning of 2 others,

actually covered 3 tax years.

The rate of value appreciation for the timber,

including both growth and price appreciation to mid1992, was a robust 25.6 percent. Since then the

stumpage prices for Douglas-fir, which comprises

most of the standing timber, have more than doubled.

The grantor is the trustee, but he faces perhaps the

most challenging aspect of the trust strategy in identifying a successor trustee who has the business accumen to manage securities and timber plus the personal

interest in the welfare of the family.

73

Chapter 11

Life Insurance

ROLE OF LIFE INSURANCE

Insurance Program

The life insurance program must be part of the

overall evaluation of the estate plan. The estate

planner should review all of the landowner’s policies,

inventory the provisions and benefits, and make projections of needed insurance changes over time in

conjunction with other estate assets.

There are two primary reasons for buying life

insurance: (1) to replace the foregone income of the

principal breadwinner and (2) to provide liquidity.

The liquidity is needed to prevent shrinkage from

forced liquidations of estate assets under unfavorable

terms, to cover the cost of estate administration, and

to pay estate taxes, if any.

For a young family with limited assets and heavy

financial commitments, insurance protection is a

necessary expenditure. Many observers have noted

that the family’s greatest insurance needs peak

immediately following the birth of their last child.

Insurance can provide an instant estate for the

surviving spouse in the event of a primary breadwinner’s premature death. Over time, the family’s

insurance needs generally decline with the selfsufficiency of the children and with the accumulation

of capital assets, such as timberland and other

retirement benefits.

There are also alternatives to insurance for liquidity

purposes, such as government and corporate bonds,

and publicly traded securities. These investments

fluctuate in value, and there is always the risk that

one or all could be at a low ebb in their cycle when

cash is needed. However, the risk-return tradeoff is

the nature of the investment choice. Most life insurance carries an investment component, which is relatively safe with highly rated companies. Insurance

firms are highly regulated, well diversified, and

professionally managed. A minimum return is usually guaranteed, but a policyholder should be cautious

in believing the projected returns because they are

just that--projections--and, thus, subject to error.

Life insurance receives favorable tax treatment

under the Federal estate tax laws. Insurance payable

to the named beneficiary is tax exempt in many

States. The Federal estate tax exempts insurance

75

proceeds payable to beneficiaries other than the

executor of the insured’s estate, if the decedent

retained no incidents of ownership in the policy at

death. Insurance is also favorably treated for income

tax purposes at the Federal level and in most States. In

addition to favorable tax treatment, insurance benefits

include the flexibility of different settlement options,

financial security for survivors, and the convenience of

low-interest, cash value loans when the policyholder

may need them.

Life Z nsurunce Contract.--Perhaps, the most important provision of the policy is that of ownership. The

insured is usually the owner, but he (she) may divest

himself (herself) of incidents of ownership and make

the proceeds payable to someone other than to the

insured’s estate. With no incidents of ownership and

with proceeds payable to a named beneficiary other

than the estate, the value will not be included in the

decedent’s estate. Because the policyholder exercises

control over the insurance contract, he (she) can name

one or more beneficiaries including contingent beneficiaries. The owner controls the payment options

depending on the needs of the beneficiaries, but the

procedural rules of the policy should be followed

carefully.

The insurance contract lists the schedule of cash

value over time, if any. The cash value is a close

approximation of the policy’s gift tax value. If a

policy is a participating type, it will stipulate how the

dividends--the nontaxable return of excess premiums--

will be paid. It describes the various options that are

available for dividends, such as cash payments, paidup additions, retention of premiums with interest, and

others.

In the event that premiums are not paid in a timely

manner, most permanent insurance provides for a

period of extended coverage as term insurance. This

is generally not the preferred method. If the owner

decides to stop paying the premiums on the policy,

paid-up insurance can be obtained instead of cash.

The insurance policy will spell out the procedural

rules for making an assignment of the policy. This

normally must be done in writing and must be

received by the company to be effective. Many newer

policies have special provisions for so-called “living

benefits” that are available when the insured contracts

a terminal illness. In effect, the insured draws on the
death benefit during his (her) life to cover living

expenses associated with the final illness.

Permanent insurance (as compared to term) permits

the policy owner to borrow a specified proportion of

the policy’s cash value. The contract has a guaranteed rate that is available to the policyholder and is

normally below the rate charged by commercial lenders. There are also various options for loan repayment, as well as provisions for premium payment

with loan proceeds.

D eJinition of Life Insurance.--Life insurance is

defined for tax purposes--estate, gift, and income--in

Internal Revenue Code (IRC) Section 7702. The

applicable test is basically the distinction between

contracts of life insurance and thinly veiled investment vehicles. If an insurance policy fails to meet

the test, the pure insurance component--the difference

between the cash surrender value and the death

benefit--is treated as term insurance for tax purposes.

The cash surrender part is treated separately with the

income being taxable to the insured. More importantly, all income--not only that from the current year

but also that earned in prior years--will be included

in gross income and taxed to the policyholder at

ordinary rates. Income is defined in this context as

the amount by which the net surrender value less the

cost of insurance exceeds the premiums paid less

dividends credited, if any. If a policy is disqualified,

the pure insurance portion--the excess of the death

benefits over the net surrender value--will qualify for

the income tax exclusion. Thus, buying an investment contract disguised as an insurance policy carries

the added risk of disqualification by the Internal

Revenue Service (IRS). If life insurance is needed,

a forest landowner should buy an appropriate policy.

The types of policies are described below.

Estate’s Needs

The estate’s needs should be considered, the

alternatives for meeting family needs should be

evaluated, and the economy of meeting these needs

with insurance should be considered.

retirement. For young couples, insurance can create

an instant estate for the surviving spouse and children

in the case of untimely death.

TYPES OF INSURANCE

Insurance comes in many combinations of pure protection (term) and types of investment. Term insurance is the cheapest and provides the greatest protection per dollar invested in the short run. It may not be

the best vehicle over time because the rates increase

with the age of the insured and a person may become

uninsurable. Term insurance is a means of deferring

risk until the owner can afford higher cost, investment

component policies. The ultimate choice of pure

insurance versus insurance with an investment component depends on the opportunity for sound outside

investments, the tax effects (including both the rates

and whether the investment component gets tax-free

buildup), the premium cost and amount of cash buildup, and finally, the probability of the insured dying

with the policy in force. Cash buildup in a policy

reduces the actual death benefit, but at the same time,

it increases the pool of funds against which the insured

can borrow at a low, favored rate for any purpose.

Term Insurance

Term insurance is purchased for pure protection.

Policy premiums are related directly to probability of

death. It is sold in fixed-benefit policies with

increasing premiums or decreasing term policies with

fixed premium payments. Some policies may be converted to whole life (see below) without a physical

examination, which guards against the problem of

insurability. The primary characteristic of term insurance is low-cost protection, and it is most suitable for

an insured who needs large amounts of coverage for

short periods of time--for example, a young, married

couple who have young children. Reducing term

policies are often a good idea in conjunction with

mortgage redemption, installment contracts, or other

short-term loan repayments.

uses

Whole Life Insurance

Insurance may provide equity for absentee heir(s)

who have chosen to live and work away from the

timberland. Insurance can provide liquidity to pay

estate or other debts, protect a dependent’s income

stream, and perhaps accumulate funds for the parent’s

Whole life combines a cash value with pure protection. Payments in early years exceed the cost of

pure protection. The saving-investment element of

insurance found with whole life policies should be

76
compared with alternative saving opportunities. With

ordinary life policies, the insured pays a fixed

premium for life. Generally, the death benefits are

fixed, there is a fixed maturity date, fixed premiums,

and a fixed buildup of cash values. This is the most

common type of policy, because it provides protection, some investment, and a source of emergency

funds for young, single persons and newly married

couples.

Other Insurance

Numerous options are available for specialized

needs, but all should be compared with alternatives.

The Technical and Miscellaneous Revenue Act

(TAMRA) of 1988 not only changed the definition of

insurance, but it also instituted income tax changes

for policies that fail a seven-payment premium test.

The Act created a new category of policy called a

modified endowment contract (MEC). An MEC

satisfies the life insurance test but fails the premium

test. That is, the cumulative amount paid on the

policy exceeds the sum of the net level premiums that

would have been paid if the policy contract had provided for paid-up future benefits after the payment of

seven level premiums. Loans and partial withdrawals

are taxed on a last-in, first-out (LIFO) accounting

basis. Earnings are treated first and are taxable. In

addition the insured has a lo-percent, early withdrawal penalty for withdrawals made before age 59

l/2. This penalty also applies to insurance policy

terminations.

Single premium policies were hit hard by TAMRA

because they were primarily designed for the investment component. They are attractive to investors for

the tax-free buildup and estate-tax-free transfer of

assets. They also avoid probate and challenges to the

decedents’s will. Universal life, limited payment life,

and single premium life policies with a high investment component have similarly been restricted by

changes in the definition of life insurance under

TAMRA (IRC Section 7702). Universal life and

variable life policies separate the cash value and term

protection elements of whole life. The investment

option will cover the term insurance portion of the

premium. If the investment side of the policy fails to

earn enough for the insurance portion, then additional

premiums are required or the death benefit is

reduced. These are most attractive to high-income

individuals who want the tax-free buildup.

77

Spousal or second-to-die insurance is used to pay

the estate tax liability of the surviving spouse. It is

often used in conjunction with charitable remainder

trusts (see example 8.7) to replace the principal that

went into the charitable trust. First-to-die insurance is

often used in buy-sell agreements to balance the interests of the heirs who choose to live in other areas with

those who choose to live on the tree farm and continue

to help with the day-to-day management.

ESTATE

Proceeds

As noted

AND GIFI- TAX CONSIDERATIONS

above, life insurance proceeds are included

in the gross estate if payable to the estate or, if payable to others, from policies in which the decedent

retained “incidents of ownership.” Transfer of policy

ownership within 3 years of the decedent’s death, as

discussed in chapter 8, will also result in a policy

being included in the decedent’s estate, together with

any gift tax paid.

Example 10.1. The taxable estate of a landowner

was exactly $600,000 after careful estate planning.

Unfortunately, the decedent forgot about an insurance policy of $100,000 that he owned and which

was payable to the estate to take care of beneficiaries’ needs. The policy was includable in the

decedent’s estate, and the $100,000 that the decedent had intended for the heirs’ benefit actually

amounted to $63,000. This difference accounts for

Federal estate tax only, and additional State death

tax may be due. To avoid this problem all

“incidents of ownership” must be transferred out of

the insured’s control more than 3 years before the

date of death. The recipient must not be under any

obligation to the estate for the proceeds or they will

be drawn back into the estate. The term “incidents

of ownership” is emphasized because it is defined to

include the power to change the beneficiaries, cancel

the policy, assign it, pledge the policy for a loan, or

borrow against the cash value. The insured should

not pay the premiums on the policy within 3 years

of death after giving up ownership. Gifts of cash or

income-producing property to the policyholder on

the insured’s life should not be in amounts or timed

so as to have the appearance that the insured is

supplying funds for the premiums.
Transfers of Ownership

A transfer of insurance policy ownership results in

a gift roughly equal to the cash value of the policy.

The value of the gift of insurance is the cost of

replacing the policy--the cash surrender value. The

insurance company will supply the amount on

request. This amount is generally much smaller than

the face amount of the policy when it endows (that is,

becomes paid up).

Premiums paid by the insured on his (her) life for

a policy owned by the beneficiaries constitutes a taxable gift even though the donee’s rights are conditioned on their surviving the insured. The $10,000

annual gift tax exclusion is available for the transfer

of the insurance policy and for making gifts of the

premium payments. If the payment is for premiums

of insurance held by a trust, the gift is treated as a

future interest and the annual exclusion is not available. The unified credit can be used to cover the gift

and premium payments. If the donor makes a split

gift of insurance or premiums within 3 years of

death, there is an exception that expressly exempts

the transfer of life insurance [IRC Section

2035(b)(2)1.

If the policyholder dies before the insured, the

value of the unmatured policy is included in the

policyholder’s estate. The value is the interpolated

term reserve; the insurance company will provide the

amount.

To avoid problems of inclusion, a younger family

member should be made the owner, or the insurance

should be put in trust. The trustee of a revocable

trust should not be designated as beneficiary nor

should a policy be subject to a loan. Both situations

cause problems.

CHOICE OF BENEFICIARIES

(INCLUDING CONTINGENCIES)

Tax Lability

Beneficiary designation is especially important in

determining if policy proceeds are subject to Federal

estate tax. The policy owner has nearly complete

freedom in naming a beneficiary. Should it be the

spouse, the estate, the executor of the insured, the

trustee of either a lifetime trust or a testamentary

trust set up by the insured, or one or more

individuals?

If proceeds are made payable to the executor of the

estate, they are includable in probate and increase

administration cost, and estate tax, if taxable. This

action will not hurt tax wise if the estate tax is

deferred by virtue of the marital deduction. But, there

is a better way.

Beneficiary Designation

Beneficiary designation is extremely important in

determining the overall plan for the distribution of

assets. It should be coordinated with the will, any

trusts established, and the overall plan.

A responsible individual (family member), who can

be trusted to make the proceeds available to meet the

estate’s liquidity needs, will keep the proceeds out of

probate. If the owner does not have an individual in

whom he (she) has confidence, a trust should be considered.

Normally, the spouse is named the beneficiary with

the children listed as contingent beneficiaries. Doing

so will avoid probate and, generally, State death taxes.

However, if the children are minors, a guardian will

have to be appointed for each with added expense ani

complications.

Insurance Trusts

An insurance trust can combine the flexibility of

trusts with the protection advantages of insurance. It

may be funded or unfunded, revocable or irrevocable;

testamentary trusts are possible. The key advantage of

naming a trust as beneficiary is greater flexibility in

distributing the proceeds to meet the needs of the

family. There is also the ability to put restrictions and

limitations on use of funds for beneficiaries under

other settlement options. The need for guardians for

minor beneficiaries can be eliminated in most cases,

subject to State law. The trust can eliminate the

second estate tax for life insurance beneficiaries.

Depending on the goals of the grantor, the trustee can

be authorized to accumulate income and have broad

investment discretion for the benefit of the family.

The flexibility and use of restrictions are perhaps most

important and must be balanced against the costs,

broadly defined, of using a trust.

An Irrevocable Insurance Trust.- -Th e advantages to

be gained are avoidance of estate taxes, avoidance of

probate, and possibly avoiding State death tax. The

reasons noted above for choosing a trust also apply.

An irrevocable trust has two big problems for the

78
grantor that were discussed in chapter lo--loss of

control and the gift tax liability in establishing the

trust. These are complex problems and should be

considered with the expert advice of an estate planner

who is familiar with both trusts and insurance.

OTHER CONSIDERATIONS

Settlement Options

Life insurance proceeds may be received under

four basic options: (1) interest--paid for a limited

time and then another option is selected, (2) fixed

period--equal installments paid for a fixed period at

a guaranteed rate, (3) fixed income--amount is fixed

for a specific period after which the balance is payable under some other option, and (4) life income--an

annuity for life. The choice is basically a gamble

and, once made, involves rigidity not present in a

trust. An insurance specialist should be consulted in

arriving at the best choice for meeting the individual’s objectives.

Replacing Policies in Force

Replacing policies in force is rarely advisable due

to new acquisition costs, policy value increases with

age, a contestable period, unequal dividends, unequal

cash values, and replacement by policies of a different type.

HOW MUCH INSURANCE IS ENOUGH?

The choice of how much insurance to purchase is

highly subjective, but there are some guidelines that

can be followed in reaching a logical, affordable, and

common sense decision. Avoid rules of thumb such

as the lo-times-earnings rule.

stream that requires replacement if the generator dies

prematurely. First, information about the family

assets and liabilities and the family estate plan should

be assembled. What are the family’s goals and

aspirations? Then, the net value of the assets and

liabilities should be projected for a reasonable planning

horizon. A 5-year horizon should be sufficient, but

not more than 10 because anything more than 10 years

is pure guesswork. The effects of an untimely death

of the primary breadwinner should be calculated--such

as estate taxes, administration costs, funeral expenses,

and family income needs due to the loss of his (her)

salary and leadership. The status of the liquid funds

needed to maintain the family’s standard of living

should be evaluated. That is, will the family have to

cash in principal in the form of savings accounts or

harvest timber to meet the deficits? What are the

family’s goals for shelter, college, retirement,

recreation, more timberland, or better management of

what is owned?

If the primary income producer should happen to die

before the family goals are met through hard work,

how much and what kind of insurance is needed to

protect the family? There are two basic courses of

action if the resources are not sufficient to meet the

goals--increase earnings or reduce costs and goals.

Insurance can fill some of the gaps.

Periodic Review

The policies should be reviewed periodically so that

adequate coverage will continue to be provided at

affordable cost. Also, the steps that are outlined

above should be reviewed periodically. What are the

resources? What are the goals? Can the resources

(timberland, growing stock, and capital) be increased

to produce the income (growth) that is needed to meet

the family’s goals?

Minimum Standard

Income Producer

The insurance should be concentrated on the person

who generates the family income. This is the income

Use insurance to bring income protection up to the

minimum level desired to assure a particular standard

of living.

79

Chapter 12

Installment Contracts

GENERAL PROVISIONS

If certain conditions are met, the gain recognized

on an installment sale of real property can be spread

over the duration of the contract for income tax purposes. An outright sale, on the other hand, triggers

immediate recognition of all gain in the year of sale

for income tax purposes. Although the 1987

Revenue Act repealed the installment sale method of

reporting for dealers in real and personal property, it

specifically exempted sales of property used or produced in the trade or business of farming as defined

in Sections 2032A(4) and (5) of the Internal Revenue

Code (IRC) (see chapter 13). This definition of

farming includes timber growing.

In addition to the income tax advantages, installment sales can also be a good estate planning tool.

Their use has become much more prevalent in recent

years for facilitating the lifetime transfer of farm and

forest property to succeeding generations, while

deferring recognition of gain to future years.

Basic Requirements

The former requirements that an installment obligation must have two or more payments spread out over

at least 2 tax years and that the payment(s) in th e

year of sale not exceed 30 percent of the selling price

were repealed in 1980. Now the installment method

of reporting gain is available when at least one payment is to be received after the close of the taxable

year in which the sale occurs. No payment is

required in the year of sale, although one or more

can be made. The installment method is available

only for reporting gains; losses cannot be deferred

but must be recognized in the tax year of the sale.

Paym ents in th e Year of Sale.--Payments in the

year of sale include down payments made in a prior

year as well as payments received in the year that the

benefits and burdens of ownership pass to the buyer.

This is usually the year of transfer of possession, or

the year of title passage, whichever occurs first.

Example 12.1. Suppose a forest landowner agrees

to sell his tree farm for $150,000 and receives a

down payment of $2,000 on September 15, 1992.

The first installment payment of $25,000 is received

on April 30, 1993, and possession is given to the

buyer at that time. A total payment of $27,000 is

reportable as income by the seller in 1993.

Restrictions

Certain restrictions on the use of installment sales

should be noted. For example, a sale of depreciable

property between related persons, as defined in Section

1239(b) of the IRC, cannot be reported by the installment method unless it is established that the transaction did not have as one of its principal purposes the

avoidance of taxation. Another restriction governs the

sale of nondepreciable property between related parties

and then a resale by the purchaser. If the purchaser,

in turn, sells the property before the installment payments are made in full, the amount realized by the

related party second seller from the second disposition

is treated as being received by the initial seller at that

time. In other words, the first seller’s gain is accelerated to the extent of the payment received by the

second seller. In many cases, however, because of the

specific provisions governing the resale rule, the

related party restrictions will not apply if the second

sale takes place more than 2 years after the first. A

related person includes a spouse, child, grandchild,

parent, grandparent, brother, and sister; and corporations, partnerships, and estates that are 80 percent or

more owned by such persons.

Mechanics of the Election

If the eligibility requirements discussed above are

met, the installment method of reporting income is

automatic for sales of real property and casual sales of

personal property unless the taxpayer elects out of

such a reporting method. This “negative” election

recognizes that almost all taxpayers prefer the installment method of reporting income when possible. An

election not to use the installment method must be

made on or before the due date, including extensions,

for filing the taxpayer’s return for the tax year in

which the installment sale occurs.

81
Computing the Gain

In order to compute the portion of each installment

payment that will be reported as gain, the selling

price (the contract price) and the gross profit must be

determined. The selling price includes the amount of

the down payment, the face value of the installment

obligations, and the amount of any liability or

indebtedness that the purchaser assumes. Gross profit is the difference between the selling price and the

seller’s basis in the property. The contract price is

the selling price less the amount of liabilities or

indebtedness assumed by the purchaser. However, if

the liabilities or indebtedness exceeds the seller’s

basis, the excess is not subtracted from the selling

price to calculate the contract price. Once the gross

profit and contact price have been calculated, the

percentage of each payment to be reported as gain is

determined by dividing the gross profit by the contract price. The following example illustrates the

computation procedures:

Example 12.2. The taxpayer decides to sell 150

acres of timberland on the installment method and

enters into an agreement providing for a $20,000

down payment, annual installments of $7,000 each

over a period of 10 years, a final balloon payment

of $25,000, and assumption by the purchaser of a

$65,000 mortgage. The taxpayer’s basis in the

property is $50,000 and sale expenses are $5,000.

The calculations are as follows:

Selling price

Down payment

Total annual installments

Balloon payment

Assumption of mortgage

Selling price

Gross profit

Selling price

Adjusted basis

Gross profit

Sale expenses

Gross profit to be realized

Contract price

Selling price

Mortgage assumed

Subtotal

Mortgage exceeds basis

Total (contract price)

$ 20,ooo

70,000

25,000

65.000

$180,000

$180,000

- 50,000

130,000

- 5,000

$125,000

$180,000

- 65,000

115,000

+ 15,000

$130,000

The percentage gain on each payment is:

$125,000/$130,000=96.2%.

ESTATE PLANNING CONSIDERATIONS

Advantages

An installment sale contract may be an ideal tool for

parents to use if they wish to begin lifetime transfers

of forest land to their children. Such contracts may be

particularly attractive to a surviving spouse wanting to

avoid heavy involvement in management of the tree

farm. In this regard, the following can be accomplished: (1) an interest in the property as security can

be retained by keeping the title, (2) a steady, annual

income can be received for the duration of the

contract--with income not subject to the social security

tax or reducing social security benefits, (3) management responsibility can be transferred to the children,

(4) an opportunity for the children to acquire an interest in the property with a low down payment can be

provided, (5) the size of the estate can be reduced by

consuming or making gifts of the installment payments

received, and (6) because the contract value is fixed,

further increases in value after the contract is signed

will not increase the size of the estate.

Disadvantages

There may also be certain disadvantages associated

with an installment sale from parents to children that

should be considered. For example, the parents may

outlive the term of the contract and then have to

depend on other sources of income. Inflation may

elevate the parents’ cost of living to a point where they

will have difficulty living on the fixed-contract payments. Although an installment contract reduces the

uncertainty of available annual income, it increases the

uncertainty of outliving one’s assets.

Other Considerations

It is necessary to give careful consideration to

establishing the price and terms in an installment sale

in order to further the objectives of transferring future

appreciation out of the parent’s estates, and facilitating

transfer of ownership and management control from

one generation to the next. If the price is too high or

the terms too inflexible, the purchaser may be unable

to meet the payments. If the price is too low, the

transaction may be characterized as part sale and part

gift, thus making the sale subject to gift tax as well as

income tax.

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If the parents are concerned that the child

(children) purchasing the tree farm will have difficulty in generating a sufficient cash flow to finance

the purchase, they may wish to establish a selling

price below market value. The danger of this, however, is that transfers for inadequate consideration

will be treated as gifts to the extent that the fair

market value of the property exceeds the sale price.

Because transfers of property between family members will be carefully scrutinized to determine

whether a gift has occurred, unless a gift is intended

the parties must structure the sale to insure that it has

the characteristics of a business transaction.

Although many court decisions suggest that the sale

need not be at the top of the market in order to avoid

characterization as a gift, the parties should proceed

with caution. Because the gift tax statute of limitations does not begin to run until a gift tax return is

filed, there is always the danger that the IRS will

examine the transaction many years later, perhaps

during an estate tax audit, and contend that the sale

was in fact a gift. For that reason, it might be advisable, if the sale is substantially below market, to file

a gift tax return at the time of transfer.

Use of Installment Sales to Facilitate Gifts

On the other hand, an installment sale may facilitate the gifting of forest property by making it possible for the parents to convey the woodland to a child

or children and avoid the gift tax by keeping annual

gifts to each child within the $20,000 split gift tax

exclusion amount. For example, if the parents have

already used their unified credit against gift taxes and

wish to give the tree farm to their children, the value

of the gift in excess of $20,000 per child would be

subject to gift tax. If the parents wished to stay

within the $20,000 limit, they would have to convey

the property a few acres at a time or give small fractional interests, neither of which are very suitable

alternatives. An installment sale, however, can provide a vehicle for immediate transfer of the woodland

to the children while making it possible for the

parents to stay within the exclusion amount for each

child.

For example, the property may be conveyed in

exchange for $10,000 principal amount, interestbearing notes, payable semiannually. If the parents

wish to make a gift to the acquiring child, they may

forgive the notes as they become due. Caution must

be exercised, however, so that the IRS will not

contend that a gift of the entire value of the property

occurred in the year of sale. There should be no

problem if the notes are legally enforceable and subject to assignment or sale to third parties, if the

property is subject to foreclosure in the event of

default, and if the parents have no legal obligation to

make annual gifts to the children [see Estate ofKelZ ey,

63 TC 321 (1974); and H udspeth v. Com m issioner,

509 F2d 1224 (9th Circuit 1975)].

INSTALLMENT OBLIGATION

DISPOSITIONS AT DEATH

Income Tax Basis

Generally, upon death of a property owner, the

property receives a new income tax basis (the so-called

“stepped-up basis”), and the potential gain or loss is

eliminated. But on the death of a seller within the

term of an installment sale transaction, the installment

obligation as an asset of the estate does not receive a

new basis. Payments received after death are reported

in the same manner, for income tax purposes, as the

seller would have done if living. There is, however,

a deduction for the estate tax attributable to the obligation. This feature may pose an income tax disadvantage compared with retention of the property

until death. The disadvantage is greatest for property

that has appreciated substantially in value.

Transfer to the Obligor

Previously unreported gain from an installment sale

will be immediately recognized by (become part of) a

deceased seller’s estate, if the installment obligation is

transferred by bequest or inheritance from the decedent to the obligor (purchaser) or is canceled by the

seller’s executor. For example, suppose a father sold

10 acres of woodland to his only son, John, in 1990

for $96,000 using an installment sale. After receiving

the first two payments under the contract, the father

died with the contract passing to John by inheritance.

All unreported gain in the installment obligation would

be taxable to the father’s estate.

In order to avoid this result, installment obligations

could be bequeathed to family members other than the

obligor. This would mean that family members

would own each other’s installment obligations but not

83
their own and that payments would have to continue

to be made. Another possible method of avoiding

acceleration of income to the estate as a result of a

disposition of an installment obligation to the obliger

might be to provide that the obligation be transmitted

to an irrevocable trust in which the obligor is a

beneficiary. The obligor would have to continue to

make payments that would constitute income to the

trust, but the estate could argue that no taxable

obligation had occurred because the trust has to be

treated as a separate taxpayer.

INSTALLMENT SALES BY THE ESTATE

A different rule applies if the estate is the seller

under an installment obligation. In that case, distribution of the obligation to the heirs causes immediate

taxation of the gain in the obligation under all circumstances. For some assets with a new income tax

basis received at death, the amount of gain may be

little or none. But if the sale involves timber property

that had been valued under special use valuation (see

chapter 13), the amount of gain could be substantial.

The new basis at death would only be up to the value

set for Federal estate tax purposes--in this case, special

use value--and not up to fair market value.

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PART III

APPLICATION OF FORESTRY-SPECIFIC ESTATE PLANNING TOOLS

85

Chapter 13

Special Use Valuation

Section 2032(A) of the Internal Revenue Code

(IRC) permits certain real property to be valued for

Federal estate tax purposes on the basis of its

“current use” rather than at “highest and best use.”

This is commonly termed “special use valuation.”

Real property may qualify for special use valuation if

it is located in the United States and is devoted to

either (1) use as a farm for farming purposes or (2)

use in a closely held trade or business other than

farming. In either case, there must be a trade or

business use. Personal property also qualifies for

special use valuation if it is used in connection with

eligible real property.

The term “farm” is defined to include woodland.

The term “farming purposes” includes the planting,

cultivating, caring for, cutting down, and preparing

for market of trees. The qualified property to be

specially valued includes buildings, structures, and

improvements functionally related to the qualified

use. Unrelated items of value, such as mineral

rights, are not eligible.

REDUCTION IN VALUE

Special use valuation cannot reduce the fair market

value of the gross estate by more than $750,000. If

the woodland in question was owned by both

spouses, the $750,000 limitation applies to each

estate. Consequently, a reduction in value of up to

$1.5 million is available. This can have a profound

effect on application of the unlimited marital

deduction to a forest estate.

Community Property

The full statutory reduction in value ($750,000) is

allowed for a decedent’s community property interest

in timberland, even though the decedent made no

contribution to the property (Letter Ruling 8229009).

Revenue Ruling 83-96 applies the same rule to all

community property eligible for special use valuation.

QUALIFYING CONDITIONS

In the right situations, special use valuation of tree

farms can save substantial amounts of estate taxes.

Careful planning--both predeath and postdeath--will be

required, however, in order to qualify and receive the

maximum benefits. There are six major predeath

requirements, as follows:

(1) The decedent must have been a resident or

citizen of the United States, and the property

must be located in the United States.

(2) The property must pass to a qualified heir or

heirs.

(3) The decedent and/or a member of his (her)

family must have owned the qualifying property for at least 5 of the last 8 years immediately preceding the decedent’s death; and

during at least 5 years of such ownership, the

qualifying property must have been used for

farming or a closely held business purpose--to

include timber growing--by the decedent and/or

a member of the decedent’s family, and have

been devoted to such use on the date of the

decedent’s death.

(4) The decedent and/or a family member must

have materially participated in the operation of

the property for at least 5 years during the 8

year period ending on the earliest of: (a) the

date of the decedent’s death, (b) the date on

which the decedent became disabled, provided

disability continued until the date of death, or

(c) the date on which the decedent began

receiving social security retirement benefits,

provided the benefits continued until the date of

death.

(5) The adjusted value of the real and personal

property qualifying for special use valuation

must comprise, at fair market value, at least 50

percent of the adjusted value of the decedent’s

gross estate.

(6) At least 25 percent of the adjusted value of the

decedent’s gross estate must be qualified real

property.

Requirements 2 through 6 will be discussed in more

detail in the following paragraphs.

Qualified Heirs

The term “qualified heir” is defined as an ancestor

of the decedent; spouse of the decedent; lineal descendent of the decedent, of the decedent’s spouse, or of

the decedent’s parents; or the spouse of any such lineal

87
descendent. Where there is a further disposition of

any interest in the property from a qualified heir to a

member of the qualified heir’s family, such member

of the family must also meet the definition of

“qualified heir. ” In interpreting this provision, the

Tax Court has held that the nephew of a decedent’s

predeceased spouse was not a qualified heir because

the nephew was not a lineal descendent of the decedent’s parents, but rather was a lineal descendent of

the decedent’s spouse’s parents (Z.M. Cone Estate, 60

TCM 137, TC Memo 1990-359).

Possible Passage to Nonq uali$e d H eirs. --All

interests in the property to be specially valued must

pass to a qualified heir or heirs. Any possibility that

all or part of the property may pass from the decedent to a nonqualified heir will render the property

ineligible. For example, the power existing in a

trustee or executor to use discretion to place property

either in trust for qualified heirs or in trust for

nonqualified heirs will destroy eligibility (Letter

Rulings 8244001, 8441006). Also, the Internal

Revenue Service (IRS) regulations stipulate that if

successive interests are created in the property, such

as a life estate followed by a remainder interest,

qualified heirs must receive all interests. Nevertheless, the IRS has ruled that an estate could elect

special use valuation for property in which a qualified

heir received a life estate under the decedent’s will,

even though the heir also received the power to

appoint the remainder interest in the property to a

nonqualified heir. The election was allowed because

the heir executed a qualified disclaimer (see chapter

7 for a discussion of disclaimers) of the power of

appointment, thus causing the remainder interest to

vest in another qualified heir (Revenue Ruling 82-

140). Additionally, at least three court decisions

have held that, when unqualified heirs are in a

position to receive remainder interests, special use

valuation will not be precluded if the possibility of

receiving those interests is extremely remote (see D.

D avis IV Estate, 86 TC 1156; C. M . Clinurd Estate,

86 TC 1180; and L. Sm oot, Executor, CA-7, 9 0-l

USTC 160,002).

QZ 7P Trusts.--Proposed QTIP regulations (see

chapter 6 for definition and discussion of QTIP) may

have created a trap for the unwary in the use of a

QTIP trust to receive property for which a special use

valuation election is planned to be made in the surviving spouse’s estate. Under Proposed Regulation

20.2044-1(b), in order for property passing to a

QTIP to be eligible for special use valuation, the

remaindermen following the surviving spouse’s life

interest must be qualified heirs of the surviving

spouse, not of the decedent.

Qualified Use

The 5of-8-years requirement for predeath qualified

use will be met if either the decedent or a member of

his (her) family has utilized the property for the

required time in a qualified use. “Member of family”

is defined to include the same persons as are listed in

the definition of “qualified heir. ” The IRS has further

interpreted the qualified use requirement to mean that

the decedent or a family member must have borne

some of the financial risk (have had an equity interest)

associated with the operation (Technical Advice

Memorandum 8201016, 9-22-81). In furtherance of

this concept, numerous court decisions have held that

a cash lease of otherwise qualified property by the

decedent, particularly to nonrelatives, did not constitute a qualified use.

Projit- m ak ing Activity.- -Th e IRS has also mandated

that qualified use be synonymous with a profit-making

activity by the decedent (Letter Ruling 8820002).

Here the estate included forest land and a cattle

operation. Woodland was ruled ineligible because no

timber had been cut from it, there were no records of

regular inspections or maintenance activities, and there

was no showing of an intention by the decedent to

profit from timber growing and harvesting.

Ch ristm as Tree Ope rations. --In Letter Ruling

9117046, the IRS ruled that an executor of an estate

was entitled to make a special use valuation election

for a Christmas tree farm. The farm was qualified

real property because it was used for farming purposes. It was willed to qualified heirs who were

children of the deceased. The heirs also had

materially participated in the operation of the tree farm

for the required length of time by making all management decisions and performing substantially all of the

physical work..

Material Participation

The material participation regulations adopted under

IRC Section 2032(A) discuss in detail the factors to be

considered in determining whether the decedent and/or

a member of his (her) family materially participated in

operation of the property in question for the required

period of time prior to the decedent’s death. No

single factor is determinative; each situation stands on

its own set of facts.

88
Em ploym ent and Managem ent.- - Ph ysical work and

participation in management decisions are the

principal factors considered. At a minimum, the

decedent and/or family member must have regularly

advised or consulted with the other managing parties

(if any) on operation of the business. The decedent

and/or family member need not have made all management decisions alone but must have participated in

making a substantial portion of the decisions.

Production activities on the property should be

inspected at regular intervals by the participant.

Financial Risk.--Another factor considered in the

determination of material participation is the extent to

which an individual has assumed financial responsibility for the business. This includes the advancement of funds and assuming financial responsibility

for a substantial portion of the expenses involved.

Self- em ploym ent Tax.--Payment of self-employment

taxes on income derived from the business is also an

indicator of material participation. Although payment

of such taxes is not conclusive evidence, if they have

not been paid, material participation is presumed not

to have occurred unless the executor demonstrates

otherwise and explains why no tax was paid. With a

timber operation, of course, the presumption would

be that all timber income is capital gain under Section

63 1 of the IRC--not ordinary income--and, therefore,

not subject to the self-employment tax. Thus payment or nonpayment should not be a consideration

with respect to specially valued tree farms unless

timber sale receipts are reported as ordinary income.

O th e r Consid erations.- -The sole activities of either

the decedent or a family member must amount to

material participation at a given time, because the

activities of more than one person at a given time

cannot be considered in the aggregate. If nonfamily

members participate in the business, part time activities by the decedent and/or family members must be

pursuant to a provable oral or written agreement

providing for actual participation by the decedent

and/or family member(s).

Active Managem ent.--A special rule applies to

liberalize the material participation requirement with

respect to a surviving spouse who receives qualifying

property from a decedent in whose estate the property

was eligible for special use valuation, whether or not

such valuation was actually elected. Active management by the surviving spouse will satisfy the material

participation requirement for purposes of electing

special use valuation in the surviving spouse’s gross

estate. The IRC defines active management as the

making of management decisions of a business rather

than daily operating decisions.

Tree Farm Consid e rations.--Exam ple 7 of the IRS

Section 2032A material participation regulations

concerns a tree farm. Although not definitive of each

timberland situation, the example does provide an

insight as to how the IRS views material participation

with respect to woodland.

Example 13.1. [Regulation 8 20.2032A-4 (Example

711. K, the decedent, owned a tree farm. He

contracted with L, a professional forester, to

manage the property for him as K, a doctor, lived

and worked in a town 50 miles away. The activities

of L are not considered in determining whether K

materially participated in the tree farm operation.

During the 5 years preceding K’s death, there was

no need for frequent inspections of the property or

consultation concerning it, inasmuch as most of the

land had been reforested and the trees were in the

beginning stages of their growing cycle. However,

once every year, L submitted for K’s approval a

proposed plan for the management of the property

over the next year. K actively participated in

making important management decisions, such as

where and whether a precommercial thinning should

be conducted, whether the timber was adequately

protected from fire and diseases, whether fire lines

needed to be plowed around the new trees, and

whether boundary lines were properly maintained

around the property. K inspected the property at

least twice every year and assumed financial responsibility for the expenses of the tree farm. K also

reported his income .from the tree farm as earned

income for purposes of the tax on self-employment

income. Over a period of several years, K had harvested and marketed timber from certain tracts of

the tree farm and had supervised replanting of the

areas where trees were removed. K’s history of

harvesting, marking, and replanting of trees showed

him to be in the business of tree farming rather than

merely passively investing in timber land. If the

history of K’s tree farm did not show such an active

business operation, however, the tree farm would

not qualify for special use valuation. In light of all

these facts, K is deemed to have materially participated in the farm as his personal involvement

amounted to more than managing an investment.

The Sh e rrod Case.--The forestry example above has

been considered in at least one court decision (Sh e rrod

v. Com m issione r, 82 TC 40). At death, the decedent

(Mr. Sherrod) was the beneficial owner of nearly

1,500 acres of land. During the last 25 years of his

life, 1,108 acres were in timber, 270 acres in row

crops, and 100 acres in pasture. All of it was under

the exclusive management and control of the decedent

89
until 5 years before his death when he put the

property into a revocable living trust. Thereafter,

until the decedent’s death, management and control

were exercised by the decedent’s son who was one of

the trustees. Management activities included: (1)

negotiation of annual rental payments on the crop and

pasture lands; (2) contact from time to time with tenants and neighbors to check tenant performance and

to see if they were aware of any problem with respect

to the timberland; (3) supervision of the timberland

by personal inspection, and contact with the tenants

and adjoining landowners to protect against trespassers, insect infestation, and disease; (4) negotiation of timber-cutting contracts; and (5) payment of

property taxes. Timber harvesting consisted of selection cutting and all regeneration was natural. The

decedent personally supervised all logging by the

timber purchasers. The IRS argued that these activities did not rise to the level of a qualified use and

material participation because they did not include

construction of fire lines, pruning dead and

undesirable growth, and thinning--citing the forestry

example in the material participation regulations.

The Tax Court, however, held that the activities of

the decedent and his son did constitute a qualified use

and material participation because they had made

every managerial decision and had performed every

act necessary to carry on the business for the last 25

years. That these activities did not require a great

deal of time, were not extensive, and did not conform

in a number of respects to the forestry example in the

IRS regulations was immaterial. The court concluded

that the activities cited by the IRS as lacking were not

practical or financially feasible with respect to the

property in question--that management actions taken

on one woodland are not necessarily those required

for good management of another timber property.

i%e Mangels Case.--Timberland material participation has also been considered in at least one other

court decision (Mangels, DC Iowa, 4/22/86). Here,

for 6 years before the decedent’s death, her conservator, a bank, leased her timberland and pasture

on a cash basis to parties unrelated to her. The issue

was whether the material participation test was met.

The court ruled for the government. The conservator’s participation in the operations of the property

was insufficient to satisfy the threshold requirements

for material participation. No agent of the conservator did physical work on the property, and participation in management decisions was minimal.

The 50- and 25percent Tests

Several important considerations must be kept in

mind with respect to meeting the 50- and 25percent

tests. The determination of sufficiency of property for

both tests is based on fair market value minus mortgages and related liens. Increasing an existing mortgage or taking out a new one on property previously

qualified for special use valuation could cause the net

value to drop below one or both of the percentage

thresholds.

Partial Election.- -Th e special use valuation election does not have to be made for all the qualified

property used to satisfy the 50-percent test. The

25-percent test, however, must be met from property

actually elected for special use valuation.

Gift w ith in 3 Years of Death.--Nonqualified property cannot have been gifted by the decedent within 3

years of death in order to meet the 50- or 25-percent

eligibility tests. Any transfer of property within this

time period will be includable in the gross estate for

the limited purpose of determining the estate’s qualification for special use valuation.

Example 13.2. Mr. Tree Farmer, a widower, owns

a tree farm with a fair market value of $300,000

and a special use value of $150,000. His other

assets, which are not eligible for special use

valuation, have a fair market value of $400,000.

The total estate thus has a fair market value

of $700,000. On this basis, the tree farm

could not qualify for special use valuation

because its fair market value is only 42.9 percent

($300,000 + $700,000) of the fair market value of

the total estate. Assuming no change in asset value,

$100,000 would be subject to Federal estate tax at

Mr. Tree Farmer’s death. With the spec.al use valuation percentage requirements in mind, Mr. Tree

Farmer gifts $105,000 of securities to his only

child, using $95,000 of his unified credit. The fair

market value of the estate is now $595,000, with the

tree farm’s fair market value now comprising more

than half. Mr. Tree Farmer gives a sigh of relief--

he has just saved $33,300 in estate taxes--or so he

believes. Unfortunately, he has a heart attack and

dies 35% months after making the gift. The gift

will, therefore, be brought temporarily back into his

estate for the sole purpose of determining whether

the special use valuation percentage requirements

have been met. On this basis, the fair market value

of the tree farm as a percentage of total fair market

estate value once again drops below 50 percent.

9 0
Eligibility for special use valuation has been lost,

and the estate is liable for more than $33,000 in

unanticipated Federal taxes. If Mr. Tree Farmer

had died 3 weeks later, special use valuation could

have been elected with the result that no estate

taxes would be due.

ELECTION AND AGREEMENT

When making the special use valuation election and

signing the accompanying agreements, attention to

detail is necessary. Many elections have been voided

because of carelessness.

Election

The election for special use valuation is made on

Form 706 (U. S. Estate and Generation Skipping

Tax Return--see appendix) by checking the box

marked “yes” in the “Elections by the Executor”

section of the return. For timber properties, a second

election is also necessary by checking the woodlands

election box in part 2 of schedule A-l. The elections

may be made on a late-filed return if it is the first

return filed. In order to validate the election, an

estate must complete and file schedule A-l, and

attach all of the required statements and appraisals.

Schedule A-l contains the “Notice of Election” and

the “Agreement to Special Use Valuation.” The

“Notice of Election” provides the fair market value of

the property to be specially valued, its special use

valuation, and the method used for computing the

special use value. An estate may elect special use

valuation for less than all of the qualified property

included in the gross estate. However, as noted

earlier, real property for which an election is made

must comprise at least 25 percent of the total value of

the adjusted gross estate.

Corporate and Partne rsh ip Inte rests. --In order for

a decedent’s partnership interest in qualified property

to be eligible for the special use valuation election, 1

of 2 requirements must be met: (1) the partnership

must have had 15 or fewer partners, or (2) 20 percent

or more of the partnership capital interest (see page

98 for a discussion of partnership capital interest)

must be in the decedent’s estate. Eligibility

requirements for corporate interests are similar. The

corporation must have had 15 or fewer shareholders,

or 20 percent or more of the voting stock must be

included in the decedent’s estate.

Protective Election.- - W h en it is not certain that real

property meets the requirements for special use valuation, the estate executor may make a protective election to specially value the property, contingent upon

property values as finally determined. The protective

election is made by filing a notice of protective election with a timely filed estate tax return. If it is

finally determined that the property qualifies for

special use valuation, the estate must file an additional

notice of election within 60 days of the determination.

Tech nically Defective Elections. --If a timely special

use valuation election is made, and the estate tax

return, as filed, shows evidence of substantial compliance with the requirements relating to special use

valuation, the executor has a reasonable time--not to

exceed 90 days--in which to cure any technical defects

or flaws in the form of the election that would prevent

it from being otherwise valid. The 90-day period

commences following notification by the IRS that a

defect exists. Examples of such technical defects or

flaws are the failure to include all required information

in the notice of election and the failure to include

signatures of heirs with relatively small interests.

The Agreement

The “Agreement to Special Use Valuation,” which

is part 3 of schedule A-l of the Federal estate tax

return, must be signed by each person having an interest in the qualified real property for which the election

is made. It does not matter whether any of these persons are in possession of the property or not. In the

case of a qualified heir, the agreement expresses consent to persona1 liability for any additional estate tax

that may become due in the event of recapture due to

any of the postdeath requirements (as discussed on

page 87) not being met. Signees other than the

qualified heirs are not personally liable but must

express consent to collection of any such additional tax

from the qualified property.

Corporate and Trust Inte rests.- -Corporate interests

cannot be valued under special use valuation unless the

agreement contains a signature that binds the corporation. Signatures by shareholders or heirs in their

individual capacities is not enough (Technical Advice

Memorandum 8602007, 9/7/85). Similarly, a decedent’s interest that passes to a testamentary trust is

not eligible for special use valuation unless the trust

beneficiaries consent to be personally liable for the

recapture tax. The trustee’s signature alone is

91
insufficient (Technical Advice Memorandum

8802005, 9/29/87).

Tenants in Com m on.- -Th e Tax Court has held that

the IRS regulation governing the signing of the agreement is invalid insofar as it requires that all

individuals having tenancy in common interests in

property subject to a special use election sign the

agreements. The court noted that the surviving

tenants in the situation in question did not have “an

interest in the property” because only the decedent’s

tenancy in common interest was includable in his

gross estate and thus subject to the election.

VALUATION

In making the election, two valuations must be

determined for the affected property: special use

value and fair market value. Both must be reported

on the estate tax return. With respect to woodlands,

either bare land or standing timber or both may be

specially valued. Often, it is only by including some

or all of the standing timber on the property that the

50- and/or 25percent tests can be met. For a

detailed discussion of the procedures applicable to

fair market valuation of timber property, see chapter

4.

Alternate Valuation

When an estate elects to use the alternate valuation

date of 6 months after the decedent’s death (see

chapter 4 for a discussion of the alternate valuation

date) and also elects special use valuation, the special

use value must be determined as of the alternate

valuation date. The alternate valuation date must also

be used when determining whether the aggregate

decrease in value of the qualified property exceeds

the statutory limit of $750,000 (Revenue Ruling 88-

90).

Special Use Valuation of Woodlands

Timberland special use valuation procedures must

follow the general special use valuation rules applicable to farms, as set out in the IRS regulations. No

valuation procedures specifically applicable to woodlands are provided. Two methods of farm valuation

are described: the “farm” method and the “multiple

factors” method.

Farm Me th od .- -Th e farm method is the preferred

IRS special use valuation method. It is determined

by dividing the average annual gross cash rental for

comparable land used for the same purpose and

located in the same locality, minus the average annual

property tax for such land, by the average annual

effective interest rate for all new Federal land bank

loans. The average annual computations are to be

made on the basis of the 5 most recent calendar years

ending before the date of the decedent’s death.

Timberlands in the South are sometimes specially

valued under the farm method by using rental payments specified in long-term leases of forest lands to

forest product companies--when the details of such

leases for comparable forest property can be obtained.

If no comparable land can be identified for which

the average annual gross cash rental can be determined, the farm method may be used by substituting

the average annual net share rental. Obviously, this

has no applicability to forest land.

M ultiple Factors M eth od .--As an alternative to the

farm method, if no comparable rented timberland can

be documented, the executor may elect to value the

property using the multiple factors method. The regulations list the following factors: (1) capitalization of

income that the property can be expected to yield over

a reasonable period of time under prudent management, taking into account the soil and other features

affecting productivity; (2) capitalization of the fair

rental value of the land for farming purposes; (3) the

assessed property tax value in a State that provides

differential or use value property tax assessment procedures for rural land; (4) comparable sales of other

property in the same geographical area far enough

removed from a metropolitan or resort area so that

nonagricultural use is not a significant factor in the

sales price; and (5) any other factor which fairly

values the farm value of the property.

The IRS has ruled, with respect to the multiple

factors method, that the executor cannot select only

one of the factors enumerated above as the exclusive

basis of valuation unless none of the other factors is

relevant. Each factor relevant to the valuation must be

applied, although, depending on the circumstances,

certain factors can be weighed more heavily than

others (Revenue Ruling 89-30).

Tech nical Advice Mem orandum 9 328004. - -The IRS

recently (March 1993) addressed the valuation method

to be used for special use valuation purposes with

respect to a Douglas-fir tract included in a decedent’s

estate. The executor used the farm method, citing a

single property in the area that included woodlands

and that was leased on a cash basis. The IRS ruled

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that the two properties were not comparable and that

the executor thus was required to use the multiple

factors method of valuation. The memorandum discusses at length the applicability of the multiple

factors method to woodlands and how it is to be used

to specially value forest property.

W oodland Special Use Valuation.- -The special use

valuation election for forest land is directed toward

limiting the highest and best use of such acreage to

timber growing. Purely speculative and inflationary

components of value are designed to be eliminated by

the election. Factors 1, 3 and 4 above are the most

likely to apply to forest land. Of these, income

capitalization is probably the most often used factor.

This method of valuation, depending on the circumstances and characteristics of the property involved,

may actually result in a value lower than the current

market value for timber use.

POSTDEATH REQUIREMENTS

Certain requirements must continue to be met

during a lo-year recapture period measured from the

decedent’s date of death. If not met, a recapture tax

applies.

Continued Ownership within the Period

Ownership of the specially valued property must

continue solely within the decedent’s family, as the

term “family members” was defined earlier. Exceptions apply in the event of involuntary conversions or

tax-free, like-kind exchanges. With respect to the

former, however, the proceeds from the involuntary

conversion must be reinvested in real property that is

used for the same qualified use as was the involuntarily converted property. Similarly, property

received in an exchange must also be employed in the

same qualified use.

Material Participation

At least one member of the decedent’s family as

defined earlier must materially participate in

operation of the property during 5 of every 8 years

before the qualified heir’s death during the lo-year

period following the decedent’s death. The less

stringent active management test, as discussed on

page 83, may be substituted for material participation by surviving spouses, qualified heirs under the

age of 21, full-time students, or disabled persons. If

the property in question has been left in a trust to

which the surviving spouse is the life beneficiary and

other qualified heirs are the remaindermen, the surviving spouse is the qualified heir for purposes of

compliance with the material participation requirements (Letter Ruling 8652005).

Qualified Use

The property must continue to be used and managed for the qualified use. However, a qualified heir

may begin the qualified use at any time within 2 years

of the decedent’s death without triggering the recapture tax; the recapture period does not begin to run

until the qualified use begins. If property is left in a

trust to which the surviving spouse is the life beneficiary and other qualified heirs are the remaindermen,

the spouse is the qualified heir for purposes of compliance with the qualified use test (Letter Ruling

8652005).

Recapture Tax

The tax benefits realized by the estate when special

use valuation has been elected may be fully or partially

recaptured if one of the postdeath requirements discussed above fails to be met during the recapture

period. A second violation will not trigger a second

tax on the same qualified property, however. Thus,

when a qualified heir ceases to use the property for its

qualified purpose and later sells it during the recapture

period, a recapture tax will be imposed as to the first

event that triggers recapture, that is, cessation of use,

but not as to the second event (sale of the property).

Conservation Reserve Program Enrollment

Letter Ruling 8745016 discusses diversion of cropland to tree cover under the Conservation Reserve

Program (CRP). Here the qualified heir, for specially

valued farmland, converted the farmland from cropland to tree cover after enrolling in the CRP program.

The IRS ruled that such diversion is not a cessation of

qualified use so as to trigger the recapture tax.

Amount Subject to Recapture

The amount of the tax benefit potentially subject to

recapture is the estate tax liability that would have

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been incurred had the special use valuation procedure

not been used minus the actual estate tax liability

based on special use valuation. In other words, the

maximum additional or recapture tax is the amount

that special use valuation has saved the estate. This

is called the adjusted tax difference. The additional

tax will be less than the maximum if the fair market

value of the property interest in question--or the

proceeds from its arm’s_length sale--exceed the value

of the property interest determined under special use

valuation by less than the adjusted tax difference.

Payment of the Recapture Tax

The additional tax on recaptured property is due on

the day that is 6 months after the recapture event.

Interest runs from the due date (Revenue Ruling

81-308). However, if an election is made to adjust

the basis of the property in question to its fair market

value on the date of the decedent’s death, interest is

owed from the due date of the estate tax return.

Such an election is permitted under IRC Section

1016(c). If interest is paid, it is not deductible by

the original estate as an administrative expense. The

IRS reasons that the recapture tax and the interest on

it is not imposed in connection with a testamentary

transfer of estate property, but rather is a separate tax

imposed on the qualified heir as a result of the heir’s

own actions (Letter Ruling 8902002).

Recapture Lien

A government lien is imposed on all qualified

property for which a special use election has been

made and applies to the extent of any recapture tax

that may be imposed. It begins at the time the election is filed and continues until: (1) the tax benefit is

recaptured, (2) the qualified heir either dies or the

recapture period ends, or (3) until it can be established to the satisfaction of the IRS that no further

liability will arise. If qualified replacement property

is purchased following an involuntary conversion of

special use valuation property, the lien that was applicable to the original property attaches to the new.

Similarly, if specially valued property is exchanged

for qualified exchange property, the lien also attaches

to the new property. The IRS can subordinate the

government’s lien if it determines that the interest of

the United States will be adequately protected

thereafter.

Release from Recapture Tax Liability

A qualified heir’s liability for the recapture tax can

be extinguished in two instances: (1) if the recapture

period lapses and (2) if the heir dies without converting or disposing of the property. Additionally, a

sale or other disposition by one qualified heir to

another of specially valued property is not considered

a recapture event, and the second heir is treated as if

he (she) received the property from the decedent rather

than from the first heir. The second heir then

becomes liable for the recapture tax, and the seller is

released of further liability.

D isch arge from Liability.--An heir may be discharged from personal liability for future potential

recapture taxes by. furnishing a bond for the maximum additional tax that could be imposed on his (her)

interest in the property.

Timber and the Recapture Tax

Unfortunately, an onerous special rule applies to the

cutting of specially valued timber during the recapture

period. Any harvesting of such timber or the disposition to another of the right to harvest before the death

of the qualified heir will be termed a disposition of the

interest in the specially valued timber and, therefore,

trigger a recapture tax. The recapture amount will be

the lesser of: (1) the amount realized on the disposition (or if other than a sale or exchange at arm’s

length, the fair market value of the portion of the

interest disposed of), or (2) the amount of tax that

would be recaptured under the general recapture rules,

without regard to the woodland election, were the

entire interest in the qualified woodland disposed of.

The second of these requires that the computation be

made as if there had been a disposition of the land as

well, even though it was not actually disposed of.

The valuation of severed specially valued timber

for recapture tax purposes is discussed in detail in a

1983 Tax Court decision (D onald C. Pe ek , TC Memo

1983-224, TCM 1382). Calculation of the recapture

tax with respect to the sale of a tract of farm and

forest property is set out in Letter Ruling 8741048.

Designation of Specially Valued Tim b er.- -In most

instances, executors will probably choose not to specially value standing timber except as needed to meet

the 25- or 50-percent qualifying tests when there is

other property included, such as the underlying forest

land and/or farm acreage. Obviously, young timber

94
that would not be harvested during the lo-year recapture period should be utilized first for the special use

valuation election. The designation should be made

on an acreage basis, if possible, to avoid confusion as

to just which trees are included. If older timber is

also to be specially valued, the most feasible way

would be to do it on an acreage basis as well, for the

same reason--describing specifically the acres containing the trees to be so valued. Alternatively, the

distinction could be made by species or diameter

classes as they exist at the time of the election, but a

very careful description would be required. Specially

valuing a certain percentage of a stand’s volume--for

example, 50 percent of the merchantable volume that

exists in a stand at the time of election--should

definitely be avoided. A situation was related to the

authors in private correspondence where this was

done. The IRS accepted the election, but when the

executor decided to harvest some of the trees and

sought clarification from the IRS as to which trees he

could cut, he was confronted with an unexpected

problem. The executor wanted to cut the number of

trees whose volume would equal the percentage of

original stand volume not specially valued. The IRS

took the position, however, that the volume

breakdown applied to each tree--not to the stand as a

whole--and, therefore, part of each tree was specially

valued and the other part of the tree was not. This

meant that no trees whatsoever could be cut without

constituting a premature disposition and triggering a

recapture tax.

THE ELECTION DECISION

Like many other provisions that grant tax relief in

particular situations, special use valuation should not

be elected without careful thought and analysis. The

executor has an obligation to evaluate the election

because of its potential significant impact on estate tax

liability, and such an evaluation should not be avoided

merely because it may be difficult and complex. Like

many other provisions of tax law, its effects can be _

assessed only through mathematical application to the

circumstances of the particular estate in question.

The election may be used on a partial basis to control the valuation of only part of the estate, such as the

property for which the greatest reduction in value per

acre may be achieved, while leaving other property to

conventional valuation. Depending on the size and

nature of the estate, land that will provide the

maximum value reduction may be selected from

property intended to be retained in the family, while

preserving other property for future liquidation, if

desired.

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Chapter 14

Deferral and Extension of Estate Tax Payments

OVERVIEW OF THE ESTATE TAX

The estate tax is due and payable at the same time

the tax return is due, that is 9 months after the date

of death. It must be paid within the time prescribed

to avoid assessment of various penalties. Extensions

of time for payment may be granted, but such extensions, although preventing the application of certain

penalties, do not entirely negate the assessment of

interest.

Due Date

The payment due date is the same numbered day of

the ninth month after the date of death as that date

was of the month in which death occurred. If there

is no similarly numbered day in the ninth month, the

tax is deemed to be due on the last day of that

month. For example, if the date of death were July

3 1, the due date would be April 30 of the following

year.

Place of Payment

The law requires that the tax be paid, without any

assessment or notice by the Internal Revenue Service

(IRS), to the IRS office where the estate tax return is

filed. Unless the return is hand carried to the office

of the IRS District Director, it should be mailed to

the IRS Service Center for the State in which the

decedent was domiciled on the date of death.

Method of Payment

The tax may be paid by check or money order

payable to the IRS. If the amount of tax paid with

the return is different from the amount of the net

estate tax payable as computed on the return, the

executor should explain the difference in an attached

statement.

Flower Bonds

Treasury bonds of certain issues (known as

“flower” bonds) are redeemable at par (plus the

accrued interest from the last preceding date to the

date of redemption) upon the death of the owner, at

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the option of the estate representative. No treasury

obligations issued after March 3, 1971, will be

redeemable at par value for this purpose.

ESTATE TAX OPTION FOR

CLOSELY HELD BUSINESS INTERESTS

The estate of an individual who dies owning a

closely held business interest--including an interest in

timberland--may, by meeting certain requirements,

qualify for a special elective method of paying the

estate tax attributable to that interest. Under IRC

Section 6166, payment of the tax may be totally

deferred for the first 5 years, with the estate making 4

annual payments of interest only, followed by payment

of the balance in up to 10 annual installments of principal and interest. The maximum payment period,

however, is 14 rather than 15 years because the due

date of the last payment of interest coincides with the

due date for the first installment of tax. Election of

special use valuation as discussed in chapter 13 does

not prevent an election under Section 6166.

Percentage Test

The closely held business interest must comprise

more than 35 percent of the decedent’s adjusted gross

estate. It can be composed entirely of timber property, or partially include timberland, but must be an

active business. If special use valuation has been

elected by the estate (see chapter 13), that value is

used for purposes of determining whether the 35

percent test has been met.

Mortgage E.crs.--Insofar as the eligibility of an

ownership interest as a percentage of the decedent’s

gross estate is concerned, mortgages secured by real

property used in the business must be deducted. Eligibility is measured in terms of the net value of the

property in question and whether that value meets the

35percent threshold requirement. See IRS Letter

Ruling 8515010, which discusses the effect of a mortgage that encumbers both property used in the closely

held business and other property. The IRS here ruled

that the gross value of the decedent’s closely held

timber-growing business had to be reduced by that

portion of the outstanding mortgage attributable to it
for purposes of valuation under the Section 6166

installment provisions. The mortgage in question

encumbered both timberland and pasture. The rental

of the pasture by the decedent was determined to be

a passive activity, not the conduct of an active

business. The timberland was held to be an active

business, however, and an allocation of the mortgage

between it and the pasture on the basis of acreage

was therefore necessary.

Com bining Interests.--Interests in two or more

closely held businesses may be combined for purposes of meeting the 35percent test if more than 20

percent of the value of each is included in the gross

estate. The value of a surviving spouse’s interest in

property held as tenancy in common, tenancy by the

entirety, joint tenancy, or community property will be

counted in determining whether more than 20 percent

of the business was owned by the decedent.

Interest Payable on Deferred Tax

Interest on deferred tax is payable at a special,

low, 4-percent rate, compounded daily, on the portion attributable to the first $1 million in value of the

closely held business. After accounting for the unified

credit, this means that a maximum of $153,000 in tax

is covered by the 4-percent rate--a significant advantage for a qualifying estate. Amounts of deferred tax

beyond that level are subject to interest based on the

Federal short-term rate, also compounded daily.

Interest payments are deductible for income tax purposes or as an estate administration expense if also

deductible for that purpose under State law.

Making the Election

The election must be made on a timely filed estate

tax return containing the following information: (1)

the decedent’s name and taxpayer identification number; (2) the amount of the tax to be paid in installments; (3) the date elected for payment of the first

installment; (4) the number of annual installments,

including the first installment, in which the tax is to

be paid; (5) the properties shown on the estate tax

return that constitute the closely held business interest; and (6) the facts supporting the conclusion that

the estate qualifies for the deferral and installment

election.

Subsequent D ejk iencies.- -If th e election is made at

the time the estate tax return is filed, it will also

cover subsequent estate tax deficiencies determined

by the IRS that are attributable to the closely held

business. This is in addition to the estate tax

originally due with the return as filed.

Protective Election.- -If it is not certain at the time of

filing the return that the estate qualifies for the election, a protective election can be made. It will allow

subsequent deferral of any portion of the tax attributable to the closely held business that is shown on the

return, or deferral of deficiencies remaining unpaid at

the time values are finally determined. The protective

election must be made on a timely filed return. A

final election notice must then be filed within 60 days

after it has been determined that the estate qualifies for

the election.

Acceleration of Unpaid Taxes

Deferred tax payments are accelerated if more than

one-half of the value of the qualified business interest

is withdrawn or disposed of during the deferral period.

The same rule applies if funds or assets are withdrawn

that represent 50 percent or more of such value. For

this purpose, values are measured as of the date of the

withdrawal(s), not the date of death.

D e ath of Original H eir.- -Th e transfer of the decedent’s interest upon the death of the original heir, or

upon the death of any subsequent transferee who has

received the interest as a result of the prior transferor’s death, will not cause acceleration of taxes if

each subsequent transferee is a member of the transferor’s family.

D e linq uent Paym ents.--A delinquent payment of

either interest or tax will accelerate the due date of the

unpaid tax balance if the full delinquent amount is not

paid within 6 months of its original due date. The late

payment, however, will not be eligible for the special

4-percent interest rate. Additionally, a penalty of 5

percent per month of the amount of the payment will

be imposed.

Liability for Payment of the Tax

With a Section 6166 election, the estate representative is basically liable for payment of the tax. However, an executor or administrator seeking discharge of

liability may file an agreement that gives rise to a

special estate tax lien. The lien is against “real and

other property” expected to survive the deferral

period. The maximum amount subject to the lien is

the amount of deferred tax plus the first 4 years of

interest. All parties having an interest in the property

98
to which the lien is to attach must sign an agreement

to its creation.

Once filed, the lien is a priority claim against the

property, with some exceptions. These exceptions

are as follows: (1) real property tax and special

assessment liens; (2) mechanics’ liens for repair or

improvement of real property; (3) real estate construction or improvement financing agreements; and

(4) financing for the raising or harvesting of a farm

crop, or the raising of livestock or other animals.

What Constitutes a Closely Held Business Interest?

Sole Proprietorsh ips.- -Sole proprietorships may

qualify as closely held businesses. Assets, including

cash, must actually be involved in the trade or

business of the sole proprietorship before their value

can be included. Passive assets held by a sole

proprietorship are not considered in determining

value.

Partne rsh ips.- -If certain rules are met, partnership

interests may qualify. Either 20 percent or more of

the partnership’s total capital interest (see page 98 for

a discussion of partnership capital interests) at the

time of the decedent’s death must be included in the

decedent’s gross estate, or the total number of

partners must not exceed 15. The inclusion of the

value of passive assets held by a partnership is disallowed for purposes of the 35percent test. Partnership interests held by a decedent’s family are

treated as if owned by the decedent. Internal

Revenue Code Section 267(c)(4) defines the family of

an individual as including brothers and sisters (wholeor halfblood), spouses, ancestors, and lineal descendants. A husband and wife are considered as one

partner if the property is held as community property, tenancy in common, joint tenancy, or tenancy

by the entirety.

Corporations.--Corporate interests may also qualify

as interests in closely held businesses. In order for

a corporate interest to qualify, however, 20 percent

or more of the corporate voting stock must be

included in the decedent’s gross estate, or the total

number of shareholders must not exceed 15. Only

stock constitutes an interest in a corporate closely

held business. Corporate debt securities are not

interests. It is not necessary that the shareholder

decedent have been personally involved in the business in order for his (her) stock ownership to qualify

under Section 6166. As with partnerships, corporate

interests held by a decedent’s family are treated as if

owned by the decedent. The definition of family is

as noted above. A husband and wife are treated as

one shareholder if the stock is held as community

property, tenancy in common, joint tenancy, or

tenancy by the entirety.

Trusts.- -Th e installment payment IRC provisions

and IRS regulations do not refer specifically to trust

ownership of an interest in a closely held business.

The IRS, however, does recognize business interests

in trust as qualifying under Section 6166.

When is a Closely Held Business

an Active Business?

The line between what is and what is not an active

business is often a fine one. The required involvement

for installment payment purposes can be contrasted

with the material participation requirements for special

use valuation as discussed earlier. There are two key

differences between material participation for purposes

of special use valuation and the necessary activity for

purposes of Section 6166. For purposes of Section

6166, the question of whether the operation amounts

to an active business is determined as of immediately

prior to the decedent’s death. For special use valuation purposes, material participation by the decedent

or a family member is required for 5 or more of the

last 8 years before death, retirement, or disability,

whichever occurs earliest. It cannot be gained through

the services of an agent, such as a property manager.

On the other hand, even an unrelated agent, as well as

a family member, can assure the necessary degree of

involvement for purposes of Section 6166 (IRS Letter

Ruling 8020101). Section 6166 eligibility can also be

established through power of attorney (Letter Ruling

8134010).

D isq ualification Not Appealable.--An IRS determination that an estate does not qualify for a Section

6166 election because the decedent’s activities did not

constitute an interest in a closely held business is not

appealable to the Tax Court. See Estate of Sh e rrod

[82 TC 523, 85-2 USTC 13,644 (CA-ll)] in which

the decedent’s activities with respect to his timberland

were held by the IRS not to constitute an active trade

or business for Section 6166 purposes. The court

noted that its jurisdiction was strictly limited by statute

and that it did not have the authority to enlarge upon

the sole statutory grant of jurisdiction given to the IRS

with respect to Section 6166 eligibility.

Tech nical Advice Mem orandum 8437001 (M ay 9 ,

1984).--Here the IRS held that 5,126 acres of timberland owned by the decedent (comprising 87.7 percent

of the adjusted gross estate) did not qualify as an

interest in a closely held business within the meaning

of Section 6166(b)(l)(A) of the IRC. The decedent’s

99
activities with respect to the property included

visiting the property routinely to observe timber

growth and development, and to study the land and

its potential for raising timber; making management

decisions, such as whether to plant seedlings, when

to sell timber, whether to clear and replant after

cutting, and in general what forestry techniques were

best suited to his particular situation; negotiating

contracts for the sale and harvesting of timber;

observing cutting operations to insure compliance

with contract terms; and overseeing the maintenance

of roads and firebreaks, and the prevention of trespass. During a 6-year cutting contract, however, the

decedent had granted the contractor almost complete

control over the cutting operation and the property.

The IRS found that during this period the decedent’s

prerogatives with respect to the property were limited

to policing the cutting for the purpose of enforcing

the contract terms, and that the cutting arrangement

was thus similar to a “net\net” lease arrangement

wherein the lessor merely receives a net income

based on ownership of the leased property. This fact

was the overriding factor in the IRS conclusion that

the decedent’s relationship to his timber assets was

not that of a proprietor carrying on a trade or

business.

IR S Atlanta D istrict M em orandum .- -In an unnumbered and undated memorandum issued by the IRS

Atlanta District Oft-ice, the IRS held that the nature

and level of the decedent’s activities with respect to

his nearly 500 acres of timber property was insufficient to constitute an active trade or business for

Section 6 166 purposes. The estate representative’s

statements that the decedent had actively managed the

property in accordance with good forestry practices

was countermanded by an IRS appraiser who stated

that the timber was all natural; that none had been

planted; that there was no evidence of cutting in

recent years or of thinning; that the only firebreaks

were roads; and that here had been no prescribed

burning within the past 5 years. He concluded that

the decedent had just let the timber take its natural

course and that there was no evidence of forestry

practices.

Letter R uling 9 015003 (D e cem b er 22, 1989).--In

supplementing Letter Ruling 9001062, the IRS concluded that a decedent’s one-third interest in a timber

business held in trust qualified as an interest in an

active, closely held business for Section 6166 purposes. The property was under active forest management; daily operations and timber sales were carried

out by an independent forest management company.

The decedent, individually and through her agents,

participated in the decision-making process in running

the business. She and other grantors met annually

with the trustee and a representative of the forest management company to review the prior year’s forest

management activities, to discuss plans for the coming

year, and to make long-term plans. The decedent also

shared equally with the other grantors the income from

and the expenses of the business, and thus also shared

in the risks involved. For purposes of Section

6166(a), activities of an agent may be attributed to a

decedent. In this case, the trustee was the decedent’s

agent.

What Constitutes Withdrawal or Disposition?

Changes in organizational form do not terminate the

installment payment right if they do not materially

affect the business. Thus, incorporation of a sole proprietorship, a shift from sole proprietorship status to

partnership, liquidation of a corporation, and transfer

of a sole proprietorship to a limited partnership have

all been held not to accelerate payment. Installment

sale of property, however, will terminate Section 6166

status if the 50-percent limit is reached.

Converting cropland, for which a Section 6166 election is in force, to grass or tree cover under the

Conservation Reserve Program is not a withdrawal or

disposition (IRS Letter Ruling 9212001). The tax

attributable to the property will continue to be eligible

for deferral and payment in installments.

Lik e -k ind Exch ange.- -Th e transfer of assets in a taxfree exchange does not accelerate payment of tax that

has been deferred. In Letter Ruling 8722075, an

estate’s partition of an undivided interest in woodlands, followed by a like-kind exchange, did not affect

the 6166 election that was in force. Although more

than 50 percent of the property may have been transferred, depending on whose values were accepted, the

exchange did not materially alter the timber business

or the estate’s interest in the timber business. The

partition and exchange was, therefore, not a disposition for acceleration purposes.

Letter R uling 8437043 (June 8, 19 84). --The IRS

here held that a proposed sale of timber, comprising

51 percent of the closely held business interests and a

proposed 29-year lease of the land (comprising 35 percent of the closely held business interests) to a forest

products company would constitute a disposition under

Section 6166 (g)(l)(A). The estate, according to the

100
ruling, would be liquidating its active business

enterprise of timber production in exchange for an

arrangement in which it would merely hold the land

as an investment asset from which income would be

derived solely on the basis of ownership.

Planning Opportunities

Because the value of the closely held business must

exceed 35 percent of the adjusted gross estate, woodland owners seeking to qualify under Section 6166

should be familiar with the various elements that constitute the adjusted gross estate. If the value of the

tree farm is very close to 35 percent, consideration

should be given to increasing its value or decreasing

the adjusted gross estate during the decedent’s lifetime. In order to reduce the adjusted gross estate,

the types of expenses which may be deducted to arrive

at it should be reviewed for possible changes (see

chapter 3 for a discussion of adjusted gross estate).

Great care should be taken in deciding whether to

make gifts of assets in order to qualify for Section

6 166 treatment. Gifts made within 3 years of death

that would not normally be included in the gross estate

will be considered to determine if the 35percent

test is met. This provision was specifically designed

to prevent deathbed transfers intended to qualify the

estate for Section 6166 treatment.

Special use valuation should also be carefully evaluated. While its election will decrease estate tax

liability, its use may preclude qualifying for installment treatment. The value of deferring the estate tax

payments should be compared to the value of the

estate tax reduction.

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PART IV

FORM OF TIMBERLAND OWNERSHIP AND BUSINESS ORGANIZATION

103

Chapter 15

Sole and Joint Ownership Considerations

SOLE OWNERSHIP

Ownership of property in one name is normally the

simplest method and gives the holder the most complete ownership possible. Transfers are relatively

easy because the holder of title to the property has

the absolute right to dispose of it under most circumstances. In some cases, a spouse may have to

consent to the transfer of real property owned solely

by the other spouse because of the dower right available under the laws of some States. At death, solely

owned property passes under provisions of the will

or, if the decedent died intestate, according to the

provisions of State law. Federal estate and State

death taxes generally apply to the total value of the

property held in sole ownership. Outright ownership

of property is referred to as “fee simple,” the nearest

thing to absolute and complete ownership.

JOINT OWNERSHIP BETWEEN SPOUSES

A key estate planning element for family-owned

timberland is the manner in which the property is

held by husband and wife. Typically, the spouses

have worked together to accumulate and manage the

woodland. The result is a feeling of commonality of

ownership, and the intent that the property be

controlled by and applied to the use of the survivor

as long as he or she lives.

It is beyond the scope of this book to provide a

detailed discussion of the various methods of interspousal property holding among the 50 States. A

basic analysis of the application of estate and gift

taxes to property transfers within the marital community will, however, be presented.

Legal Development

The traditional English concept of jurisprudence

was that as long as both spouses lived, they represented a single unit of ownership, with this ownership

being represented by the surviving spouse after the

death of the other. A blending of this common law

concept of the legal unit of husband and wife with the

common law theory of joint ownership of property

led to the development of tenancy by the entirety.

105

The distinguishing feature of tenancy by the entirety is

that no partition or severance of the ownership of real

property or destruction of the survivorship feature can

be achieved by the unilateral action of either spouse.

Many States have abolished this concept as a form of

property holding; others have continued it, sometimes

with modifications.

Where tenancy by the entirety has been abolished,

common law joint tenancy may generally be utilized to

create property holdings between husband and wife

that have the survivorship feature. Joint tenancy

resembles tenancy by the entirety in that both entail a

right of survivorship. A joint tenancy, in addition,

may be created among nonspouses. Joint tenancy also

permits partition of the property at the will of any of

the cotenants, unlike tenancy by the entirety.

Community Property

Nine states--Arizona, California, Idaho, Louisiana,

Nevada, New Mexico, Texas, Washington, and

Wisconsin--derive their concepts of property holding

between husband and wife from the civil law rather

than from common law. These are the so-called

“community property States. ” The basic community

property concept is that all property acquired by the

spouses from the efforts of either during the marriage

belongs in common to both. Separate property is generally that received by either spouse by inheritance or

gift and that owned prior to the marriage. Generally,

in community property States, the surviving spouse is

protected to a greater degree in the succession to community property than in succession to separate property. The profits and earnings from community property, and in some cases from separate property, are

considered community as well.

Advantages of Joint Ownership

In many States, the probate procedure is perceived

to be so cumbersome, time consuming, and expensive

that joint tenancies are common. Joint property

holding tends to express the common feeling of joint

endeavor and mutual accomplishment enjoyed by

owners of farm, forest, and other rural properties. It has been commonly utilized as a substitute

for more complex business organization arrangements.
Survivorship property ownership arrangements can

offe r each the emotional and financial security of

knowing that the mutually acquired property cannot

be lost by the survivor, in whole or in part, upon the

death of the other. Additional advantages include the

ease of understanding and implementing the concept;

and the uncomplicated and inexpensive transfer

process.

Disadvantages of Joint Ownership

Basis Limitations.--Despite the valuable uses of

joint property holding arrangements between spouses,

there are potential problems--particularly with respect

to those estates that have values greater than the unified credit exemption equivalent. When spouses are

exclusively joint tenants in property, regardless of

which spouse provided the consideration for the

jointly held property, one-half of the value of the

property is included in the gross estate of the first

spouse to die. Although no Federal estate tax is paid

on property passing to the surviving spouse because

of the unlimited marital deduction, the surviving

spouse in noncommunity property States will receive

a stepped-up basis only in that property included in

the gross estate of the decedent spouse. If the first

spouse to die had owned all of the property, a full

step-up would be obtained.

Unintentional Te rm ination.- -In some States, joint

tenancy ownership may be severed by a contract to

sell to third parties or even by the placing of a mortgage on the property. As a result, the parties may

fail to achieve their purpose through an unintentional

termination of the survivorship feature.

Lim itation on Using a D isclaim e r.- -Th e role of disclaimers (see chapter 7) as a post mortem estate

planning tool is extremely limited. Only a few States

permit a disclaimer of the interest in property that has

been perfected in the survivor. Thus, this highly

desirable method of post mortem tailoring of property

descent is not available if not provided for by State

statute, and the resultant afterdeath tax planning is

generally denied to the surviving joint tenant.

Additionally, the Internal Revenue Service (IRS)

has taken the position that a disclaimer of a joint

tenancy interest is not effective for estate tax purposes, even though it may be valid under State law,

on the ground that the donee accepted the property

when the joint tenancy was created (Letter Rulings

7829008,7911005, and 7912049). The reasoning set

out in the rulings is that property transferred to a

joint tenant who may become the survivor is accepted

by that joint tenant when the joint tenancy is created

and, thus, must be disclaimed within the statutorily

required period of 9 months from the date of creation

of the joint tenancy. It is the position of the ruling

that by the time of the death of the first tenant to die,

acceptance has been completed, and the statutory

period for the disclaimer has expired.

Postdeath Income Tax Considerations

Another disadvantage of joint tenancy involves

postdeath income tax considerations. There are a

great many advantageous income tax options available

to the estate of a decedent. Because survivorship

property passes to the survivor immediately upon the

death of the deceased, there is no intervening estate to

act as a taxable entity. Thus, the surviving joint

tenant cannot take advantage of the post mortem tax

options generally available to estates.

Creation of Joint Tenancies in Real Estate

Most States with joint tenancy statutes now permit

the creation of joint tenancies in real property by a

conveyance to the joint tenants(s) that sets forth the

existence of the survivorship feature. In those States

that recognize tenancies by the entirety, State statutes

and sometimes case law provide various methods of

creation. Once such ownerships have been established, the ownership of income resulting therefrom

sometimes becomes an issue. The status of the income

is critical to the tax consequences associated with it,

particularly with respect to proof regarding contributions by a nonspousal donee or surviving joint owner.

Profits and proceeds generally, including those from

the sale of standing timber, that are derived from

entirety property are themselves treated as entirety

property. Similarly, property purchased with the

proceeds from selling entirety property is also entirety

property. Income realized from joint tenancy property, on the other hand, is treated in most States as the

separate property of the joint tenants in proportion to

their ownership interests.

Federal Estate Tax Aspects of Joint Tenancies

The estate tax consequences of the death of an

individual who has an interest in a joint tenancy are

governed by Internal Revenue Code (IRC) Section

2040. Section 2040(b) establishes the concept of a

106
“qualified joint interest. ” This concept is defined as

“any interest in property held by the decedent and the

decedent’s spouse as (1) tenants by the entirety or (2)

joint tenants with right of survivorship, but only if

the decedent and his (her) spouse are the only joint

tenants. ” For such an interest in property, the value

to be included in the decedent’s gross estate is onehalf of the value of the interest.

NonspousaZJointZnterests.--Section2040(a) applies

to all situations involving nonspousal joint interests.

The value of any such joint interest held by the decedent at death is to be included in his (her) gross

estate to the extent of the decedent’s fractional share

of the property, in cases where the property was

acquired by gift, bequest, devise, or inheritance; or

to the extent that it cannot be demonstrated that the

surviving tenant(s) provided consideration for the

acquisition of the property in those cases in which the

property was acquired by other means. Thus, if a

personal representative is unable to show that the

property was acquired by gift, bequest, devise, or

inheritance--or that the surviving tenant(s) provided

consideration for acquisition of the property--the value

of all of the jointly held property will be included in

the decedent’s gross estate. Because determination of

the amount of consideration provided by each tenant

can sometimes be difficult, it is very important that

accurate records be kept when using nonspousaf joint

property-holding arrangements.

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Chapter 16

Partnerships

Most family timberlands have been traditionally

operated as sole proprietorships or in joint fee ownership. Increasingly, however, nonindustrial woodland

owners are turning to partnerships and corporations

as ownership vehicles, particularly if two or more

persons are involved in the ownership or management. This is due in part to the increasing financial

values associated with managed woodlands and the

desire to utilize prudent business and income tax

practices. However, there is also a special interest in

using partnerships and corporations for estate planning purposes.

A key factor in selecting a form of organization is

whether it is intended that the tree farm operation

will continue beyond the lives of the current

owner(s). If this is not the case, sole proprietorship

may be the best device. But if it is expected that the

tree farm as an entity will continue into the next

generation, a corporation or partnership may be a

better choice. Partnerships will be discussed in this

chapter, corporations in chapter 17.

DEFINITION OF A PARTNERSHIP

A partnership is generally defined as an association

of two or more persons, as coowners, to operate a

business for profit. Tests for determining what is and

what is not a partnership have been developed in each

State. Written partnership agreements are not necessarily required if the actions of the parties involved

and the attributes of their relationship are sufficient to

indicate partnership status. Most States require a

sharing of profits for a partnership to exist. Some

also require a sharing of losses. Most States generally give weight to the way the parties believe they

are organized. Therefore, it may not be wise to use

the term “partnership” in business transactions, discussions with others, or correspondence unless partnership status is desired.

The best procedure is to develop a written partnership agreement and to state clearly the provisions

governing the arrangement. Unless otherwise specified in the agreement, all partners in a general partnership have an equal voice in managing the business

and a majority vote governs. Limited partnerships,

as discussed later, are an exception to this rule.

109

Partnership Mechanics

Partnership accounting procedures define partnership

interests in terms of capital, profits, and losses. A

partner’s capital interest is measured by his (her)

capital account which reflects that person’s economic

stake in the partnership at any given time. Initial

contributions are recorded and are increased to reflect

income and decreased to reflect losses and distributions .

Partnership Units

Family partnerships sometimes utilize partnership

units to reflect ownership interests. These are similar

to shares of stock and may be represented by paper

certificates as is stock. The use of units on the partnership books rather than percentage adjustments

makes gifts and sales of partnership interests to family

members easier to accomplish. Such transactions can

be made by simply transferring certificates.

PARTNERSHIP ATTRIBUTES

Under State law a partnership is an entity that may

acquire and convey title to property. When a partnership does own property, any partner (except in a

limited partnership) may convey title on behalf of the

partnership.

Flexibility

As compared to corporations, partnerships are

extremely flexible devices. The partnership agreement

can easily be amended up until the time the partnership

income tax return is filed in order to realize desired

economic and tax consequences. This additional flexibility in structuring financial arrangements may lead,

however, to a substantially more complex partnership

agreement and increased scrutiny under the Federal

income tax law.

Contributions.--Contributions of property may be

made to a partnership without recognition of gain; in

some cases, this is not possible with a corporation.

The partnership adopts the partner’s basis for property

transferred to it, and the contributing partner’s capital
account, in turn, adopts the basis of the transferred

property.

Withdrawals.--The ability to withdraw property

from a partnership without adverse tax consequences

is a significant advantage. The distribution of

property, other than cash, by a partnership to its

partners normally is not subject to taxation. Instead,

the partner receives the property with a carryover

adjusted basis unless the distribution is being made in

liquidation of a partner’s interest. In that case, the

adjusted basis of the property is determined with

reference to the adjusted basis of the partner’s partnership interest. Corporate distributions, on the other

hand, are treated as dividend payments or, if made as

liquidating distributions, as payments in exchange for

stock. And finally, liquidation of a partnership is

generally a nontaxable event. This is generally not

the case with a corporate liquidation.

Unlimited Liability

Probably the best known characteristic of a general

partnership is the unlimited liability of all partners for

obligations of the partnership. The partnership creditors must first make a claim against the partnership

assets; they can then make a claim against the personal assets of the individual partners if any debt

remains. Also, creditors of an individual partner can

make a claim against the partnership assets up to the

amount of that partner’s interest. These rules do not

apply to the limited partners in a limited partnership

as discussed later.

Management Rights

In a general partnership (as opposed to a limited

partnership), all partners have equal rights in the

management and conduct of the business. No one

can become a member (partner) of the partnership

without the consent of all of the members. Both

these rules, however, are subject to any agreement to

the contrary among the partners. Thus, while State

corporate statutes establish specific requirements

relating to voting rights, partnership statutes permit

almost complete flexibility subject to the requirement

that the partners all agree.

will bind the partnership. Partnership liability does

not result, however, if the partner has no authority to

bind the partnership and the party with whom the partner is dealing has knowledge of that fact.

Assignment of Partnership Interest

A partner’s assignment of interest in the partnership

does not automatically entitle the assignee to participate in the business. Unless the assignee is accepted

as a partner by agreement of all of the original partners, the assignee is merely entitled to receive a share

of the partnership profits.

Partnership Termination

A partnership may not have as much stability as the

members might like. As with a sole proprietorship or

joint ownership, a partnership is generally vulnerable

to premature liquidation in the absence of prior planning. If there is a written partnership agreement, the

term of existence can be stated. Usually, however,

partnership agreements provide that the partnership

exists at the will of the partners. Even though a term

of existence may be specified, the courts do not generally force partnership continuation against the desire

of a partner to withdraw. Dissolving partners have

three choices: (1) liquidate, (2) form a new partnership, or (3) shift to a sole proprietorship or corporation.

On the death of a partner, the surviving partners are

generally under a duty to wind up the business and

make a distribution to the deceased partner’s estate.

But some courts have recognized the right of the surviving partners to bind the deceased partner’s heirs to

continue the business. When continuation is desired,

steps should be taken to include a provision in the

partnership agreement that requires continuation and

that gives the executor of each partner the power to act

as a partner.

ESTATE PLANNING WITH PARTNERSHIPS

Minors as Partners

Partners as Agents

Every partner in a general partnership is an agent

of the partnership for purposes of its business, and

any action by a partner within the scope of business

Estate planning for members of a family partnership

often involves transfer of partnership interests to

minors. The intention may be to reduce the family

income tax bill, reduce death taxes, or simply move

older children into the business. But minors as

110
partners can create problems. For Federal income

tax purposes, a minor is not recognized as a partner

unless control is exercised by another person for the

benefit of the minor or the minor is “competent to

manage his (her) own property and participate in the

partnership activities in accordance with his (her)

interest in the property. ” The test of competency is

whether the minor has sufficient maturity and experience to be competent in business dealings, regardless

of State law. Unless the minor has significant

involvement in the management of the partnership,

the interest should probably be conveyed to a trustee

for the minor’s benefit, because the IRS regulations

require adequate judicial supervision. A minor may,

however, be a limited partner because limited

partners are precluded from management. In any

event, a gift of a partnership interest should be made

in accordance with the Uniform Gift to Minors Act.

Retained Control

Whether the parents should retain control of the

partnership is usually a nontax matter involving basic

personal goals. Retention of control, however, may

involve significant income and estate tax consequences. The owner of a capital interest in a partnership in which capital is a substantial incomeproducing factor, such as one structured around

family timberlands, will be recognized as a partner

for income tax purposes whether the owner received

the interest by purchase or gift. However, retained

control over a gifted interest may cause the donor to

be treated as the owner for income tax purposes.

Whether the retained controls are significant enough

to cause such a result is a question of fact. This

problem can be circumvented with a limited partnership.

Limited Partnerships

Limited partnerships are closer in structure to

corporations than are general partnerships. A limited

partnership may be organized in most States with one

or more limited partners if there is at least one

general partner. Limited partners do not have personal liability beyond their investments in the

partnership, but the price of this status is that a

limited partner may not participate in management.

Only general partners have management authority. A

limited partner who does participate in management

may become liable as a general partner. Nevertheless,

the limited partnership provides an ideal vehicle for

excluding certain family members, such as minors and

distant co-owners, from management control. A

limited partnership may also be useful if one of the

partners, such as a parent, wishes to withdraw from

active participation in management of the tree farm.

It permits the parent to leave capital invested without

the fear of unlimited liability.

Unlike a general partnership, which requires no

formal action other than agreement among the partners, a limited partnership must be formed in compliance with specific State law. This requires the

execution of a certificate of limited partnership, which

is placed on file with a public official, usually the

county clerk.

Example 16.1. Mr. and Mrs. Brown together own

a substantial tree farm and have decided to utilize

the annual gift exclusion in conjunction with a

limited family partnership in order to lower the

value of the timberland for estate and gift tax

purposes. This procedure will allow the Browns to

gradually transfer ownership of the timberland to

their children but yet permit them to continue managing the property and make all the operating

decisions. To implement the plan, the Browns first

execute a limited partnership agreement in accordance with the law of their State, with themselves as

general partners and the children as limited partners.

Concurrently with establishment of the partnership,

ownership of the tree farm is transferred to the partnership, with Mr. and Mrs. Brown each having a

partnership interest equal to 50 percent of the tree

farm’s value. Beginning that year, and each year

thereafter, the Browns gift to their children an

interest in the partnership equal to or less than the

annual gift tax exclusion. The value of the gifts can

be substantially discounted because---for many

years, at least--the Browns are giving their children

minority interests in the partnership. Both Mr. and

Mrs. Brown, or one of them, could be paid a salary

or other compensation by the partnership for managing the tree farm from timber sale or other

income received by the partnership. The Browns,

as managing (general) partners, would determine

how to distribute and/or invest the cash received by

the partnership.

111

Chapter 17

Corporations

Closely held, family-owned tree farm corporations

have increased in number during the past several

decades in most States that have a substantial commercial timber acreage. Research findings indicate

that estate planning considerations are a major reason

for incorporation of nonindustrial tree farms. The

corporate stock is typically owned by persons related

by blood or marriage or both. Some nonindustrial

woodland corporations are also owned by unrelated

shareholders, most of these are small and closely

held.

CORPORATE FORMATION

AND MANAGEMENT

A corporation is a distinct entity, separate from the

shareholders who own it or from those who manage

or work for it. Thus, a corporation can sue and be

sued, enter into contracts, and own property--all in its

own name. A corporation has most of the rights of

an individual.

A corporation is formed by drafting the necessary

documents and filing them with the designated State

official, usually the Secretary of State. Generally,

these documents consist of the corporate name, the

nature of the business, the names and addresses of

the incorporating parties, the corporate charter, and

the articles of incorporation. State law specifies

certain items to be addressed in the charter and

articles of incorporation; others can be added by the

incorporators. Additional documents may also be

required, depending on the State in question. An

incorporation fee will have to be paid

filed at least annually with the State.

and reports

Qualifying as a Foreign Corporation

Because a corporation is formed under the laws of

a particular State, it cannot do business in other

States without qualifying in them as a foreign corporation. This requirement should be considered if the

timber land ownership in question lies in more than

one State. However, occasional transactions outside

the State of incorporation that do not occur on a

regular basis generally do not constitute “doing

business. ”

Limited Liability

Probably the most notable feature of a corporation

is the limited liability status of its shareholders.

Corporate debts and liabilities may be satisfied only

from corporate assets. Thus, unlike partnerships,

shareholder personal assets--other than investment in

the corporate stock--are protected from corporate

liability. If the shareholders commit substantial

personal assets to the corporation, limited liability

obviously has less meaning than if such assets are

maintained outside the corporate structure.

Loss of Lim ited Liability--A corporate shareholder

may lose his (her) limited liability in three ways:

(1) if the shareholder is personally involved in a tort

that gives rise to corporate liability; (2) if the

shareholder personally signs a corporate contractual

obligation--that is, signs without acting on behalf of

the corporation; and (3) if the corporation fails to meet

and maintain corporate organization and management

requirements on a continuing basis.

Corporate Management

A corporation contains three clearly defined managerial groups: shareholders, board of directors, and

officers. In a closely held family corporation, the

same individuals often fill all these positions.

Sh areh old ers.- -Th e shareholders are the persons

who have contributed money or property to the corporation in return for shares of stock. In some cases,

the stock may have been received by gift or inheritance. The shareholders are the basic decision-making

group. They approve changes in the corporate charter

and articles of incorporation, and also elect the board

of directors. Each shareholder has one vote for each

share of voting stock. Most States permit nonvoting

stock but a few do not.

Generally, a majority vote governs, and the holders

of 51 percent or more of the stock have direct control

over corporate decisions made at the shareholder level.

The shareholders also indirectly control decision

making at the other levels because of their power to

elect the board of directors. Minority shareholders

have little, if any, decision-making power unless

permitted by the majority.

113
It is possible to grant minority shareholders greater

participation in decision making. In most States, the

vote level required for shareholder action may be

increased from a simple majority to some higher

level. The majority of States also allow cumulative

voting. This procedure permits shareholders to

multiply their votes by the number of directors to be

elected and cast the entire number for one director.

It helps insure that minority shareholders will at least

be represented on the board of directors.

Board @Directors.--The board of directors is the

policy-making body of the corporation. It develops

corporate policy and long-range management strategies. The board also establishes the bylaws, which

are written rules and guidelines for corporate structure and day-to-day management. The directors may

receive fees for their services but are not salaried. In

a family corporation, the fees may be waived. The

selection of the officers is another important responsibility of the board.

Q@cer.s.--The officers are the day-to-day corporate

decision makers. Usually in a small or family corporation these are a president, vice president, secretary, and treasurer. The officers often also function

as employees and receive salaries. They are charged

with executing policy developed by the board of

directors. Authority to hire employees, sign negotiable instruments, enter into contracts, and borrow

money may be granted to designated officers by the

board.

INCOME TAX IMPLICATIONS

OF INCORPORATION

Before addressing estate planning considerations

related to corporations, a discussion of income tax

implications is appropriate. An incorporated family

tree farm is treated virtually the same with respect to

expenditures as is a noncorporate timber ownership.

Certain other aspects of corporate income taxation,

however, differ from the rules applicable to

individual woodland owners.

Depreciation

Although depreciation is handled in essentially the

same way after incorporation as before, there are a

few exceptions. One of these concerns the expense

method of depreciation under Section 179 of the

Internal Revenue Code (IRC). Section 179 previously

permitted most taxpayers in a trade or business to

immediately deduct rather than depreciate up to

$10,000 of otherwise depreciable costs per tax year.

The 1993 Revenue Reconciliation Act raised the maximum Section 179 deduction to $17,500 beginning in

1993. As under prior law, the maximum deduction

phases out dollar-for-dollar for that portion of the total

cost of qualifying property placed in service during the

year that exceeds $200,000. For example, if $210,000

of qualifying property were placed in service during

the year, the maximum deduction under Section 179

would be $16,500. With respect to corporations,

members of a group of controlled corporations (discussed on page 109) divide the expensed amount.

Normally, however, a family tree farm corporation

will not be part of a group of controlled corporations.

In that case, there is no difference in Section 179

treatment between corporate and noncorporate taxpayers.

Taxation of Corporate Income

Two methods for the taxation of corporate income

are available to qualifying corporations. These are the

regular method for so-called “C” corporations and the

tax-option method for so-called “Subchapter S” corporations. Most closely held family tree farms will

qualify for either method.

“C” Corporation.--If no Subchapter S election is

made as discussed on page 109, a family woodland

corporation will pay income tax under the regular

method. Federal corporate tax rates were reduced in

1987 and increased slightly in 1993 by the 1993

Revenue Reconciliation Act. The current corporate

rates are as follows:

Corporate taxable income Marginal rate

$5O,ooE :

$5O,ooo 15 percent

$75400 25 percent

$75400 - $10,ooo,ooo 34 percent

over - $10,ooo,ooo 35 percent

An additional 5-percent surtax (for a maximum of

$11,750) is imposed on a corporation’s taxable income

above $100,000. This provision will completely phase

out the benefit of the 15- and 25-percent rates for

corporations with taxable incomes of more than

$325,000. For corporations with taxable incomes

between $100,000 and $335,000, the 15- and 25-

percent rate benefits will be partially phased out.

Corporations with taxable income above $15 million

also pay a 3-percent surtax on income above that

amount to a maximum of $100,000 extra tax. This

recaptures the benefit of the 34-percent rate.

114
The attractiveness of the regularly taxed corporation is dependent on the relationship of corporate

income tax rates to the rates applicable to individuals.

The top individual marginal rate on ordinary income

is currently 39.6 percent as compared to the top marginal corporate ordinary rate (including surtax) of 39

percent. Although this represents little difference,

the spread between corporate and noncorporate longterm capital gains rates is considerably greater. The

maximum long-term capital gain rate for individuals

is 28 percent; for corporations it is 39 percent at

income levels where the 5percent surtax applies.

This is particularly significant in the case of corporate

family tree farms where, presumably, most of the

income would be from timber sales and thus capital

gain.

In effect, formation of a regularly taxed corporation represents creation of a new taxpayer at the 15

percent rate for the first $50,000 of corporate taxable

income and at the 25percent rate for the next

$25,000. This may save on income taxes for those

shareholders whose individual rate is 28 or 31 percent, with respect to net income left in the corporation for business purposes or expansion. However, if the net earnings are removed from the corporation and paid to the shareholders as dividends,

the shareholders will have to pay tax on the dividends

received as ordinary income, resulting in the socalled “double taxation” associated with “C” corporations.

A group of controlled corporations cannot be used

to circumvent the graduated corporate rate brackets.

In other words, it is not possible to create two or

more corporations with common ownership in order

to take advantage of the reduced corporate tax rates

on the first $75,000 of corporate taxable income.

Thus, if two corporations are established with respect

to a family tree farm--one to own the land and the

other the timber--there will be only one set of graduated rate brackets below 35 percent. With no stipulation for unequal apportionment, each corporation

would be taxed at 15 percent on the first $25,000 of

taxable income and at 25 percent on the next

$12,500.

Subchapter S Corporations

Although the double taxation of dividends associated with family owned “C” corporations can sometimes be avoided to a certain extent by making payments in the form of salaries and bonuses, which are

deductible by the corporation, this method will never

alleviate the problem entirely. Another problem concerns the corporation accumulating funds rather than

using them to pay dividends. The so-called

“accumulated earnings tax” is designed to discourage

the buildup of funds within a corporation in excess of

reasonable business needs. A corporation can accumulate up to $250,000 of earnings and profits without

imposition of the tax. Beyond that level, accumulations are taxed at rates ranging from 27 l/2 to 38 l/2

percent unless higher accumulations are justified as

being retained for the reasonable needs of the business. For those woodland corporations investing in

additional timberland, the $250,000 level should pose

no problem.

The Subchapter S corporation method of taxation

was enacted in 1958 to remove the disadvantages of

the regular corporate method of income taxation for

small, family-owned corporations. If a corporation

that meets the requirements (discussed on page 104)

elects Subchapter S status by filing Form 2553 with

the Internal Revenue Service (IRS), double taxation is

eliminated. There is no taxation of earnings at the

corporate level; only the dividends paid to the shareholders are taxed and then on their individual returns.

For all other purposes, however, a Subchapter S corporation remains identical to a “C” corporation.

A Subchapter S corporation passes through to its

shareholders their pro rata share of capital gains and

losses, operating losses, business deductions, depletion

allowances, tax exempt interest, and credits. The pass

through is on a daily basis. These items are then

reported by the shareholders on their individual

income tax returns. Gains and earnings are taxed to

the shareholders as if actually received, even if held

by the corporation for expansion or paid out as dividends at a later time. Generally, distributions from a

Subchapter S corporation without earnings and profits

are tax free to the extent of a shareholder’s adjusted

income tax basis in the stock (the amount of original

investment in the stock not previously recovered). If

a distribution exceeds a shareholder’s adjusted basis,

the excess is treated as a capital gain.

Distributions from a Subchapter S corporation can

thus affect the income tax basis of the corporate stock.

Undistributed taxable income on which tax is paid by

the shareholders increases the basis of their stock.

Losses and tax-free distributions of previously taxed

income reduce the basis. To avoid later confusion

over stock basis, the basis for each shareholder should

be computed annually and made a matter of record.

115
Requirements for Electing and Maintaining

Subchapter S Status

A number of requirements must be met in order

for a corporation to elect Subchapter S status with the

IRS and continue to maintain that status.

Shareholders.--There can be no more than 35

shareholders. Stock owned by both spouses, regardless of how it is held or in whose name, is considered

to be owned by only one shareholder. A surviving

spouse and the estate of a deceased spouse are also

treated as only a single shareholder. Generally, all

shareholders must be individuals or the estates of

individuals. In certain limited circumstances, however, trusts can be shareholders. Nonresident alien

shareholders are not permitted.

Stock.--A Subchapter S corporation can have only

one class of stock outstanding. Differences in voting

rights are allowed, however, and do not violate the

requirement for a single class of stock. This can be

an important consideration when minor children are

shareholders. Preferred stock is not allowed.

Accum ulated Earnings Carryove r.- -Som e “C” corporations have accumulated earnings and profits when

the Subchapter S election is made, which are carried

over to the Subchapter S corporation. A Subchapter

S corporation in this position cannot have passive

investment income, such as interest, in excess of 25

.percent of gross corporate receipts for more than 2

consecutive years. If it does, its Subchapter S status

will be terminated. This rule could constitute a trap

for the unwary Subchapter S tree farm that maintains

an interest-bearing bank account in years in which no

timber harvesting is done.

Election.- -Th e election, as noted earlier, is made

by filing Form 2553 with the IRS. It may be made

at any time during the preceding taxable year, or on

or before the 15th day of the 3d month of the taxable

year in question. An election too late for 1 year may

become effective the following year. All shareholders of record must consent to the election. It can

be voluntarily revoked but only if the holders of

more than half of the corporate stock consent to the

revocation. Thus, a new shareholder by reason of

gift or inheritance cannot unilaterally terminate the

election, as was once allowed, unless he (she) owns

a majority of the voting stock. The election can also

be terminated by the IRS for failure to continue to

meet the Subchapter S requirements.

In general, a new election cannot be made within

5 years of a revoked election without IRS consent.

This provision was recently utilized by a Subchapter S

corporation formed to hold and manage timber properties (Letter Ruling 9 111036). The corporation

obtained a new treasurer in 1986 who was unaware of

the Subchapter S election and, thus, began filing conventional “C” corporation tax returns. In addition, the

corporation, through the treasurer, had violated the 25-

percent passive income rule because no timber sales

had been made for a number of years due to depressed

prices, but yet interest was earned on the accumulated

earnings realized from the “C” corporation years. For

these reasons, the IRS revoked the Subchapter S status

in 1990. At the corporation’s request, however, the

IRS determined that the election had been inadvertently terminated because of the treasurer’s lack of

knowledge. It permitted the corporation to return to

Subchapter S status in 1991 after filing amended tax

returns for the tax years after 1987, paying additional

taxes due, and eliminating the interest-bearing account

until such time as timber sales were resumed.

ESTATE PLANNING CONSIDERATIONS

Certain characteristics of corporate ownership may

enable it to more completely accomplish a forest landowner’s estate planning objectives than will other

forms of ownership. This is particularly true if the

tree farm is to continue as an economic unit beyond

the death of the parents as majority or sole owners.

Lifetime Transfer of Stock

When planning for continuation of the family tree

farm, particular attention should be given to transfers

of ownership and management from one generation to

the next. This process is simplified with a corporation, in which ownership and control is facilitated by

merely transferring shares of stock.

Parents who are sole owners or co-owners of forest

property may be reluctant, for reasons of personal

security, to make gifts of the property to the children

in order to achieve death tax savings or business continuation. Their fear may be compounded by the fact

that the donees are free to retransfer the property to

others once the gifts are made. Restrictions on

retransfers are often unenforceable. Even if gifts are

otherwise acceptable, however, donations of forest

land are not easily made--either in terms of undivided

interests or as separate parcels (see chapter 8).

On the other hand, transfer of corporate stock does

not involve these disadvantages. Tree farm ownership

116
can be divided into easily transferred shares of stock

so that the gift or sale of stock translates into a proportionate share of the tree farm. Majority owners

can dispose of some stock without losing control over

decision making. They can be assured of continued

employment as corporate officers and of control over

corporate dividend policy. This eases the income

security problem. Restrictions can also be placed on

the retransfer of stock by those receiving it through

gift or sale. Stock can additionally be used to channel tree farm income to low tax bracket taxpayers so

as to minimize overall income tax liability.

Transfers to Minors

It may be desirable to transfer interests in the

timberland to minors in order to reduce the family

income tax burden or to encourage the minors to

develop a greater involvement and interest in the tree

farm. Minors, however, are not considered legally

competent to manage their property. The transfers of

property interests to minors have long created problems. Such gifts are usually made easier if the

transfer is in the form of shares of corporate stock.

Uniform Gifts to Minors Acts.--Stock in a family

corporation is eligible for transfer to minors under

the Uniform Gifts to Minors Acts now available in

every State. These statutes are relatively easy to use,

inexpensive, and involve little red tape. They basically provide for a simple custodianship by which a

bank or an adult holds and manages the property for

the minor. Only gifts of stock, securities, or money

are eligible for transfer in most States. Gifts of land

and timber, by contrast, are generally not eligible.

An important consideration is that, if the donor is

also the custodian and dies before the child reaches

majority, the amount of the property held would very

likely be included in the donor’s estate for death tax

purposes. Therefore, the custodian should probably

be someone other than the donor.

Unearned Income.--Unearned income of a child

under. age 14 who has at least one living parent will

be taxed at the parent’s marginal income tax rate if

the child’s investment income is more than $1,100

for the year. This rule may lessen the advantage of

making transfers to young children.

Estate Settlement

A corporation is an entity that does not terminate

when one of the owners (a shareholder) dies. On the

other hand, at the death of an individual owner with

fee title, all of his (her) property is normally subject to

probate--a process during which all assets are usually

administered by the estate representative. Upon the

death of a corporate shareholder, in contrast, only the

corporate stock owned by the decedent is subject to

probate and transfer--not the underlying assets. The

stock, of course, must be valued for Federal estate and

State death tax purposes, but operation of the tree farm

may be continued without interruption.

Ancillary Probate.--If an individual owns real property in two or more States, a probate proceeding is

normally required in each State. A probate court proceeding in one State cannot pass title to real property,

including land and timber, in another State. Thus, the

original probate proceeding is held in the State of

residence and ancillary probate in the other State(s).

In the event that real property is owned in two State(s)

by a corporation, however, ancillary proceedings are

not required because corporate stock is personal

property--not real property--and generally is subject to

the law of the decedent’s State of domicile at death.

Loss of Capital

The right of partition and sale (see chapter 15),

which is generally available to joint tenants or tenants

in common for terminating co-ownership arrangements, is not available to corporate shareholders.

While those shareholders not actively participating in

operation of the tree farm may have sufficient votes to

dissolve the corporation, they do not have the option

of receiving their portions through division or forced

sale of the property. This corporate feature may cause

disputes, however. Restrictions are often placed on

retransfer of inherited or gifted stock, and minority

shareholders have relatively few management rights.

Stock Purch ase Options.--To avoid this problem, it

may be advisable for those most concerned with continuity of the tree farm to gradually purchase the stock

held by the other shareholders. A buy-sell or first

option agreement could specify that the purchase price

is to be paid either in cash or by installments over a

period of time with interest.

As an alternative, stock could be permitted to pass

to minority heirs with specific rights granted in regard

to management, a minimum dividend level in conjunction with timber sales, and a ready market for their

stock in the event they may wish to sell. This would

balance corporate stability against minority shareholder

rights.

117
Corporate Disadvantages

A corporation has estate planning disadvantages as

well as advantages. Some can be resolved with

proper planning, others cannot.

Subch apte r S Corporations.--As discussed earlier,

a Subchapter S corporation can have no more than 35

shareholders. If death and inheritance result in more

than 35, Subchapter S status is lost. Another disadvantage is that a Subchapter S corporation’s stock

cannot be held by a trust except in certain limited

instances, even though trusts are key estate planning

devices (see chapter 10). It is not possible to

establish a testamentary trust for minors, with the

trust holding Subchapter S stock, and have the trust

continue as a shareholder for more than a short

period of time after the death of the grantor. Nor is

it possible for stock in a Subchapter S corporation to

be held by a marital deduction trust (see page 68).

Adjustment of Basis

One corporate attribute that may prove to be a

decided disadvantage with respect to tree farms concerns the basis of the land and timber. Assets held

until death receive a new income tax basis, which is

generally equal to the fair market value of the assets

on the date of the decedent’s death or 6 months after.

This adjustment in basis cancels out any unrecognized

gain or loss on the property and the new basis provides values (depletion values in the case of timber)

for computing future gains or losses upon sale.

Thus, when a shareholder dies, the shares of stock

owned at death receive a new income tax basis equal

to their value as determined for death tax purposes.

But the basis of the underlying property, such as land

and timber, in the hands of the corporation remains

unchanged. Therefore, the sale of timber by a corporation after the death of a shareholder creates the

same amount of taxable gain or loss as if the timber

had been sold before the shareholder died. Also,

depreciable property already fully depreciated by the

corporation may not be placed on a new depreciation

schedule with a new income tax basis after a shareholder dies. These features of the corporation may

discourage incorporation by those older family members holding valuable timber assets that have a low

basis.

Com plexities and Expenses.--Incorporation is a more

formal and complex method of organization than a

partnership or sole proprietorship, and a corporation

is more expensive to form and maintain. In addition

to the legal cost of incorporation, most States impose

an annual fee and require the filing of an annual

report. The initial costs are deductible over the first

5 years, however, and subsequent costs are usually

deductible annually.

Liq uidation.--A corporation may usually be dissolved under State law either by written consent of all

shareholders or by approval of the board of directors

followed by a simple majority or higher vote of the

shareholders. This process usually poses few problems. The greatest concern is the income tax consequences of liquidation as the corporate assets are

distributed to the shareholders in exchange for their

stock. A corporation can be formed rather easily

without paying income tax on the gain in property

transferred to the corporation. Liquidating a corporation, however, without adverse income tax consequences is more difficult. Basically, a liquidating

corporation, including a closely held family corporation, recognizes gain or loss on the distribution of

property that takes place in a complete liquidation as

if the property had been sold at its fair market value.

Revised Estate Plans

Upon formation of a corporation, the wills and

estate plans of each shareholder should be reviewed.

Corporate stock is personal property and will pass as

such at the death of the shareholder. If a will was

drafted to pass real property, it may have become outdated by incorporation. If Subchapter S status has

been elected, wills should be checked and revised, if

necessary, to insure that the stock does not pass into

a testamentary trust. If it does, the Subchapter S

election will be lost after 60 days, and the corporation

will revert to “C” corporation status and the double

taxation rules.

118
Chapter 18

Limited Liability Companies

OVERVIEW

A limited liability company (LLC) is a hybrid

entity that combines the corporate benefit of limited

liability for its owners with the partnership’s advantage of pass-through treatment for income tax purposes. It is created under State law, just like a corporation. As of this writing, 28 States have enacted

limited liability company statutes, as follows:

Alabama (effective 10-l-93), Arkansas (effective 4-

12-93), Arizona (effective 9-30-92), Colorado (effective 4-18-90), Delaware (effective 10-l-92), Florida

(enacted 4-92), Georgia (effective 3-l-94), Idaho

(effective 7-l-93), Illinois (effective l-1-94), Indiana

(effective 7-l-93), Iowa (effective 7-l-92), Kanas

(effective 7-l-90), Louisiana (effective 7-7-92),

Maryland (effective lo- l-92)) Michigan (effective

6-l-93), Minnesota (effective 10-l-93), Montana

(effective 10-l-93), Nebraska (effective 9-9-93),

Nevada (effective 10-l -9 l), North Dakota (effective

7-l-93), Oklahoma (effective 9-l-92), Rhode Island

(effective 9-19-92), South Dakota (effective 7-l-93),

Texas (effective 9-l-91), Utah (effective 7-l-91),

Virginia (effective 7-l -9 l), West Virginia (effective

3-6-92), and Wyoming (enacted 1977). In addition,

authorizing legislation is pending in California,

Massachusetts, New Jersey, New York, and

Pennsylvania.

ORGANIZATION AND OPERATION

Articles of Organization

Instead of filing articles of incorporation, limited

liability companies file articles of organization.

These notify potential creditors that, generally, the

LLC itself will be the sole recourse for payment.

Companies that fail to properly file articles of

organization may be fined, barred from doing business in the State, or have difficulty establishing legal

status to sue. Furthermore, creditors might try

reach the personal assets of the LLC’s members

though they were partners in a partnership.

to

as

Members

An LLC is owned by its members, rather than by

shareholders or partners. Generally, an LLC must

have at least two members. This requirement is consistent with its classification for income tax purposes

as a partnership. Although several States apparently

permit only one member, it is likely that the Internal

Revenue Service (IRS) would treat such an entity as a

corporation rather than a sole proprietorship for tax

purposes. A corporation, partnership, trust, estate,

another LLC, or other legal entity, as well as an

individual, may be a member. These coincide with

the partnership classification rules of the Internal

Revenue Code (IRC), which do not condition partnership status on the legal form of an entity’s owners.

Contributions to an LLC in exchange for a membership interest may be made in the form of cash, property, the use of property, services, or any other

valuable consideration. In some States, contributions

may also be made in the form of promissory notes or

other binding obligations.

Operation

Generally, an LLC is not required to have an

operating agreement. Some States, however, require

the adoption of one and specify certain mandatory

provisions. In the absence of an operating agreement,

an LLC is governed by its articles and State law.

Provisions concerning an LLC’s affairs usually may be

included in an operating agreement to the extent that

they are not inconsistent with State law or the articles

of organization.

Management

The typical LLC statute makes extensive use of

default rules, which allow an LLC to be customized to

suit the needs of its members. The statute generally

reserves management rights for the members in proportion to their capital contributions or income

interest, unless the articles of organization provide

otherwise. An LLC that concentrates management

authority in the hands of a few elected or appointed

managers will be considered to have the corporate

119
characteristic of centralized management (see page

115) and could be treated as a corporation if it has

other corporate attributes.

Ownership Interests.--Members of an LLC are

usually permitted under State law to customize both

distribution of cash and property, and allocation of

profits and losses, to themselves through the operating agreement or articles. In the absence of such

special financial provisions, distributions are generally made, and profits and losses allocated, on a

proportional basis in accordance with the members’

respective contributions.

Withdrawals.--Members of an LLC are also generally permitted under State law, unless otherwise

provided in the articles or operating agreement, to

withdraw on 6-months notice and receive the fair

market value of their interests. Withdrawals, deaths,

bankruptcies, and other events that cause the loss of

a member can have serious consequences because the

LLC could terminate unless the remaining members

agree to continue the business. This requirement is

usually imposed by State law so that the LLC will not

have the corporate characteristic of continuity of life.

An LLC can also be dissolved by written consent of

its members or by court order if it is unable to carry

on the business.

Assignment ofZnterest.--Unless the operating agreement or articles provide otherwise, a membership

interest is assignable in whole or in part. The assignment entitles the assignee to receive to the extent

assigned only the distributions to which the assignor

would otherwise have been entitled. In most States,

in order for an assignee to participate in an LLC’s

management and affairs and to exercise other membership rights, the remaining members must unanimously agree to the assignee’s admission as a member. Although some State statutes may not prohibit

an agreement over and above the operating agreement

that allows an assignee to become a member on the

consent of fewer than all the remaining members,

such a side agreement may cause an LLC to be

classified as a corporation for Federal income tax

purposes.

Limited Liability.--One of the key advantages of an

LLC is that it provides limited liability to all of its

members and managers. The typical State statute

provides that an individual or entity belonging to an

LLC does not have any personal obligation for the

LLC’s obligations solely because of being a member,

manager, or other agent of the LLC. This ability to

insulate an LLC member from personal liability as a

member, regardless of management activities, is one

of the chief distinctions between an LLC and a limited

partnership. Some States permit a member to waive

limited liability.

TAX CONSIDERATIONS

A primary reason for using the limited liability company form of organization is to avoid the double taxation associated with a corporation but yet achieve

pass-through taxation for the members and, at the

same time, protect the members’ personal assets from

liability for the debts and obligations of the business.

Corporate Attributes

The key to the favorable tax status of LLG’s is that

they are unincorporated business entities, and the IRS

will not treat unincorporated entities as corporations

unless they have more corporate than noncorporate

characteristics. Internal Revenue Service Regulation

301.7701-2 lists four characteristics common to corporations but not to partnerships. The IRS will not

impose corporate tax treatment unless the business

entity has more than two of these. The four are:

limited liability, continuity of life, free transferability

of interests, and centralized management. Because

limited liability is almost always present in an LLC,

the test hinges on whether the LLC has more than one

of the three remaining corporate attributes.

Continuity of Life

An LLC lacks continuity of life if the death, retirement, mental incapacity, bankruptcy, or expulsion of

any member causes the LLC to dissolve. In Revenue

Ruling 88-76, the IRS determined that a Wyoming

LLC lacked continuity of life because the State

statutory provision requiring the LLC to be dissolved

upon the occurrence of a withdrawal event, unless its

business was continued by the unanimous consent of

the remaining members, only established a mere contingent continuity of life. However, an outside

agreement obligating a member to approve the continuation of the LLC’s business upon either all or certain

specified withdrawal events, or on the direction of

another member or a certain percentage of the other

members, may change this conclusion.

Example 18.1. Four related persons, each with an

undivided interest in 1,500 acres of timberland in

120
Virginia, organized a limited liability company to

manage the property. In Virginia, LLC’s must

dissolve upon the death, resignation, expulsion,

bankruptcy, or other departure of a member, or

upon the occurrence of any other event that terminates continued membership (other than assignment of the member’s interest), unless all

remaining members agree to continue the business.

Therefore, this LLC lacks the corporate characteristic of continuity of life.

When a dissolution event occurs, LLC’s no longer

need the consent of all the remaining members to

continue the business. The IRS has amended

Regulation 301.7701-1(b)(l) so that continuity of life

will be lacking as long as at least a majority of the

LLC’s members must consent to continuation of the

business to prevent its dissolution. Although this

change applies to tax years beginning on or after June

14, 1993, taxpayers also have the option of applying

it to earlier years.

Example 18.2. A tree farm organized as an LLC

has four members. One member holds 80 percent

of the interests. The LLC has a provision in its

articles of organization allowing dissolution, upon

the loss of a member, to be prevented by a majority vote of the remaining members. This LLC has

the corporate characteristic of continuity of life. It

could allow members holding only a 20-percent

interest to continue the LLC despite the inaction or

objections of the go-percent interest holder.

Centralization of Management

A business entity has centralized management if

one or more of its members, but fewer than all members, has (have) exclusive authority to make business

decisions for the entity. Most State LLC statutes vest

management authority in the hands of all members,

unless the members choose to concentrate such

authority with just a few of their number or hire

nonmembers to manage the business. When all

members--as a membership right--can exercise management authority to bind the LLC, the corporate

characteristic of centralized management is lacking.

Centralized management, however, is always present

if State law requires the LLC members to elect

managers to run the business and vests the managers

with the managerial authority that most States reserve

for the members (Revenue Ruling 93-6).

Example 18.3. The Silver Pines family tree farm

LLC states that it is reserving management

authority for its members in the articles of

organization filed with the State agency that

regulates LLC’s. However, the seven LLC

members agree among themselves that only three of

their number will actually manage the woodland.

Nevertheless, State law binds the LLC for business

or management actions taken by any of its members

with third parties that do not have notice of the

informal agreement. Because any of the LLC

members could easily exercise binding management

authority despite the informal agreement, the three

designated managers lack the sole authority required

for the corporate characteristic of centralized

management.

Free Transferability of Interests

An organization has the corporate characteristic of

free transferability of interests if members owning substantially all of the interests in the organization can

transfer all attributes of their interest to others without

the consent of the rest of the members. However,

interests are not deemed to be freely transferrable if

only the right to share in profits can be assigned without consent, but not the right to participate in management. An LLC does not have the corporate characteristic of free transferability of interests if membership

and related management rights cannot be transferred

without the consent of the other members.

Example 18.4. The Lonesome Oak Tree Farm was

organized with only two members, John and Peter.

State law allows LLC members to freely transfer

their income and capital interests, but their

membership interest expires unless all the other

members consent to the transfer to the third party.

The Lonesome Oak Tree Farm lacks free transferability of interests, even though the consent of only

one remaining LLC member (Peter) is needed in

order for John to transfer half of his membership

interest to his son.

IMPLICATIONS FOR TIMBER PROPERTIES

The LLC represents the latest advance in the forms

of business entities. An LLC that is classed as a partnership and which is assured of limited liability in all

jurisdictions in which it will operate will combine

ownership, operational, tax, and liability advantages in

a way that neither the Subchapter S corporation nor

the limited partnership can do. For family-owned tree

121
farms, the LLC certainly shows promise as an

advantageous way to organize for current operations.

With respect to estate planning, the advantages are

less clear. The restriction on transferability of

interests could pose a problem in some situations.

However, with a closely knit, family-owned tree

farm, there may be no problem. The unanimous

consent of the members to give membership rights to

an heir of a deceased member or donee of a living

member may be easily obtainable. In considering

whether to become an LLC, however, a family timber

ownership should proceed with caution and with good

professional advice. Because the LLC format is

relatively new, its use still involves many

uncertainties.

122
Chapter 19

State Death Tax Considerations

TYPES OF STATE DEATH TAXES

The Federal estate tax liability may be readily

deferred at the death of the first spouse by proper

estate planning; however, State death taxes must still

be considered. Three types of death taxes are levied

by individual States. They are inheritance, estate,

and piggy-back taxes.

Inheritance Tax

An inheritance tax is a levy on the right to receive

property by individual heirs or legatees. The share

value received by each individual beneficiary forms

the basis for this tax. Currently, 18 States levy an

inheritance tax (see table 19.1).

Estate Tax

An estate tax is a levy on the right to transfer property by the decedent’s estate. Presently, the Federal

government and four States levy an estate tax, five

fewer States than in 1980 (see table 19.1).

Piggy-back Tax

A so-called “piggy-back tax” is equal to the State

death tax credit allowable as a deduction against the

Federal estate tax (see appendix, page 134). The

piggy-back tax is now the most prevalent form of

State death tax and is levied currently in 28 States

(see table 19.1). A piggy-back levy does not result

in any additional tax burden, but merely apportions

the total tax burden between the Federal and State

governments. In addition, Massachusetts is phasing

in a piggy-back tax, which becomes effective in

1997.

Pickup-Tax

In the States that impose inheritance and estate

taxes and the State death tax levy is less than the

State death tax credit allowable as a Federal

deduction, this additional, so-called “pick-up tax”

absorbs the difference. Currently, 21 States have a

pick-up tax (see table 19.1).

123

Gift Tax

In addition to death taxes, six States also levy a gift

tax (see table 19.1). Most of these States have incorporated the Federal gift tax provisions and, thus, tax

gifts above the $10,000 annual gift tax exemption per

donee.

Death Tax Provisions

Although there are only three basic forms of State

death taxes (inheritance, estate, and piggy-back), the

specific tax provisions vary greatly among the States.

The allowable deductions, tax credits, exemption

amounts, and tax rates depend on State law. The

States with a piggy-back form of tax have levies that

are based on the Federal return; therefore, the deductions, exemptions, rates, and credits will be the same

in each of these States. However, the tax statutes of

the 22 remaining States--those with inheritance and

estate taxes--differ considerably, and require coordinated planning with the Federal provisions in order to

obtain the best results.

Profound changes were introduced into the Federal

unified estate and gift transfer taxes by the Economic

Revenue Tax Act of 1981 and subsequent tax legislation. Many States have followed suit and changed

their State statutes in order to move closer to the

Federal tax model in form. For example, since 1980,

States with an estate tax have decreased from 9 to 4;

States with an inheritance tax have decreased from 30

to 18; and States with a piggy-back form of estate tax

have increased to 28. State Departments of Revenue

have cooperated closely with the Internal Revenue

Service in the administration of these taxes.

COMBINED FEDERAL-STATE

TAX LIABILITY

Since the passage of the Economic Recovery Tax

Act of 1981, substantial flexibility at the Federal level

has been provided for forest landowners. However,

State death taxes have often been overlooked. Effective estate planning requires consideration of both

Federal and State taxes.
Table 19.1 .-State death and gzji taxes in the United States, by region, 1993.

state Type of Tax

Estate Inheritance Piggy-back Pick-up Gift

Northeastern region

Connecticut

Delaware

X X X

X X X

Maine

Maryland

Massachusetts

New Hampshire

New Jersey

New York

Ohio

Pennsylvania

Rhode Island

Vermont

West Virginia

Southern region

Alabama

Arkansas

Florida

Georgia

Kentucky

Louisiana

Mississippi

North Carolina

South Carolina

Tennessee

Texas

Virginia

Midwestern region

Illinois

Indiana

X

X

X

X

X

X

X

X

X

X

X

X

X

X

X

X

X

X

X

X

X

X

X X

124
Table 19.1.~State death and gift taxes in the United States, by region, 1993.--Continued

State Type of Tax

Estate Inheritance Piggy-back pick-up Gift

Northeastern region

Iowa

Kansas

Michigan

Minnesota

Missouri

Nebraska

North Dakota

Oklahoma

South Dakota

Wisconsin

X X

X X

X X

X

X

X X

X

X

X

Western region

Alaska

Arizona

California

Colorado

Hawaii

Idaho

Montana

Nevada

New Mexico

Oregon

Utah

X

X

X

X

X

Washington

Wyoming

125
First Spouse to Die

In the States with the piggy-back form of estate

tax, effective use of the Federal unified credit of

$192,800 and the unlimited marital deduction to defer

taxes on the estate of the first to die also accomplishes the same result at the State level. Therefore,

if no Federal estate tax is due, then no State death tax

will be due.

In States with estate and inheritance taxes, the

allowable deductions may be quite different from the

Federal deductions. Some States do not have a marital deduction; thus, the estate value deferred at the

Federal level may be taxable by the State. In 1987,

the State death tax for forested ownerships with gross

estates ranging from $600,000 to $3,000,000 varied

from 4 to 7 percent of the net taxable estate value,

depending on the State in which the property was

located, even though the Federal tax had been completely deferred.

Special Use Valuation.- -Th e advantages and disadvantages of electing special use valuation under

Internal Revenue Code (IRC) Section 2032A at the

Federal level are discussed in chapter 13. In 1993,

special use valuation was indirectly available at the

State level in the 28 States with a piggy-back tax law.

It is also available in approximately one-half of the

States with inheritance and estate tax laws by means

of a special use valuation law at the State level. The

remaining States with inheritance and estate tax laws

either have no provisions for special use valuation or

deny it explicitly.

D e fe rral and Extension of Tax Paym ents. - -The deferral

and extension of Federal tax payments under IRC

Section 6166 is discussed in chapter 14. At the State

level, the 28 States with piggy-back tax laws permit

deferral and extension indirectly when these are

elected on the Federal return. Varying levels of

extension and deferral are available in approximately

two-thirds of the other States.

Second Spouse to Die

At the death of the second spouse, effective estate

planning at the Federal level has carried through to the

State level for the 28 States with piggy-back tax laws.

Assuming no remarriage, the unified credit is available

to the estate of the second spouse to die, but there is

no martial deduction to further defer the tax. Trusts,

joint ownerships, aggressive gifting programs

including charitable bequests, and other measures

discussed elsewhere is this book provide mixed results

in States with inheritance and estate taxes when the

State death tax provisions are not explicitly incorporated in the planning process. These results occur

because so much variability exists among the various

State statutes and because some State statutes work

counter to the Federal provisions. Thus, State law

should be explicitly included in the timber estate

planning process, especially in the 22 States that have

either an inheritance or an estate tax law.

126
Appendixes

127

Appendix I

A

Adjusted gross estate-The gross estate less funeral

expenses, expenses of estate administration during

probate, debts of the estate, and casualty losses

suffered during estate administration.

Administration-The care and management of an

estate by a trustee, guardian, administrator, or

executor.

Administrator-A male person appointed by the

court to administer the estate of a deceased person

(collect assets of the estate, pay debts, distribute

residue to those entitled to it) who (1) dies leaving

no will, or (2) leaves a will naming an executor or

executors who for some reason cannot serve.

Administratrix-The female counterpart of an

administrator.

Agent-A person who acts for another person by

the latter’s authority.

Amortization-Paying off a loan by regular

installments.

Ancillary administration-Probate administration

of property (usually real property) owned in a State

other than the one in which the decedent had his or

her principal residence at the time of death.

Annuity-A periodic (usually annual) payment of

a fixed sum of money for either the life of the

recipient or for a fixed number of years.

Appraisal-A determination of property value.

Assets-(l) The property comprising the estate of

a deceased person, (2) the property in a trust

account.

Attorney-at-law-A person who is legally qualified and licensed to practice law, and to represent

and act for clients in legal proceedings.

Attorney-in-fact-A person who, acting as an

agent, is given written authorization by another

person to transact business for him (her) out of

court.

GLOSSARY

B

Beneficiary-A person or institution named in a

will or other legal document to receive property or

property benefits.

Bequeath-To gift property by will.

Bequest-Property gifted by will.

Bond-An agreement under which a person or corporation (such as an insurance company) becomes

surety to pay, within stated limits, for financial loss

caused to a second person or legal entity by the act

or default of a third person, such as loss to an estate

by action of the administrator.

C

Charity-An agency, institution, or organization in

existence and operating for the benefit of an

indefinite number of persons, and conducted for

educational, religious, scientific, medical, or other

beneficent purposes.

Codicil-An addition, change, or supplement to a

will executed with the same formalities as are

required for the will itself.

Common disaster-A sudden and extraordinary

misfortune that brings about the simultaneous or

near-simultaneous deaths of two or more associated

persons, such as husband and wife.

Contemplation of death-The expectation of death

that provides the primary motive to make a gift.

129
Contingent beneficiary-Receiver of property or

benefits if the first named beneficiary fails to

receive any or all of the property or benefits in

question before his (her) death.

Contract-A legal written agreement that becomes

binding when signed.

Corporation-A legal entity owned by the holders

of the shares of stock that have been issued, and

that can own, receive, and transfer property, and

carry on business in its own name.

Curtesy-A widower’s legal interest in his wife’s

real estate.

D

Decedent-A deceased person.

Deed-The legal instrument used to transfer title

in real property from one person to another.

Dependent-A person dependent for support

another.

upon

Descendent-One who is directly descended from

another, such as a child, grandchild, or greatgrandchild.

Devise-To gift property by will.

Distribution-The appointment of personal property or its proceeds to those entitled to receive it

under the terms of a will or trust.

Don-The recipient of a gift.

Donor-The person who makes a gift.

Dower-A widow’s legal interest in her deceased

husband’s real estate.

E

Escrow-Money given to a third party to be held

for payment until certain conditions are met.

Estate-All real and personal property and property rights owned by a person.

Executor-A male person named in a will to carry

out the decedent’s directions, administer the

decedent’s estate, and distribute the decedent’s

property in accordance with the will.

Executrix-The female counterpart of an executor.

F

Fee simple-Absolute title to property with no limitations or restrictions regarding the person who may

inherit it.

Fiduciary-A trustee, executor, or administrator.

G

Gift-A voluntary transfer or conveyance of property without consideration, or for less than full and

adequate consideration based on fair market value.

Grantor-The person who places property into and

establishes a trust.

Gross estate-The total fair market value of all

property and property interests, real and personal,

tangible and intangible, of which a decedent had

beneficial ownership at the time of death before subtractions for deductions, debts, administrative

expenses, and casualty losses suffered during estate

administration.

Guardian-A person legally empowered and

charged with the duty of taking care and managing

the property of another person who, because of age,

intellect, or health, is incapable of managing his/her

own affairs.

H

Heir-One entitled by law to inherit the property

of a decedent who died without a will.

130
I

Lineal descendant-Direct descendant of the same

ancestors.

Intangible property-Property that has no intrinsic value, but is merely the evidence of value, such

as stock certificates, bonds, and promissory notes.

Intestate-Dying without leaving a will.

Inter vivos-Transfer of property from one living

person to another living person.

Irrevocable trust-A trust arrangement that cannot

be revoked, rescinded, or repealed by the grantor.

J

Joint tenancy-A form of property ownership in

which two or more parties hold an undivided interest in the same property that was conveyed under

the same instrument at the same time. A joint

tenant can sell his (her) interest but not dispose of

it by will. Upon the death of a joint tenant, his

(her) undivided interest is distributed among the

surviving joint tenants.

L

Law of descent-The State statutes that specify

how a deceased person’s property is to be divided

among the decedent’s heirs if there is no will.

Legacy-A gift of property made by will.

Legate-A beneficiary of a decedent’s property

named in the decedent’s will.

Liabilities-The aggregate of all debts and other

legal obligations of a particular person or legal

entity.

Lien-A claim against real or personal property in

satisfaction of a debt.

Life estate-A property interest limited in duration

to the life of the individual holding the interest (life

tenant).

M

Marital deduction-The deduction(s) that can be

taken in the determination of gift and estate tax

liabilities because of the existence of a marriage or

marital relationship.

Mortgage-The written agreement pledging property to a creditor as collateral for a loan.

Mortgagee-The person to whom property is

mortgaged and who has loaned the money.

Mortgagor-The person who pledges property to

a creditor as collateral for a loan and who receives

the money.

P

Partnership-A voluntary contract between two or

more persons to pool some or all of their assets into

a business, with the agreement that there will be a

proportional sharing of profits and losses.

Personal property-All property that is not real

propertyPer stirpes-The legal means by which the children of a decedent, upon the death of an ancestor at

a level above that of the decedent, receive by right

of representation the share of the ancestor’s estate

that their parent would have received if living.

ProbateProving a will’s validity to the court and

securing authority from the court to carry out the

will’s provisions. Also used in a broad sense to

mean administration of a decedent’s estate.

R

Real property-Land, and all immovable fixtures

erected on, growing on, or affixed to the land.

131
Remainder-An interest in property that takes

effect in the future at a specified time or after the

occurrence of some event, such as the death of a

life tenant.

Remainderman-One entitled to the remainder of

an estate after a particular reserved right

interest, such as a life tenancy, has expired.

Revocable trust-A trust agreement that can

canceled, rescinded, revoked, or repealed by

grantor (person who establishes the trust).

or

be

the

Right of survivorship_The ownership rights that

result in the acquisition of title to property by

reason of having survived other co-owners.

S

Sole ownershipThe type of property ownership

in which one individual holds legal title to the

property and has full control of it.

T

.Tenancy in common-The type of property ownership in which two or more individuals have an

undivided interest in property. At the death of one

tenant in common, his (her) fractional percentage

of ownership in the property passes to the

decedent’s heirs rather than to the surviving tenants

in common. Also called nonspousal joint tenancy.

Tenancy by the entirety-A type of joint tenancy

between husband and wife that is recognized in

some States. Neither party can sever the joint tenancy relationship and, upon death of one, the survivor acquires full title to the property.

Testate-To die leaving a will.

Testator-A male person who leaves a will at

death.

Testatrix-The female counterpart of a testator.

Trust-An arrangement made during life or under

the terms of a will by which a property interest is

held by one party (the trustee) for the benefit of one

or more beneficiaries.

Trustee-A person or institution holding and

administering property in trust.

Trustor-The person who makes or creates a

trust. Also known as the grantor or settlor.

w

Will-A legal declaration of the manner in which

a person wishes to distribute his (her) estate after

death.

132
Appendix II

ADDITIONAL READINGS

Chapters 1 and 2

Harl, N.E. 1988. Farm estate and business

planning. Niles, IL: Century Publications. 411 p.

Kess, S.; Westlin, B. 1991. CCH financial and

estate planning guide. Chicago: Commerce Clearing

House, Inc. 869 p.

Small, S.J. 1989. Preserving your family’s land.

Forest Farmer. 49(2): 273-275.

Chapter 3

Armstrong, A.A.; St. John, R.R. 1986. Federal

estate and gift taxes--past, present and future. Taxes.

64(10): 634-653.

Commerce Clearing House. 1992. Federal estate

and gift taxes explained. Chicago: Commerce

Clearing House, Inc. 446 p.

Chapter 4

Champagne, E. 1984. The valuation of forest lands

for estate tax purposes. Alabama’s Treasured Forest.

3(2): 7-9.

Fowler, A.C. 1986. Valuation of undivided interests in realty: when do the parts sum to less than the

whole? Journal of Real Estate Taxation. 13(2): 123-

167.

Horsman, S.E. 1987. Minority interest discounts on

gifts among family members. Trusts and Estates.

126(7): 54-55.

Chapter 6

Steiner, B.D. 1986. Estate tax marital deduction

planning for alternative valuation. Journal of

Taxation. 65(4): 232-236.

Chapter 7

Ramlow, J.M. 1988. Qualified disclaimers: planning

considerations under the final regulations. Idaho Law

Review. 24(3): 413-442.

Chapter 8

Harris, R.W.; Jacobson, S.W. 1992. Maximizing the

effectiveness of the annual gift exclusion. Taxes.

70(3): 204-214.

Kornfield, I.E. 1993. Conserving natural resources

and open spaces: a primer on individual giving

options. Environmental Law. 23( 1): 185-22 1.

Chapter 10

Denny, C., III; Rogers, N.N. 1990. Use of trusts by

timberland owners. Forest Farmer. 50(2): 9-l 1, 26-

28.

Elzer, R.W. 1987. Using a revocable trust to minimize probate proceedings or avoid them entirely.

Estate Planning. 14(5): 286-294.

Pennel, J.N. 1982. Avoiding tax problems for

settlors and trustees when an individual trustee is

chosen. Estate Planning. 9(5): 264-272.

Chapter 11

Perkins, D.A. 1988. Survivorship life insurance

offers many advantages for estate planning. Estate

Planning. 15(5): 296-302.

Sutherland, CF.; Siegel, W.C.; Palena, D.A. 1981.

Using insurance to pay forest taxes at death. Forest

Farmer. 40(3): 10, 15.

133
Chapter 13 PtilV

Condrell, W.K.; Neidich, G. 1982. Amendments

made by the Economic Recovery Tax Act of 1981 to

Section 2032A for woodlands. Agricultural Law

Journal. 3(4): 346-363.

Gardner, A.B.; Olson, S.C.; Haney, H.L., Jr.;

Siegel, W.C. 1984. Election by forest estates of

certain Federal estate tax provisions. Journal of

Agricultural Taxation and Law. 6(l): 400-428.

Garrison, L.R. 1987. Later actions can result in

loss of special use valuation benefits. Taxation for

Lawyers. 16(3): 180-183.

Jurinski, J.J.; Singleton, W.R. 1987. Maximize

timberland elections. Trusts and Estates. 126(12):

45-56.

Kelly, D.M.; Bellatti, R.M. 1987. Computing and

reporting the Section 2032A recapture tax. Journal

of Agricultural Law and Taxation. g(2): 120-141.

Summer, R.D. 1990. Select a business entity that’s

right for you. Forest Farmer. 50(2): 14-15.

Chapter 16

Levun, C.R. 1987. Partnerships--the preferred form

of doing business after the Tax Reform Act of 1986.

Taxes. 65(9) : 600-603.

Chapter 17

Coleman, J.E.; Reed, A.E. 1988. Factors to consider in electing Sub S status. Massachusetts CPA

Review. 62(5): 14-34.

Steinsapir, S. 1989. Estate planning for the S

corporation shareholder. Journal of Taxation of Trusts

and Estates. l(2): 47-50.

Chapter 18

Chapter 14

Gardner, A.B.; Olson, S.C.; Haney, H.L., Jr.;

Siegel, W.C. 1984. Election by forest estates of

certain Federal estate tax provisions. Journal of

Agricultural Taxation and Law. 6(l): 400-428.

Jurinski, J.J.; Singleton, W.R. 1987. Maximize

timberland elections. Trusts and Estates. 126(12):

45-56.

Kasner, J.A. 1993. When does cash qualify as

property used in a trade or business? Tax Notes.

58(11): 1484-1485.

Kiziah, T.S. 1993. Deferring estate tax is not

always a beneficial move. Estate Planning. 20(l):

12-19.

Virga, S.; Brandt, L. 1985. Current techniques for

using installment payments of estate tax to increase

liquidity. Estate Planning. 12(6): 344-349.

Ale, J.C. 1992. An introduction to limited liability

companies. Practical Lawyer. 38(8): 35-50.

Mezzullo, L.A. 1993. Limited liability companies:

a new business form? Taxation for Lawyers. 21(5):

296-302.

Chapter 19

Walden, J.B.; Haney, H.L., Jr.; Siegel, W.C. 1987.

The impact of recent changes in State and Federal

death tax laws on private nonindustrial forest estate in

the South. Southern Journal of Applied Forestry.

1 l(1): 17-23.

Walden, J.B.; Haney, H.L., Jr.; Siegel, W.C. 1988.

Federal-state death tax implications for private

nonindustrial forest landowners in the Northeast.

Northern Journal of Applied Forestry. 5(2): 135-141.

134
Appendix III

STATE DEATH TAX CREDIT’,’

Estates of Decedents Dying After 1976

Adjusted Taxable Estate

(“Adjusted Taxable Estate” is

the decedent’s taxable

estate less $6O,OCQ

From To Credit =

0 $40,000 0

$40,000 90,000 0

90,000 140,000 $400

140,000 240,000 1,200

240,000 440,000 3,600

440,000 640,000 10,000

640,000 840,000 18,000

840,000 1,040,000 27,600

1,040,000 1,540,000 38,800

1,540,000 2,040,OOO 70,800

2,040,OOO 2,540,OOO 106,800

2,540,OOO 3,040,000 146,800

3,040,000 3,540,ooo 190,800

3,540,ooo 4,040,000 238,800

4,040,OOO 5,040,000 290,800

5,040,000 6,040,OOO 402,800

6,040,OOO 7,040,000 522,800

7,040,000 8,040,OOO 650,800

8,040,OOO 9,040,000 786,800

9,040,000 10,040,000 930,800

10,040,000 1,082,800

' The above table may not be used in computing taxes cm estates of certain servicemen.

Of Excess Over

+A

0.8 0

1.6 $40,000

2.4 90,000

3.2 140,000

4 240,000

440,000

4.8 640,000

5.6 840,000

6.4 1,040,000

7.2 1,540,000

8 2,040,OOO

8.8 2,540,OOO

6.6 3,040,ooo

10.4 3,540,ooo

11.2 4,040,000

12 5,040,000

12.8 6,040,OOO

13.6 7,040,000

14.4 8,040,OOO

15.2 9,040,000

16 10,040,000

’ There is a limitation on the credit in estates of nonresidents not citizens dying after November 13, 1966. See Code Sec. 2102.

135

Appendix IV

137

Form 706 United States Estate (and Generation-Skipping Transfer)

(Rev. October 1991) Tax Return OME NO. 1545-0015

Estate of a citizen or resident of the United States (see separate instructions). To be Expires 6-30-93

Lmpatiment of the Treasury filed for decedents dying after October 8,1990, and before January 1, 1993. For

l”krml Revenue Smvlce Papemork Reduction Act Notice, see page 1 of the instructions.

1 la Decedent’s first name and middle initial (and maiden name, if any) 1 lb Decedent’s last name 1 2 Decedent’s social se curity no.

2

2

;

2

~

;

2

i

i

2

je r

3a Domicile at time of death (county and state, or foreign country) 3b Year domicile established 4 Date of birth 5 Date of death

ja Name of executor (see Instructions) 6b Executor’s address (number and street including apartment or suite no. or rural

route; city, town, or post office; state; and ZIP code)

%z Executor’s social secunty number (see instructions)

la Name and locatIon of court where WIII was probated or estate administered 7b Case number

8 If decedent died testate, check here W 0 and attach a certified copy of the wilLI 9 If Form 4768 is attached, check here b 0

IO If Schedule R-l is attached, check here b n

5

6

7a

b

C

8

9

IO

I I

12

13

14

15

16

17

I8

19

!o

!l

!2

!3

!4

!5

!6

!7

Total gross estate (from Part 5, Recapitulation, page 3, item 10) ...........

Total allowable deductions (from Part 5, Recapitulation, page 3. item 20) .........

Taxable estate (subtract line 2 from line 1) ..................

Adjusted taxable gifts (total taxable gifts (within the meaning of section 2503) made by the decedent

after December 31, 1976, other than gifts that are includible in decedent’s gross estate (section 2001 (b))

Addlines3and4 .........................

Tentative tax on the amount on line 5 from Table A in the instructions. .........

If line 5 exceeds $lO,OOO.OOO, enter the lesser of line 5 or $21.040.000. If

line 5 is $10.000,000 or less, skip lines 7a and 7b and enter -O- on line 7c.

Subtract $lO,OOO,OOO from line 7a ...........

Enter 5% (.05) of line 7b ..............

Total tentative tax (add lines 6 and 7c) ...................

Total gift tax payable with respect to gifts made by the decedent after December 31, 1976. Include gift

taxes by the decedent’s spouse for such spouse’s share of split gifts (section 2513) only if the decedent

was the donor of these gifts and they are includible in the decedent’s gross estate (see instructions)

Gross estate tax (subtract line 9 from line 8) ........

Maximum unified credit against estate tax .........

Adjustment to unified credit. (This adjustment may not exceed $6.000.

See instructions.). ................

Allowable unified credit (subtract line 12 from line 11). ..............

Subtract line 13 from line 10 (but do not enter less than zero) ............

Credit for state death taxes. Do not enter more than line 14. Compute the credit by using the amount

on line 3 less $80.000. See Table B in the instructions and attach credit evidence (see instructions)

Subtract line 15 from line 14 .............

Credit for Federal oift taxes on pre-1977 gifts (section 2012) (attach computation)

Credit for foreign death taxes (from Schedule(s) P). (Attach Form(s) 706CE)

Credit for tax on prior transfers (from .&hedule a). ......

Total(addlines17,18,and19) .....................

Net estate tax (subtract line 20 from line 16) ..................

Generation-skipping transfer taxes (from Schedule R, Part 2, line 10) ..........

Section 4980A increased estate tax (from Schedule S. Part I, line 17) (see instructions)

Total transfer taxes (add lines 21, 22, and 23) ........

Prior payments. Explain in an attached statement .......

United States Treasury bonds redeemed in payment of estate tax

Total (add lines 25 and 26). .............

!8 Balance due (or overpayment) (subtract line 27 from line 24). . . . . . . 1 28 1 I

penalties of perjury, I declare that I have examined this return, including accompanying schedules and statements, and to the best of my knowledge and belief,

it IS true, correct. and complete. Declaration 01 preparer other than the executor IS baWd on all lntormahon 01 which preparer has any knowledge.

Signature(s) of executor(s) Date

Signature of preparer other than executor Address (and ZIP code)

Cat. No. 20548R

Date

138

Form 706 (Rev. 10-91)

Estate of:

Part 3.-Elections by the Executor

1 Do you elect alternate valuation? .................

2 Do you elect special use valuation? .......................

Pati 4.-General ~nfOrrIlatiOn (Note: Please attach the necessary supplemental documents. YOU must attach the death certificate.)

Authorization to recerve confidential tax information under Regulations section 601.502(c)(3)(ii), to act as the estate’s representative before the Internal Revenue

Service, and to make written or oral presentations on behalf of the estate if return prepared by an attorney, accountant, or enrolled agent for the executor:

Name of representative (print or type) State Address (number, street. and room or suite no., city, state, and ZIP code)

I declare that I am the 0 attorney/u accountant/ 0 enrolled agent (you must check the applicable box) for the executor and prepared this return for

the executor. I am not under suspension or disbarment from practice before the Internal Revenue Service and am qualified to practice in the state shown

gbo e.

Signtture CAF number Date Telephone number

1 Death certificate number and issuing authorfty (attach a copy of the death certificate to this return).

2 Decedent’s business or occupation. If retired, check here b 0 and state decedent’s former business or occupation.

3 Marital status of the decedent at time of death:

0 Married

0 Widow or widower-Name, SSN. and date of death of deceased spouse W _ __ __ _. _ __ __ _ _. _ __ __ _. . . ___ _. __ ___ _. _ __ _ __ _ _ _. _.

____.._.___....___....__~_...______...____._._____....____....._...................................................~.........................

0 Single

0 Legally separated

0 Divorced-Date dtvorce decree became final b

4e Surviving spouse’s name 4b Social security number 4o Amount received (see instructions)

5 Individuals (other than the surviving spouse), trusts, or other estates who receive benefits from the estate (do not include charitable beneficiaries

shown in Schedule 0) (see instructions). For Privacy Act Notice (applicable to individual beneficiaries only), see the Instructions for Form 1040.

Name of indmdual. trust. or estate recetving $5.000 or more Identifying number Relationship to decedent

All unascertainable beneficraries and those who receive less than $5,000 . . . . . . . . . . . . . . b

Total.................................. .

(Continued on next page)

7

Amount (see rnstructrons)

Page 2

140
Form 706 (Rev. 10-91)

Part 4.-General information (continued)

Please check the ‘Yes” or “No” box for each question. [Yes] No

6 Does the gross estate contain any section 2044 property (qualified terminable interest property (CITIP) from a prior gift or

e decedent at the time of death own any property as a joint tenant with right of survivorship in which (a) one or more

of the other joint tenants was someone other than the decedent’s spouse, and (b) less than the full value of the property is

15 Was the decedent, immediately before death, receiving an annuity described in the “General” paragraph of the instructions

Part 5.--Recapitulation

1

2

3

4

5

6

7

8

9

10

11

12

13

14

15

16

17

18

19

20

. . . . . . . . . . . . . . . . .

Schedule B-Stocks and Bonds. . . . . . . . . .

Schedule C-Mortgages, Notes, and Cash . .

Schedule D-Insurance on the Decedent’s Life (attach Form(s) 712) . . .

Schedule E-Jointly Owned Property (attach Form(s) 712 for life insurance)

Schedule F-Other Miscellaneous Property (attach Form(s) 712 for life insurance)

Schedule G-Transfers During Decedent’s Life (attach Form(s) 712 for life Insurance)

Schedule H-Powers of Appointment . . .

Schedule J-Funeral Expenses and Expenses Incurred in Administenng Property Subject to Claims .

Schedule K-Debts of the Decedent . . .

Schedule K-Mortgages and Liens . . . . . .

Total of items 11 through 13. . .

Allowable amount of deductions from item 14 (see the instructions for Item 15 of the Recapitulation)

Schedule L-Net Losses During Administration . .

Schedule L-Expenses Incurred in Administering Property Not Sublect to Claim s

Schedule M--Bequests, etc.. to Surviving Spouse . . . . . . .

I Schedule O-Charitable, Public, and Similar Gifts and Bequests I

. . . . . . . I

Total allowable deductions (add items 15 through 19). Enter here and on line 2 of the Tax Computation

Page 3

141
Form 706 (Rev 10-91)

Estate of:

SCHEDULE A-Real Estate

(For joint/y owned propeny that must be disclosed on Schedule E, see the instructions for Schedule E.)

(Real estate that is part of a so/e proprietorship should be shown on Schedule F: Real estate that is included in the

gross estate under section 2035, 2036, 2037, or 2038 should be shown on Schedule G. Real estate that is included in

the gross estate under section 2047 should be shown on Schedule H.)

(If vou elect section 2032A valuation, you must complete Schedule A and Schedule A- 1.)

Description Alternate

valuation date

Total from continuation schedule(s) (or additional sheet(s)) attached to this schedule.

TOTAL. (Also enter on Part 5, Recapitulation, page 3, at item 1.) .

Alternate value Value at date of death

(If more space is needed, attach the continuation schedule from the end of this package or additional sheets o

(See the instructions on the reverse side.)

the same size.)

Schedule A-Page 4

142
Form 706 (Rev. 10-91)

Instructions for Schedule A.- Real Estate

If the total gross estate contains any real estate, you

must complete Schedule A and file it with the return.

On Schedule A list real estate the decedent owned or

had contracted to purchase. Number each parcel in

the left- hand column.

Describe the real estate in enough detail so that the

IRS can easily locate it for inspection and valuation.

For each parcel of real estate, report the area and, if

the parcel is improved, describe the improvements. For

city or town property, report the street and number,

ward, subdivision, block and lot, etc. For rural property,

report the township, range, landmarks, etc.

If any item of real estate is subject to a mortgage for

which the decedent’s estate is liable, that is, if the

indebtedness may be charged against other property

of the estate that is not subject to that mortgage, or if

the decedent was personally liable for that mortgage,

you must report the full value of the property in the

value column.

item

number

Item

number

Enter the amount of the mortgage under

“Description” on this schedule. The unpaid amount of

the mortgage may be deducted on Schedule K. If the

decedent’s estate is NOT liable for the amount of the

mortgage, report only the value of the equity of

redemption (or value of the property less the

indebtedness) in the value column as part of the gross

estate. Do not enter any amount less than zero. Do not

deduct the amount of indebtedness on Schedule K.

Also list on Schedule A real property the decedent

contracted to purchase. Report the full value of the

property and not the equity in the value column.

Deduct the unpaid part of the purchase price on

Schedule K.

Report the value of real estate without reducing it for

homestead or other exemption, or the value of dower,

curtesy, or a statutory estate created instead of dower

or curtesy.

Explain how the reported values were determined

and attach copies of any appraisals.

Schedule A Examples

In this example the alternate valuation is not adopted; the date of death is January 1, 1991.

Description

House and lot, 1921 Willram Street NW, Washington, DC (lot 6. square 481). Rent

of $2,70-O due at end of each quarter, February 1, May 1, August 1, and November

1. Value based on apprarsal, copy of which is attached .

Rent due on item 1 for quarter ending November 1, 1990. but not collected at date

of death. . .

Rent accrued on item 1 for November and December 199 0

House and lot, 304 Jefferson Street, Alexandria, VA (lot 18, square 40). Rent of $600

payable monthly. Value based on appraisal, copy of which is attached .

Rent due on item 2 for December 1990, but not collected at date of death

\

Alternate

raluation date

A lte rnate

value

In this example alternate valuation is adopted; the date of death is January 1, 1991.

Description

House and lot, 1921 William Street NW, Washington, DC (lot 6. square 481). Rent

of $2,700 due at end of each quarter, February 1, May I, August 1, and November

1. Value based on appraisal, copy of which is attached. Not disposed of within 6

months following death . . .

Rent due on item 1 for quarter ending November I. 1990, but not collected until

February 1, 1991 . . . . . . . . .

Rent accrued on item 1 for November and December 1990, collected on February

1,1991 . . . . . . . . . .

House and lot, 304 Jefferson Street, Alexandria, VA (lot 18, square 40). Rent of $600

payable monthly. Value based on appraisal, copy of which is attached. Property

exchanged for farm on May 1, 1991. . . . . .

Rent due on item 2 for December 1990, but not collected until February 1, 1991

Alternate

valuation date

7/I /91

2/l/91

2/l/91

5/l/91

2/l/91

Alternate

value

90.000

2,700

1.800

90,000 96,000

600 600

Schedule A-Page 5

4

Value at

date of death

108,000

2,700

1.800

9 6,000

600

Value at

date of death

108.000

2,700

1.800

143
Form 706 (Rev. 10-91)

Checklist for Section 2032A Election-/f you are

going to make the special use valuation election on

Schedule A-l, please use this checklist to ensure that

you are providing everything necessary to make a valid

election.

To have a valid special use valuation election under

section 2032A, you must file, in addition to the Federal

estate tax return, (a) a notice of election (Schedule A-l,

Part 2) and (b) a fully executed agreement (Schedule

A-l, Part 3). You must include certain information in

the notice of election. To ensure that the notice of

election includes all of the information required for a

valid election, use the following checklist. The checklist

is for your use only. Do not file it with the return.

1. Does the notice of election include the decedent’s

name and social security number as they appear on

the estate tax return?

2. Does the notice of election include the relevant

qualified use of the property to be specially valued?

3. Does the notice of election describe the items of

real property shown on the estate tax return that are to

be specially valued and identify the property by the

Form 706 schedule and item number?

4. Does the notice of election include the fair market

value of the real property to be specially valued and

also include its value based on the qualified use

(determined without the adjustments provided in

section 2032A(h)(3)(B)?

5. Does the notice of election include the adjusted

value (as defined in section 2032A(h)(3)(B)) of (a) all real

property that both passes from the decedent and is

used in a qualified use, without regard to whether it is

to be specially valued, and (b) all real property to be

specially valued?

6. Does the notice of election include (a) the items of

personal property shown on the estate tax return that

pass from the decedent to a qualified heir and that are

used in qualified use and (b) the total value of such

personal property adjusted under section

2032A(h)(3)(B)?

7. Does the notice of election include the adjusted

value of the gross estate? (See section 2032A(h)(3)(A).)

8. Does the notice of election include the method

used to determine the special use value?

9. Does the notice of election include copies of

written appraisals of the fair market value of the real

property?

10. Does the notice of election include a statement

that the decedent and/or a member of his or her family

has owned all of the specially valued property for at

least 5 years of the 8 years immediately preceding the

date of the decedent’s death?

11. Does the notice of election include a statement

as to whether there were any periods during the 8-year

period preceding the decedent’s date of death during

which the decedent or a member of his or her family

(a) did not own the property to be specially valued, (b)

use it in a qualified use, or (c) materially participate in

the operation of the farm or other business? (See

section 2032A(e)(6).)

12. Does the notice of election include, for each item

of specially valued property, the name of every person

taking an interest in that item of specially valued

property and the following information about each such

person: (a) the person’s address, (b) the person’s

taxpayer identification number, (c) the person’s

relationship to the decedent, and (d) the value of the

property interest passing to that person based on both

fair market value and qualified use?

13. Does the notice of election include affidavits

describing the activities constituting material

participation and the identity of the material

participants?

14. Does the notice of election include a legal

description of each item of specially valued property?

(In the case of an election made for qualified

woodlands, the information included in the notice of

election must include the reason for entitlement to the

woodlands election.)

Any election made under section 2032A will not be

valid unless a properly executed agreement (Schedule

A-l, Part 3) is filed with the estate tax return. To

ensure that the agreement satisfies the requirements

for a valid election, use the following checklist.

1. Has the agreement been signed by each and

every qualified heir having an interest in the property

being specially valued?

2. Has every qualified heir expressed consent to

personal liability under section 2032A(c) in the event of

an early disposition or early cessation of qualified use?

3. Is the agreement that is actually signed by the

qualified heirs in a form that is binding on all of the

qualified heirs having an interest in the specially valued

property?

4. Does the agreement designate an agent to act for

the parties to the agreement in all dealings with the

IRS on matters arising under section 2032A?

5. Has the agreement been signed by the designated

agent and does it give the address of the agent?

Page 6

144

Form 706 (Rev. 10-91)

Estate of:

Decedent’s Social Security Number

SCHEDULE A-l-Section 2032A Valuation

Part I.-Type of Election:

0 Protective election (Regulations section 2CL2032A-6(b)).-Complete Part 2, line 1, and column A of lines 3 and 4. (See instructions.)

0 Regular election.-Complete all of Part 2 (including line 11, if applicable) and Part 3. (See instructions.)

Part 2.-Notice of Election (Regulations section 20.2032A-8(a)(3))

Note: A// real property entered on lines 2 and 3 must also be entered on Schedules A, E, F; G, or H, as applicable.

A

Schedule and item number

from Form 706

1 Qualified use-check one b 0 Farm used for farming, or

k 0 Trade or business other than farmina

2 Real property used in a qualified use, passing to qualified heil

I

rs, and tobe specially valued

0

Full value

(without section 2032A(h)(3)(B)

adjustment)

C

Adjusted value (with section Value based on qualified use

2032A(h)(3)(B) (without section 2032A(h)(3)(B)

adjustment) adjustment)

)n this Form 706.

Total s

Attach a legal description of all property listed on line 2.

Attach copies of appraisals showing the column B values for all property listed on line 2.

3 Real property used in a qualified use, passing to qualified heirs, but not specially valued on this Form 706.

I

I A

Schedule and item number

from Form 706

0 C

Full value

(without section 2032A(b)(3)(6)

adjustment)

Adjusted value (with section

2032A(h)(3)(B)

adjustment)

Value based on qualified use

(without section 2032A(h)(3)(B)

adjustment)

D

Totals

If you ch&ked’“Rkg~lar’el&ztibn

(Continued on next page)

D

IOU must attach copies of appraisals showing the column B values for all property listed on line 3.

Sch e dule A -l- - Page 7

146
ed heirs.

A (continued)

Schedule and item

number from Form 706

Form 706(Rev. 10-91)

4 Personal property used in a qualified use and passing to q

A

Schedule and item

number from Form 706

B

Adjusted value (with

section 2032A(b)(3)(8)

adjustment)

Subtotal . . . .

“Subtotal” from Col. B. below left

~tal adjusted value . .

B (continued)

Adjusted value (with

section 2032A(h)(3)(B)

adjustment)

5 Enter the value of the total gross estate as adjusted under section 2032A(h)(3)(A).b

6 Attach a description of the method used to determine the special value based on qualified use.

7 Did the decedent and/or a member of his or her family own all property listed on line 2 for at least 5 of the

8 years immediately preceding the date of the decedent’s death? . . . . . 0 Yes 0 No

6 Were there any periods during the 8-year period preceding the date of the decedent’s death during which

the decedent or a member of his or her family:. Yes No

a Did not own the property listed on line 2 above? . . . . . . . . . . . .

b Did not use the property listed on line 2 above in a qualified use? . . . . .

c Did not materially participate in the operation of the farm or other business within the meaning of section

If “Yes” to any of the above, you must attach a statement listing the periods. If applicable, describe whether the exceptions of

2032A(e)(6)?. . . . . . . . . . . . . . . . . . . . . . . . . . . . . E

sections 2032A(b)(4) or (5) are met.

9 Attach affidavits describing the activities constituting material participation and the identity and relationship to the

decedent of the material participants.

10 Persons holding interests. Enter the requested information for each party who received any interest in the specially valued property.

Name Address

F \ I

Identifying number Relationship to decedent Fair market value Special use value

A ) I I

B

C

_ D

E

F

You must attach a computation of the GST tax savings attributable lo direct skips lor each person listed above who is a skip person. (See instructions.)

11 Woodlands election.-Check here F 0 if you wish to make a woodlands election as described in section 2032A(e)(13). Enter the

Schedule and item numbers from Form 706 of the property for which you are making this election b.. __._.__.__ _. ______ _. __ _________

You must attach a statement explaining why you are entitled to make this election. The IRS may issue regulations that require more

information to substantiate this election. You will be notified by the IRS if you must supply further information.

Schedule A-l-Page 8

147
Form 706 IRev. lo-9 11

Part 3.-Agreement to Special Valuation Under Section 2032A

Estate of: Date of Death Decedent’s Social Security Number

We (list all qualified heirs and other persons having an interest in the property required to sign this agreement)

being all the qualified heirs and

being all other parties having interests in the property which is qualified real property and which is valued under section 2032A of the

Internal Revenue Code, do hereby approve of the election made by

Executor/Administrator of the estate of

pursuant to section 2032A to value said property on the basis of the qualified use to which the property is devoted and do hereby enter

into this agreement pursuant to section 2032A(d).

The undersigned agree and consent to the application of subsection (c) of section 2032A of the Code with respect to all the property

described on line 2 of Part 2 of Schedule A-l of Form 706, attached to this agreement. More specifically, the undersigned heirs expressly

agree and consent to personal liability under subsection (c) of 2032A for the additional estate and GST taxes imposed by that subsection

with respect to their respective interests in the above-described property in the event of certain early dispositions of the property or early

cessation of the qualified use of the property. It is understood that if a qualified heir disposes of any interest in qualified real property to

any member of his or her family, such member may thereafter be treated as the qualified heir with respect to such interest upon filing a

Form 706-A and a new agreement.

The undersigned interested parties who are not qualified heirs consent to the collection of any additional estate and GST taxes imposed

under section 2032A(c) of the Code from the specially valued property.

If there is a disposition of any interest which passes or has passed to him or her or if there is a cessation of the qualified use of any

specially valued property which passes or passed to him or her, each of the undersigned heirs agrees to file a Form 706-A, United States

Additional Estate Tax Return, and pay any additional estate and GST taxes due within 6 months of the disposition or cessation.

It is understood by all interested parties that this agreement is a condition precedent to the election of special use valuation under section

2032A of the Code and must be executed by every interested party even though that person may not have received the estate (or GST)

tax benefits or be in possession of such property.

Each of the undersigned understands that by making this election, a lien will be created and recorded pursuant to section 63246 of the

Code on the property referred to in this agreement for the adjusted tax differences with respect to the estate as defined in section

2032A(c)(2)(G).

As the interested parties, the undersigned designate the following individual as their agent for all dealings with the Internal Revenue Service

concerning the continued qualification of the specially valued property under section 2032A of the Code and on all issues regarding the

special lien under section 63248. The agent is authorized to act for the parties with respect to all dealings with the Service on matters

affecting the qualified real property described earlier. This authority includes the following:

a To receive confidential information on all matters relating to continued qualification under section 2032A of the specially valued

real property and on all matters relating to the special lien arising under section 63248.

0 To furnish the Service with any requested information concerning the property.

a To notify the Service of any disposition or cessation of qualified use of any part of the property.

l To receive, but not to endorse and collect, checks in payment of any refund of Internal Revenue taxes, penalties, or interest.

l To execute waivers (including offers of waivers) of restrictions on assessment or collection of deficiencies in tax and waivers of

notice of disallowance of a claim for credit or refund.

l To execute closing agreements under section 7121.

l Other acts (specify) b

By signing this agreement, the agent agrees to provide the Service with any requested information concerning this property and to notify

the Service of any disposition or cessation of the qualified use of any part of this property.

Name of Agent Signature Address

The property to which this agreement relates is listed in Form 706, United States Estate (and Generation-Skipping Transfer) Tax Return,

and in the Notice of Election, along with its fair market value according to section 2031 of the Code and its special use value according

to section 2032A. The name, address, social security number, and interest (including the value) of each of the undersigned in this property

are as set forth in the attached Notice of Election.

IN WITNESS WHEREOF, the undersigned have hereunto set their hands at

this day of

Qualified Heirs

Other Interested Parties

Schedule A-l--Page 9

148
Form 706 (Rev. 10-91)

Instructions for Schedule A -l .-Section

2032A Valuation

The election to value certain farm and closely held business

property at its special use value is made by checking “Yes” to

line 2 of Part 3. Elections by the Executor, Fom-r 706. Schedule

A-l is used to report the additional information that must be

submitted to support this election. In order to make a valid

election, you must complete Schedule A-l and attach all of the

required statements and appraisals.

For definitions and additional information concerning special

use valuation, see section 2032A an&the related regulations.

Part l.-Type of Election

Estate and GST Tax Elections.-If you elect special use

valuation for the estate tax, you must also elect special use

valuation for the GST tax and vice versa.

You must value each specific property interest at the same

value for GST tax purposes that you value it at for estate tax

purposes.

Protective Election.-To make the protective election described

in the separate instructions for line 2 of Part 3, Elections by the

Executor, you must check this box, enter the decedent’s name

and social security number in the spaces provided at the top of

Schedule A-l. and complete line 1 and column A of lines 3 and

4 of Part 2. For purposes of the protective election, list on line 3

all of the real property that passes to the qualified heirs even

though some of the property will be shown on line 2 when the

additional notice of election is subsequently filed. You need not

complete columns B-D of lines 3 and 4. You need not complete

any other line entries on Schedule A-l. Completing Schedule

A-l as described above constitutes a Notice of Protective

Election as described in Regulations section 20.2032A-8(b).

Part P.-Notice of Election

Line lO.-Because the special use valuation election creates a

potential tax liability for the recapture tax of section 2032A(c),

you must list each person who receives an interest in the

specially valued property on Schedule A-l. If there are more

than eight persons who receive interests, use an additional sheet

that follows the format of line 10. In the columns “Fair market

value” and “Special use value,” you should enter the total

respective values of all the specially valued property interests

received by each person.

GST Tax Savings.-To compute the additional GST tax due

upon disposition (or cessation of qualified use) of the property,

each “skip person” (as defined in the instructions to Schedule R)

who receives an interest in the specially valued property must

know the total GST tax savings on all of the interests in specially

valued property received. This GST tax savings is the difference

between the total GST tax that was imposed on all of the

interests in specially valued property received by the skip person

valued at their special use value and the total GST tax that

would have been imposed on the same interests received by the

skip person had they been valued at their fair market value.

Because the GST tax depends on the executor’s allocation of

the GST exemption and the grandchild exclusion, the skip

person who receives the interests is unable to compute this GST

tax savings. Therefore, for each skip person who receives an

interest in specially valued property, you must attach worksheets

showing the total GST tax savings attributable to all of that

person’s interests in specially valued property.

How To Compute the GST Tax Savings.-Before computing

each skip person’s GST tax savings, you must complete

Schedules R and R-l for the entire estate (using the special use

values).

For each skip person, you must complete two Schedules R

(Parts 2 and 3 only) as worksheets, one showing the interests in

specially valued property received by the skip person at their

special use value and one showing the same interests at their

fair market value.

If the skip person received interests in specially valued

property that were shown on Schedule R-l, show these interests

on the Schedule R. Parts 2 and 3 worksheets, as appropriate.

Do not use Schedule R-l as a worksheet.

Completing the Special Use Value Worksheets.-On lines 2-4

and 6, enter -0-.

Completing the Fair Market Value Worksheets.--Lines 2 and

3, fixed taxes and other charges-If valuing the interests at their

fair market value (instead of special use value) causes any of

these taxes and charges to increase, enter the increased amount

(only) on these lines and attach an explanation of the increase.

Otherwise, enter -0-.

Line 6-GST exemption-If you completed line 10 of Schedule

R, Part 1. enter on line 6 the amount shown for the skip person

on the line 70 special use allocation schedule you attached to

Schedule R. If you did not complete line 10 of Schedule R, Part

1, enter -0- on line 6.

Total GST Tax Savings.-For each skip person, subtract the tax

amount on line 10, Part 2 of the special use value worksheet

from the tax amount on line 10, Part 2 of the fair market value

worksheet. This difference is the skip person’s total GST tax

savings.

Part 3.-Agreement to Special Valuation Under

Section 2032A

The agreement to special valuation by persons with an interest

in property is required under section 2032A(s)(l)(B) and (d)(2)

and must be signed by all parties who have any interest in the

property being valued based on its qualified use as of the date

of the decedent’s death.

An interest in property is an interest that, as of the date of the

decedent‘s death, can be asserted under applicable local law so

as to affect the disposition of the specially valued property by

the estate. Any person who at the decedent’s death has any

such interest in the property, whether present or future, or

vested or contingent, must enter into the agreement. Included

are owners of remainder and executory interests; the holders of

general or special powers of appointment; beneficiaries of a gift

over in default of exercise of any such power; joint tenants and

holders of similar undivided interests when the decedent held

only a joint or undivided interest in the property or when only an

undivided interest is specially valued; and trustees of trusts and

representatives of other entities holding title to, or holding any

interests in the property. An heir who has the power under local

law to caveat (challenge) a will and thereby affect disposition of

the property is not, however, considered to be a person with an

interest in property under section 2032A solely by reason of that

right. Likewise, creditors of an estate are not such persons

solely by reason of their status as creditors.

If any person required to enter into the agreement either

desires that an agent act for him or her or cannot legally bind

himself or herself due to infancy or other incompetency, or due

to death before the election under section 2032A is timely

exercised, a representative authorized by local law to bind the

person in an agreement of this nature may sign the agreement

on his or her behalf.

The Internal Revenue Service will contact the agent

designated in the agreement on all matters relating to continued

qualification under section 2032A of the specially valued real

property and on all matters relating to the special lien arising

under section 63248. It is the duty of the agent as

attorney-in-fact for the parties with interests in the specially

valued property to furnish the IRS with any requested

information and to notify the IRS of any disposition or cessation

of qualified use of any part of the property.

Schedule A-l -Page IO

149
Form 706 (Rev. 10-91)

Estate of:

SCHEDULE B-Stocks and Bonds

(For jointly owned property that must be disclosed on Schedule E. see the instructions for Schedule E.)

Item

numbs

1

. .

Description tncludmg face amount of bonds or number of shares and par

value where needed for Identification. Gwe CUSIP number 11 avaIlable. Unit value

Alternate

valuation date

Total from continuation schedule(s) (or additional sheet(s)) attached to this schedule.

Alternate value

TOTAL. (Also enter on Part 5, Recapitulation, page 3, at item 2.) /

(If more space is needed, attach the continuation schedule from the end of this package or additional sheets of the same

(The instructions to Schedule B are in the separate instructions.) Schedule

Value at date of death

size.)

B-Page 11

150

Form 706 (Rev. 10-91)

Estate of:

SCHEDULE C-Mortgages, Notes, and Cash

(For jointly owned property that must be disclosed on Schedule E, see the instructions for Schedule E.)

Description Alternate

valuation date

Ite m

numb

1

Total from continuation schedule(s) (or additional sheet(s)) attached to this schedule .

TOTAL. (Also enter on Part 5, Recapitulation, page 3, at item 3.). . . . . .

Value at date of death

(If more space is needed, attach the continuation schedule from the end of this package or additional sheets of the same size.)

(See the instructions on the reverse side.)

Schedule C-Page 12

152
Form 706 (Rev. 10-91)

Instructions for Schedule C.-

Mortgages, Notes, and Cash

If the total gross estate contains any mortgages, notes,

or cash, you must complete Schedule C and file it with

the return.

On Schedule C list mortgages and notes payable to

the decedent at the time of death. (Mortgages and

notes payable by the decedent should be listed (if

deductible) on Schedule K. Also list on Schedule C

cash the decedent had at the date of death.

Group the items in the following categories and list the

categories in the following order:

1. Mortgages-List: (a) the face value and unpaid

balance; (b) date of mortgage; (c) date of maturity; (d)

name of maker; (e) property mortgaged; and (f) interest

dates and rate of interest. For example: bond and

mortgage of $5O,OGO, unpaid balance $24,000; dated

January 1, 1980; John Doe to Richard Roe; premises

22 Clinton Street, Newark, N.J.; due January 1, 1992,

interest payable at 10% a year January 1 and July 1.

2. Promissory notes.-Describe in the same way as

mortgages.

3. Contract by the decedent to sell land.-List: (a)

the name of the purchaser; (b) date of contract; (c)

description of property; (d) sale price; (e) initial

payment; (9 amounts of installment payment; (g)

unpaid balance of principal; and (h) interest rate.

4. Cash in possession.-List separately from bank

deposits.

5. Cash in banks, savings and loan associations,

and other types of financial organizations.-List: (a)

the name and address of each financial organization;

(b) amount in each account; (c) serial number; and (d)

nature of account, indicating whether checking,

savings, time deposit, etc. If you obtain statements

from the financial organizations, keep them for IRS

inspection.

Schedule C-Page 13

153
Form 706 (Rev. 10-91)

Itern

numbe

1

SCHEDULE D-Insurance on the Decedent’s Life

You must attach a Form 712 for each policy.

Description Alternate

valuation date

Total from continuation schedule(s) (or additional sheet(s)) attached to this schedule

T Anernate value Value at date of death

TOTAL. (A ls o enter on Part 5, Recapitulation, page 3, at item 4.). .

(If more space is needed, attach the continuation schedule from the end of this package or additional

(See the instructions on the reverse side.)

sheets c

1

the same size.)

Sch e dule D-Page 14

154
Instructions for Schedule D.-Insurance on

the Decedent’s Life

If there was any insurance on the decedent’s life,

whether or not included in the gross estate, you must

complete Schedule D and file it with the return.

Insurance you must include on Schedule D.-Under

section 2042 you must include in the gross estate:

l Insurance on the decedent’s life receivable by or

for the benefit of the estate; and

l Insurance on the decedent’s life receivable by

beneficiaries other than the estate, as described

below.

The term “insurance” refers to life insurance of every

description, including death benefits paid by fraternal

beneficiary societies operating under the lodge system,

and death benefits paid under no-fault automobile

insurance policies if the no-fault insurer was

unconditionally bound to pay the benefit in the event

of the insured’s death.

Insurance in favor of the estate.-Include on

Schedule D the full amount of the proceeds of

insurance on the life of the decedent receivable by the

executor or otherwise payable to or for the benefit of

the estate. Insurance in favor of the estate includes

insurance used to pay the estate tax, and any other

taxes, debts, or charges that are enforceable against

the estate. The manner in which the policy is drawn is

immaterial as long as there is an obligation, legally

binding on the beneficiary, to use the proceeds to pay

taxes, debts, or charges. You must include the full

amount even though the premiums or other

consideration may have been paid by a person other

than the decedent.

Insurance receivable by beneficiaries other than the

estate.-Include on Schedule D the proceeds of all

insurance on the life of the decedent not receivable by

or for the benefit of the decedent’s estate if the

decedent possessed at death any of the incidents of

ownership, exercisable either alone or in conjunction

with any person.

Incidents of ownership in a policy include:

l The right of the insured or estate to its economic

benefits;

l The power to change the beneficiary;

l The power to surrender or cancel the policy;

l The power to assign the policy or to revoke an

assignment;

0 The power to pledge the policy for a loan;

l The power to obtain from the insurer a loan

against the surrender value of the policy;

l A reversionary interest if the value of the

reversionary interest was more than 5% of the

value of the policy immediately before the

decedent died. (An interest in an insurance policy

is considered a reversionary interest if, for

example, the proceeds become payable to the

insured’s estate or payable as the insured directs

if the beneficiary dies before the insured.)

Life insurance not includible in the gross estate

under section 2042 may be includible under some

other section of the Code. For example, a life

insurance policy could be transferred by the decedent

in such a way that it would be includible in the gross

estate under section 2036, 2037, or 2038. (See the

instructions to Schedule G for a description of these

sections.)

Completing the Schedule

You must list every policy of insurance on the life of

the decedent, whether or not it is included in the gross

estate.

Under “Description” list:

l Name of the insurance company and

l Number of the policy.

For every policy of life insurance listed on the

schedule, you must request a statement on Form 712,

Life Insurance Statement, from the company that

issued the policy. Attach the Form 712 to the back of

Schedule D.

If the policy proceeds are paid in one sum, enter the

net proceeds received (from Form 712, line 24) in the

value (and alternate value) columns of Schedule D. If

the policy proceeds are not paid in one sum, enter the

value of the proceeds as of the date of the decedent’s

death (from Form 712, line 25).

If part or all of the policy proceeds are not included

in the gross estate, you must explain why they were

not included.

Schedule D-Page 15

155
Form 706 (Rev. 10-91)

Estate of:

SCHEDULE E-Jointly Owned Property

(If you elect section 2032A valuation, you must complete Schedule E and Schedule A- 7.)

PART I.-Qualified Joint Interests-Interests Held by the Decedent and His or Her Spouse as the Only Joint Tenants

(Section 2040(bM2)1

Item

numbe

Descnption

For securities, give CUSIP number. If avarlable.

Alternate

valuatron date

Total from continuation schedule(s) (or additional sheet(s)) attached to this schedule. . . .

Alternate value Value at date of death

la Totals . . . . . . . . . . . . . . . . . . . 1

lb Amounts included in gross estate (one-half of ltne la) . . . I . . 1

PART 2.-All Other Joint interests

t

2a State the name and address of each surviving co-tenant. If there are more than three surviving co-tenants, fist the additional co-tenants

on an attached sheet.

I

Name Address (number and street. city, state. and ZIP code)

A.

B.

C.

Item Enter

ener for

o-renanl

Descriotion

(including alternate valuation date d any) For

securities. 9we CUSIP number. if avarlable.

Percentage

includible l- lncludrble

alternate value

Total from continuation schedule(s) (or additional sheet(s)) attached to this schedule.

2b Total other joint interests . . .

3 Total includible joint interests (add lines 1 b and 2b). Also enter on Part 5. Recapitulation, page

3,atitem5. .

(If more space is needed, attach the continuation schedule from the end of this package or additional sh;gKe;

(See the instructions on the reverse side.)

lncludible value at

date of death

the same size.)

ule E-Page 16

156
Form 706 (Rev. 10-91 )

Instructions for Schedule E.-Jointly

Owned Property

You must complete Schedule E and file it with the

return if the decedent owned any joint property at the

time of death, whether or not the decedent’s interest is

includible in the gross estate.

Enter on this schedule all property of whatever kind

or character, whether real estate, personal property, or

bank accounts, in which the decedent held at the time

of death an interest either as a joint tenant with right to

survivorship or as a tenant by the entirety.

Do not list on this schedule property that the

decedent held as a tenant in common, but repot-t the

value of the interest on Schedule A if real estate, or on

the appropriate schedule if personal property. Similarly,

community property held by the decedent and spouse

should be reported on the appropriate Schedules A

through I. The decedent’s interest in a partnership

should not be entered on this schedule unless the

partnership interest itself is jointly owned. Solely

owned partnership interests should be reported on

Schedule F, “Other Miscellaneous Property.”

Part l.-Qualified joint interests held by decedent

and spouse.-Under section 2040(b)(2), a joint interest

is a qualified joint interest if the decedent and the

surviving spouse held the interest as:

l Tenants by the entirety, or

0 Joint tenants with right of survivorship if the

decedent and the decedent’s spouse are the only

joint tenants.

Interests that meet either of the two requirements

above should be entered in Part 1. Joint interests that

do not meet either of the two requirements above

should be entered in Part 2.

Under “Description,” describe the property as

required in the instructions for Schedules A, B, C, and

F for the type of property involved. For example, jointly

held stocks and bonds should be described using the

rules given in the instructions to Schedule B.

Under “Alternate value” and “Value at date of

death,” enter the full value of the property.

Note: You cannot claim the special treatment under

section 2040(b) for property held jointly by a decedent

and a surviving spouse who is not a U.S. citizen. You

must report these joint interests on Part 2 of Schedule

E, not Part 1.

Part 2.-Other joint interests.-All joint interests that

were not entered in Part 1 must be entered in Part 2.

For each item of property, enter the appropriate

letter A, B, C, etc., from line 2a to indicate the name

and address of the surviving co-tenant.

Under “Description,” describe the property as

required in the instructions for Schedules A, B, C, and

F for the type of property involved.

In the “Percentage includible” column, enter the

percentage of the total value of the property that you

intend to include in the gross estate.

Generally, you must include the full value of the

jointly owned property in the gross estate. However,

the full value should not be included if you can show

that a par-t of the property originally belonged to the

other tenant or tenants and was never received or

acquired by the other tenant or tenants from the

decedent for less than adequate and full consideration

in money or money’s worth, or unless you can show

that any part of the property was acquired with

consideration originally belonging to the surviving joint

tenant or tenants. In this case, you may exclude from

the value of the property an amount proportionate to

the consideration furnished by the other tenant or

tenants. Relinquishing or promising to relinquish dower,

curtesy, or statutory estate created instead of dower or

curtesy, or other marital rights in the decedent’s

property or estate is not consideration in money or

money’s worth. See the Schedule A instructions for the

value to show for real property that is subject to a

mortgage.

If the property was acquired by the decedent and

another person or persons by gift, bequest, devise, or

inheritance as joint tenants, and their interests are not

otherwise specified by law, include only that part of the

value of the property that is figured by dividing the full

value of the property by the number of joint tenants.

If you believe that less than the full value of the

entire property is includible in the gross estate for tax

purposes, you must establish the right to include the

smaller value by attaching proof of the extent, origin,

and nature of the decedent’s interest and the

interest(s) of the decedent’s co-tenant or co-tenants.

In the “lncludible alternate value” and “lncludible

value at date of death” columns, you should enter only

the values that you believe are includibte in the gross

estate.

Schedule E-Page 17

157
Form 706 (Rev. 10-91)

Estate of:

SCHEDULE F-Other Miscellaneous Property Not Reportable Under Any Other Schedule

(For jointly owned property that must be disclosed on Schedule E, see the instructions for Schedule E.)

(If you elect section 2032A valuation, you must complete Schedule F and Schedule A- 1.)

omitted.

Ite m

numbc

1

of the decedent’s em ment or death?. . . . . . . . . . . . . . . .

me and relationship of joint

If any of the contents of the safe deposit box are omitted from the schedules in this return, explain fully why

Description

For securities, give CUSIP number, if available.

Alternate

valuation date

Total from continuation schedule(s) (or additional sheet(s)) attached to this schedule.

TOTAL. (Also enter on Part 5, Recapitulation, page 3, at item 6.) . . . .

Alternate value Value at date of death

(If more space is needed, attach the continuation schedule from the end of this package or additional sheets of the same size.)

(See the instructions on the reverse side.)

Schedule F-Page 18

158
Form 706 (Rev. 10-91)

Instructions for Schedule F.-Other

Miscellaneous Property

You must complete Schedule F and file it with the

return.

On Schedule F list all items that must be included in

the gross estate that are not reported on any other

schedule, including:

l Debts due the decedent (other than notes and

mortgages included on Schedule C)

l Interests in business

l Insurance on the life of another (obtain and attach

Form 712, Life Insurance Statement, for each

policy)

Note for single premium or paid-up policies: In

cerfain situations, for example where the surrender

value of the policy exceeds its replacement cost, the

true economic value of the policy will be greater

than the amount shown on line 56 of Form 712. In

these situations, you should report the full economic

value of the policy on Schedule E See Rev. Rul.

78- 13 7, 19 78- 1 C. 6. 280 for derails.

0 Section 2044 property

l Claims (including the value of the decedent’s

interest in a claim for refund of income taxes or

the amount of the refund actually received)

l Rights

0 Royalties

l Leaseholds

l Judgments

l Reversionary or remainder interests

l Shares in trust funds (attach a copy of the trust

instrument)

l Household goods and personal effects, including

wearing apparel

l Farm products and growing crops

l Livestock

0 Farm machinery

l Automobiles

If the decedent owned any interest in a partnership

or unincorporated business, attach a statement of

assets and liabilities for the valuation date and for the

5 years before the valuation date. Also attach

statements of the net earnings for the same 5 years.

You must account for goodwill in the valuation. In

general, furnish the same information and follow the

methods used to value close corporations. See the

instructions for Schedule 6.

All partnership interests should be reported on

Schedule F unless the partnership interest, itself, is

jointly owned. Jointly owned partnership interests

should be reported on Schedule E.

If real estate is owned by the sole proprietorship, it

should be reported on Schedule F and not on

Schedule A. Describe the real estate with the same

detail required for Schedule A.

Line 1 .-If the decedent owned at the date of death

articles with artistic or intrinsic value (e.g., jewelry, furs,

silverware, books, statuary, vases, oriental rugs, coin or

stamp collections), check the “Yes” box on line 1 and

provide full details. If any one article is valued at more

than $3,000, or any collection of similar articles is

valued at more than $10,000, attach an appraisal by

an expert under oath and the required statement

regarding the appraiser’s qualifications (see

Regulations section 20.2031-6(b)).

Schedule F-Page 19

159
Form 706 (Rev. 10-91)

Item

A.

6.

1

SCHEDULE G-Transfers During Decedent’s Life

(If you elect section 2032A valuation, you must complete Schedule G and Schedule A-l.)

Description

For securities, QIW CUSIP number. if available.

Gift tax paid by the decedent or the estate for all gifts made by

the decedent or his or her spouse within 3 years before the

decedent’s death (section 2035(c)) . . . . . . . . . . .

Transfers includible under section 2035(a), 2036. 2037. or 2038:

Alternate

valuation date

xxxxx

Total from continuation schedule(s) (or additional sheet(s)) attached to this schedule . ,

TOTAL. (Also enter on Part 5, Recapitulation, page 3, at item 7.). . . . . . . .

SCHEDULE H-Powers of Appointment

Alternate value 7Value at date of death

(/f you elect section 2032A valuation, you must complete Schedule H and Schedule A-l.)

Description Alternate

valuation date

Total from continuation schedule(s) (or additional sheet(d) attached to this schedule .

A&mate value ilalua at date of death

TOTAL. (Also enter on Part 5, Recapitulation, page 3, at item 8.). . . . . . . . (

(If more space is needed, attach the continuation schedule from the end of this package or additional sheets o

(The instructions to Schedules G and l-i are in the separate instructions.)

the same size.)

Schedules G and H-Page 20

160
Form 706 (Rev. 10-91)

Estate of:

SCHEDULE l-Annuities

Note: Genera//y, no exclusion is allowed for the estates of decedents dying after December 3 7, 1984 (see instructions).

A Are you excluding from the decedent’s gross estate the value of a lump-sum distribution described in section yes 1 No

2039(f)(2)? .

If ’‘Yes,” you must attach the’information’reouired’by the instructions. ’ ’ ’ . ’ ’ ’ ’ ’ . .

I

Item

numbf

1

lncludlble

alternate value

lncludible

Show the entire value of the annuity before any exclusions. value at date of death

Alternate

valuation date

Total from continuation schedule(s) (or additional sheet(s)) attached to this schedule .

TOTAL. (Also enter on Part 5, Recapitulation, page 3, at item 9.). . . . . .

(If more space is needed, attach the continuation schedule from the end of this package or ;

(The instructions to Schedule 1 are in the separate instructions.)

jitional sheets c the same size.)

Schedule I-Page 21

161
Estate of:

SCHEDULE J-Funeral Expenses and Expenses incurred in Administering Property Subject to Claims

Note: Do not list on this schedule expenses of administering property not subject to claims. For those expenses, see the instructions

for Schedule L.

re allowable as

If executors’ commissions, attorney fees, etc., are claimed and allowed as a deduction for estate tax purposes, they are not

allowable as a deduction in computing the taxable income of the estate for Federal income tax purposes. They a

:ome tax deduction on Form 1041 if a waiver is filed to waive the deduction on Form 706 (see the Form 10~

I

an inc

Item

I1 instructions).

A. Funeral expenses:

Descrlptlon Expense amount Total Amount

Total funeral expenses. . . . . . .

B. Administration expenses:

Executors’ commissions-amount estimated/agreed upon/paid. (Strike out the words that do not apply.) . . . . . . . . . . . . . . . . . .

Attorney fees-amount estimated/agreed upon/paid. (Strike out the words that do not apply.) .

Accountant fees-amount estimated/agreed upon/paid. (Strike out the words that do not apply.). .

Miscellaneous expenses:

Expense amount

Total miscellaneous expenses from continuation schedule(s) (or additional sheet(s))

attached to this schedule. . . . . . .

Total miscellaneous expenses . . . . . . . . .

TOTAL. (Also enter on Part 5, Recapitulation, page 3, at item 11.) . . . . . . .

(If more space is needed, attach the continuation schedule from the end of this package or additional sheets c

(See the instructions on the reverse side.) Schedule J-Page 22

he same size.)

162
Form 706(Aev. 10-91)

Instructions for Schedule J.-

Funeral Expenses and Expenses Incurred

in Administering Property Subject to

Claims

General.-You must complete and file Schedule J if

you claim a deduction on item 11 of Part 5,

Recapitulation.

On Schedule J itemize funeral expenses and

expenses incurred in administering property subject to

claims. List the names and addresses of persons to

whom the expenses are payable and describe the

nature of the expense. Do not list expenses incurred

in administering property not subject to claims on

this schedule. List them on Schedule L instead.

Funeral Expenses-Itemize funeral expenses on line

A. Deduct from the expenses any amounts that were

reimbursed, such as death benefits payable by the

Social Security Administration and the Veterans

Administration.

Executors’ Commissions.-When you file the return,

you may deduct commissions that have actually been

paid to you or that you expect will be paid. You may

not deduct commissions if none will be collected. If the

amount of the commissions has not been fixed by

decree of the proper court, the deduction will be

allowed on the final examination of the return, provided

that:

l The District Director is reasonably satisfied that the

commissions claimed will be paid;

0 The amount entered as a deduction is within the

amount allowable by the laws of the jurisdiction

where the estate is being administered;

l It is in accordance with the usually accepted

practice in that jurisdiction for estates of similar size

and character.

If you have not been paid the commissions claimed

at the time of the final examination of the return, you

must support the amount you deducted with an

affidavit or statement signed under the penalties of

perjury that the amount has been agreed upon and will

be paid.

You may not deduct a bequest or devise made to

you instead of commissions. If, however, the decedent

fixed by will the compensation payable to you for

services to be rendered in the administration of the

estate, you may deduct this amount to the extent it is

not more than the compensation allowable by the local

law or practice.

Do not deduct on this schedule amounts paid as

trustees’ commissions whether received by you acting

in the capacity of a trustee or by a separate trustee. If

such amounts were paid in administering property not

subject to claims, deduct them on Schedule L.

Note: Executors’ commissions are taxable income to

the executors. Therefore, be sure to include them as

income on your individual income tax return.

Attorney Fees.-Enter the amount of attorney fees

that have actually been paid or that you reasonably

expect to be paid. If on the final examination of the

return the fees claimed have not been awarded by the

proper court and paid, the deduction will be allowed

provided the District Director is reasonably satisfied

that the amount claimed will be paid and that it does

not exceed a reasonable payment for the services

performed, taking into account the size and character

of the estate and the local law and practice. If the fees

claimed have not been paid at the time of final

examination of the return, the amount deducted must

be supported by an affidavit, or statement signed

under the penalties of perjury, by the executor or the

attorney stating that the amount has been agreed

upon and will be paid.

Do not deduct attorney fees incidental to litigation

incurred by the beneficiaries. These expenses are

charged against the beneficiaries personally and are

not administration expenses authorized by the Code.

Schedule J-Page 23

163
Fon 706 (Rev. 10-91)

Estate of:

SCHEDULE K-Debts of the Decedent, and Mortgages and Liens

Ite m Debts of the Decadent--Cred#or and nature of claim, and

allowable death taxes Amount unpaid to date Amount in contest

Total from continuation schedule(s) (or additional sheet(s)) attached to this schedule . . . . . . . .

TOTAL. (Also enter on Part 5, Recapitulation, page 3, at item 12.) . . . . .

Mortgages and Liens-De?.criptiin

Total from continuation schedule(s) (or additional sheet(s)) attached to this schedule . . . . . . . .

TOTAL. (Also enter on Part 5, Recapitulation, page 3, at item 13.) . . . . .

Amount claimed as

a deductlon

Amount

(If more space is needed, attach the continuation schedule from the end of this package or additional sheets of the same size.)

(The instructions to Schedule K are in the separate instructions.) Schedule K -Page 24

164
Form 706 (Rev 10-91)

Estate of:

SCHEDULE L-Net Losses During Administration and

Expenses Incurred in Administering Property Not Subject to Claims

Item Net losses during admnstratlon

numb, (Note : D o not de duct losse s claim e d on a Fe de ral m com e tax return.)

Total from continuation schedule(s) (or additional sheet(s)) attached to this schedule . . .

Item

numbe

1

TOTAL. (Also enter on Part 5. Recapitulation, page 3, at item 16.) . . .

Expenses incurred in admnsterlng property not subject to

claims (Indfcate whether estimated aareed uoon. or oa!d.)

--

Total from continuation schedule(s) (or additional sheet(s)) attached to this schedule . .

TOTAL. (Also enter on Part 5, Recapitulation, page 3, at item 17.) .

~ Amount

Amount

(If more space-is needed, attach the continuation schedule from the end of this package or additional sheets of the same size.)

(The instructions to Schedule L are in the separate instructions.) Schedule L -Page 25

165
Form 706 (Rev. 10-91)

Estate of:

SCHEDULE M-Bequests, etc., to Surviving Spouse

Election To Deduct Qualified Terminable Interest Property Under Section 2066(b)(l).-If a trust (or other property) meets the

requirements of qualified terminable interest property under section 2056(b)(7), and

a. the trust or other property is listed on Schedule M, and

b. the value of the trust (or other property) is entered in whole or in part as a deduction on Schedule M,

then (unless the executor specifically identifies property to be excluded from the election) the executor shall be deemed to have

made an election to have such trust (or other property) treated as qualified terminable interest property under section 2056(b)(7).

If less than the entire value of the trust (or other property) that the executor has included in the gross estate is entered as a

deduction on Schedule M, the executor shall be considered to have made an election only as to a fraction of the trust (or other

property). The numerator of this fraction is equal to the amount of the trust (or other property) deducted on Schedule M. The

denominator is equal to the total value of the trust (or other property).

Yes N o

1

2a

b

C

d

e

3

4

Did any property pass to the surviving spouse as a result of a qualified disclaimer? . . . . .

If “Yes, ” attach a copy of the written disclaimer required by section 25 18(b).

In what country was the surviving spouse born?

What is the surviving spouse’s date of birth?

Is the surviving spouse a U.S. citizen? . . . . . . . . . . . . .

If the surviving spouse is a naturalized citizen, when did the surviving spouse acquire citizenship?

If the surviving spouse is not a U.S. citizen, of what country is the surviving spouse a citizen?

Qualified Domestic Trust-Do you elect under section 2056A(d) to treat any trusts reported on Schedule M as

qualified domestic trusts? (identify in the description column on Schedule M below the trusts to which the QDT

election applies) (see instructions). . . . . . . . . . . . . . . .

Election out of QTIP Treatment of Annuities.-Do you elect under section 2056(b)(7)(C)(ii) not to treat as qualified

terminable interest property any joint and survivor annuities that are included in the gross estate and would

otherwise be treated as qualified terminable interest property under section 2056(b)(7)(C)? (see instructions‘

Item

number

1

Descrlptlon of property Interests passing to surviving spouse

5

6a

b

C

d

7

Total from continuation schedule(s) (or additional sheet(s)) attached to this schedule . . . . .

I

Total amount of property interests listed on Schedule M . . . . . . . . . . . . L5

Federal estate taxes (including section 4980A taxes) payable out of property

interests listed on Schedule M . . . . . .

Other death taxes payable out of property interests listed on Schedule M . .

Federal and state GST taxes payable out of property interests listed on

Schedule M . . . . . . .

Add items a, b, and c . . . . . . . . . . .

Net amount of property interests listed on Schedule M (subtract 6d from 5). Also enter on Part 5,

- - .^ f-lecaprtulatron, page 3. at Item 16 . . , , . . , . . . . . , . . . . . , 1 7

Amount

(If more space is needed, attach the continuation schedule from the end of th is package of additional sheets of the same size.)

Schedule M-Page 26

166
Form 706 (Rev 10-91)

Examples of Listing of Property Interests on Schedule M

Item

number Description of property interests passing to surviving spouse Amount

1 One-half the value of a house and lot, 256 South West Street, held by decedent and surviving spouse as joint tenants

with right of survivorship under deed dated July 15, 1937 (Schedule E, Part I, item 1) . . . . . . . . . $ 32,500

2 Proceeds of Gibraltar Life Insurance Company policy No. 104729, payable in one sum to surviving spouse (Schedule

D,ltem3) . . . . . . . . . . . . . 20,000

3 Cash bequest under Paragraph Six of will . . . . . . . . . 100,000

Instructions for Schedule

M.-Bequests, etc., to

Surviving Spouse (Marital

Deduction)

General.-You must complete Schedule

M and file it with the return if you claim

a deduction on item 18 of Part 5,

Recapitulation.

The marital deduction is authorized by

section 2056 for certain property

interests that pass from the decedent to

the surviving spouse. You may claim the

deduction only for property interests that

are included in the decedent’s gross

estate (Schedules A through I).

Note: The marital deduction is genera//y

not allowed if the surviving spouse is not

a U.S. citizen. The marital deduction is

allowed for property passing to such a

surviving spouse in a “qualified domestic

trust” or if such property is transferred or

irrevocably assigned to such a trust

before the estate tax return is filed. The

executor must elect qualified domestic

trust status on this return. See the

instructions for line 3 on the following

page for details on the election.

Line 1 .-If property passes to the

surviving spouse as the result of a

qualified disclaimer, check “Yes” and

attach a copy of the written disclaimer

required by section 2518(b).

Property interests that you may list on

Schedule M.-Generally, you may list on

Schedule M all property interests that

pass from the decedent to the surviving

spouse and are included in the gross

estate. However, you should not list any

“Nondeductible terminable interests”

(described below) on Schedule M unless

you are making a QTIP election. The

property for which you make this

election must be included on Schedule

M. See “Qualified Terminable Interest

Property” on the following page.

For the rules on common disaster and

survival for a limited period, see section

2056(b)(3).

You may list on Schedule M only

those interests that the surviving spouse

takes:

1. As the decedent’s legatee, devisee,

heir, or donee;

2. As the decedent’s surviving tenant

by the entirety or joint tenant;

3. As an appointee under the

decedent’s exercise of a power or as a

taker in default at the decedent’s

nonexercise of a power;

4. As a beneficiary of insurance on the

decedent’s life;

5. As the surviving spouse taking

under dower or curtesy (or similar

statutory interest); and

6. As a transferee of a transfer made

by the decedent at any time.

Property interests that you may not

list on Schedule M.-You should not list

on Schedule M:

1. The value of any property that does

not pass from the decedent to the

surviving spouse.

2. Property interests that are not

included in the decedent’s gross estate.

3. The full value of a property interest

for which a deduction was claimed on

Schedules J through L. The value of the

property interest should be reduced by

the deductions claimed with respect to

it.

4. The full value of a property interest

that passes to the surviving spouse

subject to a mortgage or other

encumbrance or an obligation of the

surviving spouse. Include on Schedule

M only the net value of the interest after

reducing it by the amount of the

mortgage or other debt.

5. Nondeductible terminable interests

(described below).

6. Any property interest disclaimed by

the surviving spouse.

Terminable interests.-Certain interests

in property passing from a decedent to a

surviving spouse are referred to as

terminable interests. These are interests

that will terminate or fail after the

passage of time, or on the occurrence or

nonoccurrence of some contingency.

Examples are: life estates, annuities,

estates for terms of years, and patents.

The ownership of a bond, note, or

other contractual obligation, which when

discharged would not have the effect of

an annuity for life or for a term, is not

considered a terminable interest.

Nondeductible terminable interests.-

A terminable interest is nondeductible,

and should not be entered on Schedule

M (unless you are making a QTIP

election) if:

1. Another interest in the same

property passed from the decedent to

some other person for less than

adequate and full consideration in

money or money’s worth; and

2. By reason of its passing, the other

person or that person’s heirs may enjoy

part of the property after the termination

of the surviving spouse’s interest.

This rule applies even though the

interest that passes from the decedent

to a person other than the surviving

spouse is not included in the gross

estate, and regardless of when the

interest passes. The rule also applies

regardless of whether the surviving

spouse’s interest and the other person’s

interest pass from the decedent at the

same time. Property interests that are

considered to pass to a person other

than the surviving spouse are any

property interest that: (a) passes under a

decedent’s will or intestacy; (b) was

trarisferred by a decedent during life; or

(c) is held by or passed on to any

person as a decedent’s joint tenant, as

appointee under a decedent’s exercise

of a power, as taker in default at a

decedent’s release or nonexercise of a

power, or as a beneficiary of insurance

in the decedent’s life.

For example, a decedent devised real

property to his wife for life, with

remainder to his children. The life

interest that passed to the wife does not

qualify for the marital deduction because

it will terminate at her death and the

children will thereafter possess or enjoy

the property.

However, if the decedent purchased a

joint and survivor annuity for himself and

his wife who survived him, the value of

the survivor’s annuity, to the extent that

it is included in the gross estate,

qualifies for the marital deduction

because even though the interest will

terminate on the wife’s death, no one

else will possess or efioy any part of the

property.

The marital deduction is not allowed

for an interest that the decedent

directed the executor or a trustee to

convert, after death, into a terminable

interest for the surviving spouse. The

marital deduction is not allowed for such

an interest even if there was no interest

in the property passing to another

person and even if the terminable

interest would otherwise have been

deductible under the exceptions

described on the following page for life

estate and life insurance and annuity

payments with powers of appointment.

For more information, see Regulations

sections 20.2056(b)-1 (fJ and 20.2056(b)-

l(g), Example (7).

Page 27

167
Form 706(&v 10-91)

If any property interest passing from

the decedent to the surviving spouse

may be paid or otherwrse satisfied out of

any of a group of assets, the value of

the property interest is, for the entry on

Schedule tvl, reduced by the value of

any asset or assets that, if passing from

the decedent to the surviving spouse,

would be nondeductible terminable

interests. Examples of property interests

that may be paid or otherwise satisfied

out of any of a group of assets are a

bequest of the residue of the decedent’s

estate, or of a share of the residue, and

a cash legacy payable out of the general

estate.

Qualified Terminable Interest Proper-&

Example: A decedent bequeathed

$100,000 to the surviving spouse. The

general estate includes a term for years

(valued at $10,000 in determtning the

value of the gross estate) in an office

building, which interest was retained by

the decedent under a deed of the

building by gift to a son. Accordingly, the

value of the specific bequest entered on

Schedule M is $90,000.

Life Estate With Power of

Appointment in the Surviving

Spouse.-A property interest, whether

or not in trust, will be treated as passing

to the surviving spouse, and will not be

treated as a nondeductible terminable

interest if: (a) the surviving spouse is

entitled for life to all of the income from

the entire interest; (b) the income is

payable annually or at more frequent

intervals; (c) the surviving spouse has

the power, exercisable in favor of the

surviving spouse or the estate of the

surviving spouse, to appoint the entire

interest; (d) the power is exercisable by

the surviving spouse alone and (whether

exercisable by will or during life) is

exercisable by the surviving spouse in all

events; and (e) no part of the entire

interest is subject to a power in any

other person to appoint any part to any

person other than the surviving spouse

(or the surviving spouse’s legal

representative or relative if the surviving

spouse is disabled. See Rev. Rul. 85-35

1985-l C.B. 328). If these five conditions

are satisfied only for a specific portion of

the entire interest, see the section

2056(b) regulations to determine the

amount of the marital deduction.

Life Insurance, Endowment, or Annuity

Payments, With Power of Appointment

in Surviving Spouse.-A property

interest consistrng of the entire proceeds

under a life insurance, endowment, or

annuity contract is treated as passing

from the decedent to the surviving

spouse, and will not be treated as a

nondeductible terminable interest if: (a)

the surviving spouse is entitled to

receive the proceeds in installments, or

is entitled to interest on them, with all

amounts payable during the life of the

spouse, payable only to the surviving

spouse; (b) the installment or interest

Page 28

payments are payable annually, or more

frequently, beginning not later than 13

months after the decedent’s death; (c)

the surviving spouse has the power,

exercisable in favor of the surviving

spouse or of the estate of the surviving

spouse, to appoint all amounts payable

under the contract; (d) the power is

exercisable by the surviving spouse

alone and (whether exercisable by will or

during life) is exercisable by the surviving

spouse in all events; and (e) no part of

the amount payable under the contract

is subject to a power in any other

person to appoint any part to any

person other than the surviving spouse.

If these five conditions are satisfied only

for a specific portion of the proceeds,

see the section 2056(b) regulations to

determine the amount of the marital

deduction.

is property (a) that passes from the _

decedent, and (b) in which the surviving

spouse has a qualifying income interest

for life.

The surviving spouse has a qualifying

income interest for life if the surviving

spouse is entitled to all of the income

from the property payable annually or at

more frequent intervals, or has a

usufruct interest for life in the property,

and during the surviving spouse’s

lifetime no person has a power to

appoint any part of the property to any

person other than the surviving spouse.

An annuity is treated as an income

interest regardless of whether the

property from which the annuity is

payable can be separately identified.

The QTIP election may be made for all

or any part of a qualified terminable

interest property. A partial election must

relate to a fractional or percentile share

of the property so that the elective part

will reflect tts proportionate share of the

increase or decline in the whole of the

property when applying sections 2044 or

2519. Thus, if the interest of the

surviving spouse in a trust (or other

property in which the spouse has a

qualified life estate) is qualified

terminable Interest property, you may

make an election for a part of the trust

(or other property) only if the election

relates to a defined fraction or

percentage of the entire trust (or other

property). The fraction or percentage

may be defined by means of a formula.

Line X-Qualified Domestic Trust

Election.-The marital deduction is

allowed for transfers to a surviving

spouse who IS not a U.S. citizen only If

the property passes to the surviving

spouse in a “qualified domestic trust”

(QDT) or if such property is transferred

or irrevocably assigned to a QDT before

the decedent’s estate tax return is filed.

Charitable Remainder Trusts.-An

interest in a charitable remainder trust

will not be treated as a nondeductible

terminable interest if:

1. The interest in the trust passes from

the decedent to the surviving spouse;

and

2. The surviving spouse is the only

beneficiary of the trust other than

charitable organizations described in

section 170(c).

A “charitable remainder trust” is either

a charitable remainder annuity trust or a

charitable remainder unitrust. (See

section 664 for descriptions of these

trusts.)

Election To Deduct Qualified

Terminable Interests @TIP).-You may

elect to claim a marital deduction for

qualified terminable interest property or

property interests. You make the QTIP

election simply by listing the qualified

terminable interest property on Schedule

M and deducting its value. You are

presumed to have made the QTIP

election if you list the property and

deduct its value on Schedule M. If you

make this election, the surviving

spouse’s gross estate will include the

value of the “qualified terminable Interest

property.” See the instructions for line 6

of General Information for more details.

The election is irrevocable.

If you file a Form 706 in which you do

not make this election, you may not file

an amended return to make the election

unless you file the amended return on or

before the due date for filing the original

Form 706.

The effect of the election is that the

property (interest) will be treated as

passing to the surviving spouse and will

not be treated as a nondeductible

terminable interest. All of the other

marital deduction requirements must still

be satisfied before you may make this

election. For example, you may not

make this election for property or

property interests that are not included

in the decedent’s gross estate.

168

A QDT is any trust:

1. That requtres at least one trustee to

be either an individual who is a citizen of

the U.S. or a domestic corporation;

2. That requires tliat no distribution of

corpus from the trust can be made

unless such a trustee has the right to

withhold from the distribution the tax

imposed on the QDT;

3. That meets the requirements of any

applicable regulations; and

4. For which the executor has made

an election on the estate tax return of

the decedent.

To make the election, you must

answer “Yes” to the question on line 3.

Once made, the election is

irrevocable.

When listing property on Schedule M,

identifv that oropertv for which the QDT

election has ‘been made. Include the

employer Identification number for each

trust and the names and addresses of all

trustees.
Form 706(&v. 10-91)

The determination of whether a trust

qualifies as a QDT will be made as of

the date the decedent’s Form 706 is

filed. If. however, judicial proceedings

are brouaht before the Form 706’s due

date (in&ding extensions) to have the

trust revised to meet the QDT

requirements, then the determination will

not be made until the court ordered

changes to the trust are made.

Line 4.-Section 2056(b)(7) creates an

automatic QTIP election for certain joint

and survivor annuities that are includible

in the estate under section 2039. To

qualify, only the surviving spouse can

have the right to receive payments

before the death of the surviving spouse.

The executor can elect out of QTIP

treatment, however, by checking the

“Yes” box on line 4. Once made, the

election is irrevocable. If there is more

than one such joint and survivor annuity,

you are not required to make the

election for all of them.

If you make the election out of QTIP

treatment by checking “Yes” on line 4,

you cannot deduct the amount of the

annuity on Schedule M. If you do not

make the election out, you must list

the joint and survivor annuities on

Schedule M.

How To Complete Schedule M.-List

each property interest included in the

gross estate that passes from the

decedent to the surviving spouse and

for which a marital deduction is claimed.

This includes othetwise nondeductible

terminable interest property for which

you are making a QTIP election. Number

each item in sequence and describe

each item in detail. Describe the

instrument (including any clause or

paragraph number) or provision of law

under which each item passed to the

surviving spouse. If possible, show

where each item appears (number and

schedule) on Schedules A through I.

Enter the value of each interest before

taking into account the Federal estate

tax or any other death tax. The valuation

dates used in determining the value

of the gross estate apply also on

Schedule M.

If Schedule M includes a bequest of

the residue or a part of the residue of

the decedent’s estate, attach a copy of

the computation showing how the value

of the residue was determined. Include a

statement showing:

l The value of all property that is

included in the decedent’s gross estate

(Schedules A through I) but is not a part

of the decedent’s probate estate, such

as lifetime transfers, jointly owned

property that passed to the survivor on

decedent’s death, and the insurance

payable to specific beneficiaries.

l The values of all specific and general

legacies or devises, with reference to the

applicable clause or paragraph of the

decedent’s will or codicil. (If legacies are

made to each member of a class, for

example, $1,000 to each of decedent’s

employees, only the number in each

class and the total value of property

received by them need be furnished.)

l The date of birth of all persons, the

length of whose lives may affect the

value of the residuary interest passing to

the surviving spouse.

l Any other important information such

as that relating to any claim to any part

of the estate not arising under the will.

Lines 6a, b, and C.-The total of the

values listed on Schedule M must be

reduced by the amount of the Federal

estate tax, the Federal GST tax, and the

amount of state or other death and GST

taxes paid out of the property interest

involved. If you enter an amount for

state or other death or GST taxes on

lines 6b or 6c, identify the taxes and

attach your computation of them. For

additional information, see Pub. 904,

Interrelated Computations for Estate and

Gift Taxes.

Attachments.-If you list property

interests passing by the decedent’s will

on Schedule M, attach a certified copy

of the order admitting the will to

probate. If, when you file the return, the

court of probate jurisdiction has entered

any decree interpreting the will or any of

its provisions affecting any of the

interests listed on Schedule M, or has

entered any order of distribution, attach

a copy of the decree or order. In

addition, the District Director may

request other evidence to support the

marital deduction claimed.

Page 29

169
Form 706 (Rev. 10-91)

Estate of:

SCHEDULE O-Charitable, Public, and Similar Gifts and Bequests

-

Y e s No

la If the transfer was made by will, has any action been instituted to have interpreted or to contest the will or any

of its provisions affecting the charitable deductions claimed in this schedule? . . . . . . . . .

If “Yes,” full details must be submitted with this schedule.

b According to the information and belief of the person or persons filing this return, is any such action planned?.

If “Yes,” full details must be submitted with this schedule.

2 Did any property pass to charity as the result of a qualified disclaimer? . . . . . . . . .

Ite m

numbs

1

Yes,” attach a copy of the written disclaimer required by section 2518(b)

Name and address of beneficiary Character of institution

Total from continuation schedule(s) (or additional sheet(s)) attached to this schedule . . . . . .

3 Total . . . . . . . . . . .

4a Federal estate tax (including section 4980A taxes) payable out of property

interests listed above . . . . . . . . . . . . . .

b Other death taxes payable out of property interests listed above . . . .

c Federal and state GST taxes payable out of property interests listed above.

Amount

d Additemsa,b,andc. . . . . . . . . . . . . . . . 4d

5 Net value of property interests listed above (subtract 4d from 3). Also enter on Part 5, Recapitulation,

page3,atitem 19 . . . . . . . . . . . . . . . . . 5

(If more space is needed, attach the continuation schedule from the end of this package or additional sheets of the same size.)

(The instructions to Schedule 0 are in the separate instructions.)

Schedule O-Page 30

170
Form 706 (Rev 10-91)

Estate of:

SCHEDULE P-Credit for Foreign Death Taxes

List all foreign countries to which death taxes have been paid and for which a credit is claimed on this return.

If a credit is claimed for death taxes paid to more than one foreign country, compute the credit for taxes paid to one country

on this sheet and attach a separate copy of Schedule P for each of the other countries.

The credit computed on this sheet is for the _________.________...___________________._____..___..............._._.......................

(Name of death tax or taxes)

___.. imposed in __________________________....__.___._.._____________________...___.

(Name of country)

Credit is computed under the _.__.___.._._._..____._._..__..._.________._.____...._..._......_...................................................

(Insert title of treaty or “statute’)

Citizenship (nationality) of decedent at time of death

(Ail amounts and values must be entered in United States money)

Total of estate, inheritance, legacy, and succession taxes imposed in the country named above attributable to property

situated In that country, subjected to these taxes, and included in the gross estate (as defined by statute)

Value of the gross estate (adjusted, if necessary, according to the instructions for Item 2)

Value of property situated rn that country, subjected to death taxes imposed in that country, and included In the gross

estate (adjusted, if necessary, according to the instructions for item 3) . . .

Tax Imposed by sectlon 2001 reduced by the total credits clalmad under secttons 2010, 2011, and 2012 (see Instructions)

Amount of Federal estate tax attributable to property specified at item 3. (Divide Item 3 by item 2 and multlply the result

byitem4.).

Credit for death taxes imposed in the country named above (the smaller of item 1 or Item 5). Also enter on line 18 of

Part 2, Tax Computation . . . .

SCHEDULE Q-Credit for Tax on Prior Transfers

Part 1 .-Transferor Information

Name of transferor Social security number IRS office where estate

lax return was flled

A

Date of death

0

C

Check here b 0 if section 2013(f) (special valuation of farm, etc., real property) adjustments to the computation of the credit were made (see

instructions).

Part 2.-Computation of Credit (see instructions)

Re m

A

Transferor

B C

Total

A, 6, 8 C

1 Transferee’s tax as apportioned (from worksheet,

(Ilne 7 : line 8) x line 35 for each column)

2 Transferor’s tax (from each column of worksheet,

line 20 )

3 Maxlmum amount before percentage requirement

(for each column, enter amount from line 1 or 2.

whichever is smaller) . .

4 Percentage allowed (each column) (see instructions)

5 Credit allowable (line 3 x line 4 for each column)

6 TOTAL credit allowable (add columns A, B, and C

of line 5). Enter here and on line 19 of Part 2, Tax

Computation

(The mstructions to Schedules P and Q are in the separate instructions.) Schedules P and Q-Page 31

171
Form 706 (Rev. 10-91)

SCHEDULE R-Generation-Skipping Transfer Tax

Note: To avoid application of the deemed allocation rules, Form 706 and Schedule R should be filed to allocate the GST exemption

to trusts that may later have taxable terminations or distributions under section 2672 even if the form is not required to be filed to

report estate or GST tax.

Part l.-GST Exemption Reconciliation (Section 2631) and Section 2652(a)(3) (Special QTIP) Election

1 Maximum allowable GST exemption. . .

2

3

Total GST exemption allocated by the decedent against decedent’s lifetime transfers .

Total GST exemption allocated by the executor, using Form 709, against decedent’s lifetime

transfers. . . . . . . . . . . .

4 GST exemption allocated on line 6 of Schedule R, Part 2 .

5 GST exemption allocated on line 6 of Schedule R, Part 3

6 Total GST exemption allocated on line 4 of Schedule(s) R-l . . . .

7 Total GST exemption allocated to intervivos transfers and direct Skips (add lines 2-6)

8 GST exemption available to allocate to trusts and section 2032A interests (subtract line 7 from

line 1). . . . . . . . . . . . . .

9

-

Allocation of GST exemption to trusts (as defined for GST tax purposes):

A 0 C D

GST exemptlon Addhonal GST

allocated on lines 2-6. exemptlon allocated

above (see instructwx) (see InstructIons)

Check box b 0 if you are making a section 2652(a)(3) (special QTIP) election (see instructions)

Name of trust Trust’s

EIN (if any)

9D Total. May not exceed line 6, above . . . . b!?

10 GST exemption available to allocate to section 2032A interests received by individual beneficiaries

(subtract line 9D from line 8). You must attach special use allocation schedule (see instructions)

(The instructions to Schedule R are in the separate instructions.)

6

7

Trust’s inclusion

rat10 (optIonal-see

InstructIons)

10

Schedule R-Page 32

172
Form 706 (Rev. 10-9 1)

Estate of:

Part 2.-Direct Skips Where the Property Interests Transferred Bear the GST Tax on

the Direct Skips

Name of skip person Description of property interest transferred Estate tax value

1

2

3

4

5

6

7

8

9

10

Total estate tax values of all property interests listed above .............

Estate taxes, state death taxes, and other charges borne by the property interests listed above .

GST taxes borne by the property interests listed above but imposed on direct skips other than

those shown on this Part 2. (See instructions.) .................

Total fixed taxes and other charges. (Add lines 2 and 3.) ..............

Total tentative maximum direct skips. (Subtract line 4 from line 1.) ...........

GST exemption allocated. ........................

Subtract line 6 from line 5 ........................

GST tax due (divide line 7 by 2.818182). ...................

Enter the amount from line 8 of Schedule R, Part 3. ...............

Total GST taxes payable by the estate. (Add lines 8 and 9.) Enter here and on line 22 of the Tax

Computation on page 1 , . . . . . . . . . . . . . . . . . . . . . . 10

Schedule R-Page 33

173
Form 706(Rev. 10-91)

Estate of:

Part 3.-Direct Skips Where the Property Interests Transferred Do Not Bear the GST

Tax on the Direct Skips

Name of skip person Description of property interest transferred Estate tax value

1 Total estate tax values of all property interests listed above ............ .

2 Estate taxes, state death taxes, and other charges borne by the property interests listed above .

3 GST taxes borne by the property interests listed above but imposed on direct skips other than

those shown on this Part 3. (See instructions.) .................

4 Total fixed taxes and other charges. (Add lines 2 and 3.) ..............

5 Total tentative maximum direct skips. (Subtract line 4 from line 1.) ...........

6 GST exemption allocated ........................

7 Subtract line 6 from line 5 ........................

8 GST tax due (multiply line 7 by 55). Enter here and on Schedule R, Part 2, line 9. . . . . , 8

Schedule R-Page 34

174

SCHEDULE R-l

(Form 706)

(October 1991)

Depanrnanr of the Treawy

Internal Revenue SeWce

Generation-Skipping Transfer Tax

Direct Skips From a Trust

Payment Voucher

OMB No. 1545-0015

Expires 6-30-93

Executor: File one copy with Form 706 and send two copies to the fiduciary. Do not pay the tax shown. See the separate instructions.

Fiduciary: See instructions on following page. Pay the tax shown on line 6.

Name of trust Trust’s EIN

Name and title of fldwary 1 Name of decedent

Address of ftduclary (number and street) Decedent’s SSN Serwe Center where Form 706 was flied

City. state, and ZIP code Name of executor

Address of executor (number and street) 1 City. state, and ZIP code

Date of decedent’s death Flltng due date of Schedule R. Form 706 (with extensions)

Part l.-Computation of the GST Tax on the Direct Skip

Description of property interests subject to the direct skip Estate tax value

1 Total estate tax value of all property interests listed above ’

2 Estate taxes, state death taxes, and other charges borne by the property interests listed above. 2 __

3 Tentative maximum direct skip from trust. (Subtract line 2 from line 1.) 3

4 GST exemption allocated . . . . 4

5 Subtract line 4 from line 3 . 5

6 GST tax due from fiduciary (divide line 5 by 2.818182) (See instructions if property will not

bear the GST tax.) . . . . . . . . 6

Under penaltIes of perjury. I declare that I have examined this return, including accompanying schedules and statements, and to the best of my knowledge and belief.

It IS true. correct, and complete.

Signature(s) of executor(s) Date

Date

Slgnature of fiduciary or officer representing fiduciary Date

Schedule R-l (Form 706)-Page 3!5

176
Form 706 (Rev. 10-9 1)

Instructions for Fiduciary

Purpose of Schedule R-l

Code section 2603(a)(2) provides that the GenerationSkipping Transfer (GST) tax imposed on a direct skip

from a trust is to be paid by the trustee. Schedule R-l

(Form 706) serves as a payment voucher for the

trustee to remit the GST tax to the IRS. See the

instructions for Form 706 as to when a direct skip is

from a trust.

How To Pay the GST Tax

The executor will compute the GST tax, complete

Schedule R-l, and give you two copies. You should

pay the GST tax using one copy and keep the other

copy for your records.

The GST tax due is the amount shown on line 6.

Make your check or money order for this amount

payable to “Internal Revenue Service,” write “GST tax”

and the trust’s EIN on it, and send it and one copy of

the completed Schedule R-l to the IRS Service Center

where the Form 706 was filed, as shown on the front

of the Schedule R-l.

When To Pay the GST Tax

The GST tax is due and payable 9 months after the

decedent’s date of death (entered by the executor on

Schedule R-l). Interest will be charged on any GST

taxes unpaid as of that date. However, you have an

automatic extension of time to file Schedule R-l and

pay the GST tax due until 2 months after the due date

(with extensions) for filing the decedent’s Schedule R,

Form 706. This Schedule R, Form 706 due date is

entered by the executor on Schedule R-l. Thus, while

interest will be due on unpaid GST taxes, no penalties

will be charged if you file Schedule R-l by this

extended due date.

Signature

You, as fiduciary, must sign the Schedule R-l in the

space provided.

Schedule R-l (Form 706)-Page 36

177
Form 706 (Rev. 10-91 )

Estate of:

SCHEDULE S-Increased Estate Tax on Excess Retirement Accumulations

(Under section 498OA(d) of the Internal Revenue Code)

m Tax Computation

1

2

Check this box if a section 4980A(d)(5) spousal election is being made. . . . . . b 0

You must attach the statement described in the instructions.

Enter the name and employer identification number (EIN) of each qualified employer plan and individual retirement account in

which the decedent had an interest at the time of death:

Plan #l

Plan #2

Plan #3

IRA #1

IRA #2

IRA #3

Name

3 Value of decedent ’s interest .

4 Amounts rolled over after death . . . .

5

6

Total value (add lines 3 and 4) .

Amounts payable to certain alternate payees (see instructions) . .

7 Decedent’s investment in the contract under section 72(f)

6 Excess life insurance amount .

9 Decedent ’s interest as a beneficiary .

10

11

Total reductions in value (add lines 6, 7, 8, and 9)

Net value of decedent’s interest (subtract line 10 from

line 5) . . .

12

13

Decedent’s aggregate interest in all plans and IRAs (add columns A-D of line 11) b

Present value of hypothetical life annuity (from Part Ill, line 4) .

14

15

Remaining unused grandfather amount (from Part II, lrne 4)

Enter the greater of line 13 or line 14 . . . . .

16 Excess retirement accumulation (subtract line 15 from line 12). .

17 Increased estate tax (multiply line 16 by 15%). Enter here and on line 23 of the Tax Computation on

EIN

A 0 C D

page1 . . . . . .I171

(The instructions to Schedule S are in the separate instructions.)

Schedule S -Page 37

178
Form 706 (Rev. 10-91)

m

Grandfather Election

Was a grandfather election made on a previously filed Form 5329? . . . . . .

If “Yes,” complete lines 2-4 below. You may not make or revoke the grandfather election after

the due date (with extensions) for filing the decedent’s 1988 income tax return. If “No,” enter

-0- on line 4 and skip to Part III.

Initial grandfather amount . . . . . . . . . . . . . . . . .

Total amount previously recovered . . . . . . . . . . . . . . .

Remaining unused grandfather amount (subtract line 3 from line 2). Enter here and on Part I, line 14,

onpage37. . . . . . . . . . . . . . . . . . . . . .

m Computation of Hypothetical Lie Annuity

1 Decedent’s attained age at date of death (in whole years, rounded down) ......... _ ’

2 Applicable annual annuity amount (see instructions). .................2

3 Present value multiplier (see instructions) .................... 3

4 Present value of hypothetical life annuity (multiply line 2 by line 3). Enter here and on Part I, line 13,

onpage37 . ............................. 4

Schedule S-Page 38

179
Form 706 (Rev. 10-91)

Estate of:

(Make copies of this schedt~le before completing it if you will need more than one schedule.)

CONTINUATION SCHEDULE

Item

numbc

Continuation of Schedule --

(Enter

Description

For securitii. give CUSIP number, if available.

:er of schedc

Unit value

SchBcIrEor~

-

pu are wntinu

Alternate

valuation date

a

Alternate value

Value at date of

death or amount

deductible

TOTAL. (Carry forward to main schedule.) . . . . . . . . . . . . .

See the instructions on the reverse side. Continuation Schedule-Page 39

180
Form 706 (Rev. 10-91)

Instructions for Continuation

Schedule

The Continuation Schedule on page 39 provides a

uniform format for listing additional assets from

Schedules A, B, C, D, E, F, G, H, and I and additional

deductions from Schedules J, K, L, M, and 0. Use the

Continuation Schedule when you need to list more

assets or deductions than you have room for on one of

the main schedules.

Use a separate Continuation Schedule for each main

schedule you are continuing. For each schedule of

Form 706, you may use as many Continuation

Schedules as needed to list all the assets or

deductions to be reported. Do not combine assets or

deductions from different schedules on one

Continuation Schedule. Because there is only one

Continuation Schedule in this package, you should

make copies of the schedule before completing it if

you expect to need more than one.

Enter the letter of the schedule you are continuing in

the space provided at the top of the Continuation

Schedule. Complete the rest of the Continuation

Schedule as explained in the instructions for the

schedule you are continuing. Use the Unit value

column only if you are continuing Schedules B or E.

For all other schedules, you may use the space under

the Unit value column to continue your description.

To continue Schedule E, Part 2, you should enter the

Percentage includible in the Alternate valuation date

column of the Continuation Schedule.

To continue Schedule K, you should use the

Alternate valuation date and Alternate value columns of

the Continuation Schedule as Amount unpaid to date

and Amount in contest columns, respectively.

To continue Schedules J, L, and M, you should use

the Alternate valuation date and Alternate value

columns of the Continuation Schedule to continue your

description of the deductions. You should enter the

amount of each deduction in the amount deductible

column of the Continuation Schedule.

To continue Schedule 0, you should use the space

under the Alternate valuation date and Alternate value

columns of the Continuation Schedule to provide the

Character of institution information required on

Schedule 0. You should enter the amount of each

deduction in the amount deductible column of the

Continuation Schedule.

Carry the total from the Continuation Schedule(s)

forward to the appropriate line of the main schedule.

Continuation Schedule-Page 40

181
Appendix V

182
Form 709 United States Gift (and Generation-Skipping Transfer) Tax Return

(Rev November 1991) (Secton 6019 of the internal Revenue Code) (For gifts made after October 6. 1990. and before January I. 19931 OMB No ,545_oo20

Depanment of the Treasury

infernal Revenue Sehlce b See separate

1 Donor S first name and mlddle ~nlt~al

- t

It

4 Address (number. street. and apanment number) 5 Legal residence (Domicllel

6 City. state. and ZIP code 7 Cltlzenshlp

8 If the donor died during the year. check here b 0 and enter date of death... .._ ..__. .______..._. , 19 _._

9 If you recerved an extensron of time to ftle this Form 709. check here b 0 and attach the Form 4668. 2688. 2350, or extension letter

10 Enter the total number of separate donees lrsted on Schedule A-count each person only once q

1 la Have you (the donor) prevrcusly frled a Form 709 (or 709-A) for any other year? If the answer IS “No. do not complete line 11 b

1 lb If the answer to line 1 la IS “Yes,” has your address changed since you last filed Form 709 (or 709-A)?

12 Gifts by husband or wrfe to third parties-Do you consent to have the grfts (rncludtng generatton-skrpprng transfers) made ’

by you and by your spouse to thrrd pa&es dunng the calendar year consrdered as made one-half by each of you? (See

rnstructrons ) (If the answer IS “Yes,” the followtng rnformatron must be furnrshed and your spouse must srgn the consent I I

shown below. If the answer is “No.” skip lanes 13-18 and go to Schedule A )

13 Name of consentmg spouse 14 SSN

15 Were you marned to one another dunng the entrre calendar year? (See rnstructrons. )

16 If the answer to 15 IS “No.” check whether 0 mamed 0drvorced or q widowed, and grve date (see rnstructrons) b

17 Will a grft tax return for thus calendar year be filed by your spouse? _,

18 COnSent of Spouse- Consent to have the gifts (and generatIon-SkippIng transfers) made by me and by my SpouSe to third parhes during the calendar year

consdered as made one-half by each of US We are both aware of the ]olnt and several liablllty for tax created by the execwon of this consent

C;onsentmg spouse’s signature t Date p

1

2

3

4

5

6

7

:

3 8

=

2

9

J IO

z

; 11

G 12

T 13

: 14

5 15

L 16

Enter the amount from Schedule A. Part 3. lrne 1 5

Enter the amount from Schedule B. tme 3

Total taxable grfts (add lanes 1 and 2 )

Tax computed on amount on lrne 3 (see Table for Computing Tax in separate Instructtons).

Tax computed on amount on ltne 2 (see Table for Computtng Tax In separate Instructtons).

Balance (subtract lrne 5 from line 4 )

Maxrmum untfied credit (nonresident aliens. see Instructtons)

Enter the unrfied credtt agatnst tax allowable for all prror periods (from Sch. 8, lrne 1, cot. C)

Balance (subtract line 8 from lrne 7 )

Enter 20% (.20) of the amount allowed as a spectftc exemptton for grfts made after September 8.

1976, and before January 1, 1977 (see Instructtons)

Balance (subtract lrne 10 from ltne 9 )

Umfied credit (enter the smaller of ltne 6 or lrne 11 )

Credrt for foreign gift taxes (see instructions )

Total credtts (add lanes 12 and 13 )

Balance (subtract ltne 14 from ltne 6) (do not enter less than zero )

Generation-skippmg transfer taxes (from Schedule C. Part 3. col. H. total)

17 Total tax (add lanes 15 and 16).

18 Gift and generatton-sktpptng transfer taxes prepard wtth extension of time to file

19 If irne 18 IS less than lrne 17, enter BALANCE DUE (see rnstructrons)

1 j

i:”

Y

ki 20 If kne 18 IS greater than ltne 17. enter AMOUNT TO BE REFUNDED ( 20 1

5

Under penalties of penury. I declare that I have examwwd this return. lncludlng any accompanying schedules and statemen:s. and to the best of my knowledge

and belief It is true. correct, and complete De&&on of preparer (other than donor) IS based on all lnformallon of which Preparer has any knowledge.

zz

g Donor’s Sfgnature W

?i

Date b

Preparer’s signature

$ (other than donor) +

4

Date b

Q Preparer’s address

(other than donor) b

For Paperwork Reduction Act Notice , see page 1 of the se parate instructions for th is form . Cal No 16763M Form 709 (Rev 1 f-91)

183
Form 709 (Rev 1 l-91) Page 2

Part l.-Gifts Subiect Onlv to Gift Tax. C‘<fts /es: J,t:za/ .Y:._, ;.?l!on. medml. and educational exclwons-see mstfucbons

A

Item

numbf

1

B

Don&s lame. relatlorship lo don01 [lf any) Ind address and

descrlptlon of gtft If Ihe gift was made oy r- -r 2 ‘ws1 enter frus1’s

tdentifylng number below al?d attach a ,cop) JI :T. ust wJrument If

the gift was secuwes. enter the CUSIP number(s). 11 avatlable

C

Donor’s adjusted

basks of glfi

D

Date

of g1n

E

Value at

date of glfl

Part 2.-Gifts Which are Direct Skips and are Subject to Both Gift Tax and Generation-Skipping Transfer Tax. You must list the gifts

in chronological order. Gffb less po/Wa/ organization, medical, and educational exclusions-see instruchons. (Also list here direct skips

that are sub/ect only to the GST tax at this time as the result of the termination of an “estate tax mclusion period.” See’instructions.)

A

Item

number

B

Donee’s name, relatlonshlp lo donor (If any), and address and

descrlptlon of gift If the gift was made by means of a trus1, enter trust’s

identifying number below and attach a copy of the trust Instrument. If

the glfi was securltles. enter the CUSIP number(s), 11 avaIlable.

C

Donor’s adlusted

basis of glfi

1

lD

Date

of glh

E

V: ‘ue at

date of glfl

Part X-Gift Tax Reconciliation

1 Total value 71 p#ft? of donor (add column E of Parts 1 and 2) -

1

2 One-half of Items __. _. __... ._._.. _... attributable lo spouse (see lnstruct’ons) 2

3 Balance (subtract line 2 from ltne 1) . 3

4 Gifts of spouse to be ~rclur?cd YrVhedulc n, ?rt 3. line 2 of spouse’s return-see mstri~r’9ps: 4

If any of the gifts Included on this lme are also subject to the generatIon-sklppmg transfer tax, check

here F 0 and enter those gifts also on Schedule C. Part 1.

5 Total gifts (add lines 3 and 4 )

G -u_ a,,;‘\.,L I,X~ ‘..sii s ‘2’ cd ?: lIsted on 3, _ ;:lle A (mcludlrs:J I;# ,2 ;, ,iL 3) \c‘;-: jnstruct;ons)

7 Total Included amount of gifts (subtract line 6 from line 5 )

Deductions (see mstructlons)

8 Gifts of Interests to spouse for which a marltal deduction will be claimed, based

on Items ._.. ._. __. ..of Schedule A

9 Exclusions attnbutable to gifts on lme 8

10 Marital deductIon-subtract line 9 from line 8

11 Charttable deductlon. based on Items to _. .less exclusions

12 Total deductlons-add lines 10 and 1 1

13 Subtract line 12 from line 7

(If more space is needed, attach addmona/ sheets of same size.)

184
Form 709 (Rev 11-91) Page 3

16 Terminable Interest @TIP) Marital Deduction. (See instructions.)

If a trust (or other property) meets the requIremen& of quaIlfled terminable Interest property under sectIon 2523(f~ and

a. the trust (or other property) IS Itsted on Schedule A, and

b. rhe value of the trust (or other property) IS entered In whole or II- par-l as a deductIon on line 8. Part 3 of Schedule A.

then the donor shall be deemed to have made an election to have such trust (or other property) treated as quaIlfled terminable Interest property

under section 2523(fl

If less than the entlre value of the trust (or other property) that the donor has Included in Par-l 1 of Schedule A IS entered as a deductIon on

line 8. the donor shall be considered to have made an electlon only as lo a fraction of the trust (or other property). The numerator of lhls fractton

IS equal to the amount of the trust (or other property) deducted on llne 10 of Part 3. The denominator IS equal to the total value of the trust (or

other property) Ned in Part 1 of Schedule A.

If you tnake the OTIP electlon (see mstructlons for line 8 of Schedule A), the terminable Interest property Involved WIII be Included in your

spouse’s gross estate upon his or her death (sectton 2044). If your spouse disposes (by gift or otherwlse) of all or part of the qualifying ltfe

Income Interest. he or she WI/I be consldered to have made a transfer of the entlre property that IS subject to the gift tax (see Transfer of Certain

Cafe Estates on page 3 of the mstructlons)

17 Election out of QTIP Treatment of Annuities

0 l Check h’ere if you elect under section 2523(f)(6) NOT to treat as qualified termmable Interest property any lolnt and survivor annuities that

are reported on Schedule A and would otherwIse be treated as quaIlfled termmable Interest property under sectlon 2523(f) (See InstructIons.)

Enter the Item numbers (from Schedule A) for the annultles for which you are makmg this election b

If you answered “Yes” On line Ila Of Page 1, Part 1, see the instructions for completing Schedule B. If your answer is 4zNo,” skip to the

Tax Computation on Page 1 (or Schedule C, if applicable).

A

Calendar year or

calendar quarter

,see InStruCtIO”S)

I -c

I

B

Internal Revenue OffIce

where prior return was flied

c

Amount of unlfled

credit agafnst gift tax

for periods after

December 31. 1976

D

Amount of speclflc

exemption for prior

periods endIng before

Januan, 1, 1977

T

t

E

Amount of

taxable gifts

1 Totals for prior periods (without adlustment for reduced speclflc 1

exemptIon), I 1

2 Amount. if any by which total specific exemptton. line 1. column D. IS more than $30.000 2

3 Total amount of taxable gifts for prior periods (add amount. column E. line 1. and amount. If any, on

line 2) (Enter here and on lme 2 of the Tax Computation on page 1.) 3

7

(If more space is needed, attach add/t/anal sheets of same s/ze.)

185
Form 709 (Rev 11-91) Fqe 4

Note: Inter vivos direct skips which are completely excluded by the GST exemption must SW be fuliy reported

(including value and exemptions claimed) on Schedule C.

A 6

Item NO. Value

(from Schedule A, (from Schedule A.

Part 2 col. A) Part 2. coi E)

Part 1 .-Generation-Skipping Transfers

1

2

3

4 . . . . . . . . . . . . . . . ..____..........___________

5

6

If you elected gtft spllttlng and your spouse

was required to file a se&ate Form 709

(see the lnstructlons for “Split Gifts”). you

must enter all of the g!fts shown on

Schedule A. Part 2, of your spouse’s Form

709 here

In column C. enter the Item number of each

gtfi I” the order It appears I” column A of

your spouse’s Schedule A, Part 2. We have

preprInted the prefix “S-” lo dlstmgulsh your

spouse’s Item numbers from your own when

you complere column A of Schedule C. Part

3.

In column D. for each gift enter the amount

reported !n column C. Schedule C. Part 1. of

c

SpM Gifts

(enter ‘% of col. B)

(see Instrucllons)

D E *

Subtract col. C Nontaxable

from COI. B portion of transfer

F

Net Transfer

(subtract co1 E

from co! D!

I I I

Split gifts from Value Included

spouse’s Form 709 from spouse’s

(enter Item number) Form 709

I

Nontaxable Net !ransfer

porlion of transfer isubrract col E j

from col DI

S- . . . . . . . . . . . . . . . . . . . . . . J . . . . . . . . . . . . . . . l..........._.___..__ 1

s- . . . . . . . . . . . . . . . . . . J . . . . . . . . . . . . . . . . . . . J .._..___._ ____...._ 1.

s- . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .._.......

syour spouse’s Form 709. SPart P.-GST’Exemption Reconciliation (Code section 2631) and Section 2652(a)(3) Election

Check box b 0 if you are making a section 2652(a)(3) (special QTIP) election (see InstructIons) I

I

Enter the item numbers (from Schedule A) of the gifts for which you are making this electlon b _. _. _.

1 MaxImum allowable exemption . .

2 Total exemption used for periods before filing this retur n

3 Exemption avallable for this return (subtract line 2 from lme 1 )

4 Exemption claimed on this return (from Part 3. col. C total. below ) ~ 4 I

5 Exemption allocated to transfers not shown on Part 3. below. You must attach a Notlce of AllocatIon. (See j i

instructions.) . 5

6 Addlines4and5 . .

7 Exemption available for future transfers (subtract line 6 from line 3 ) 7

Part 3.-Tax Computation

I- A B

Item No. Net transfer

(from Schedule (from Schedule C.

C. Part 1) Par7 1. col F)

1 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

2

3 . . ..-..............................

4

5

C D

E

F

G H

GST ExemptIon Dlvlde col. C lncluson Rat10

(subtract col D Maxtmum Estate Applicable Rate ,_ GeneratIon-Sklpplrg

Allocated bycol E from 1 .OOO) Tax Rate ; (multiply 201 E Transfer Tax

by col F) Imultiply col B by CO, Sl

--...-........____..__.______._._..

6

. . . . . . . . . . . . .._..._._______......_.

. . . . . . . . . .._............._..____

Total exemption claimed. Enter

here and on line 4. Part 2.

above. May not exceed line 3,

Part 2, above .

.L

Total generation-skipping transfer tax. Enter here. on line 14 of

Schedule A, Part 3, and on line 16 of the Tax Computation on ,

Ipagel. . /

(If more space is needed, attach addItiona/ sheets of same sac.) ‘U.S. Government Pnntlng Cika: ,991 - 61%72%40489

186
Haney, Harry L., Jr.; Siegel, William C. 1993. Estate

planning for forest landowners: what will become of your

timberland? Gen. Tech. Rep. SO-97. New Orleans, LA:

U.S. Department of Agriculture, Forest Service, Southern

Forest Experiment Station. 186 p.

This book’s purpose is to provide guidelines and assistance

to nonindustrial private woodland owners in applying estate

planning techniques to their forest properties.

Keywords: Estate tax, estate valuation, forest estate, gift

tax, timber estate.

The policy of the United States Department of Agriculture Forest Service

prohibits discrimination on the basis of race, color, national origin, age, religion,

sex, or disability, familial status, or political affiliation. Persons believing they have

been discriminated against in any Forest Service related activity should write to:

Chief, Forest Service, USDA, P. 0. Box 96090, Washington, DC 20090-6090.

Q “-8. ammm.m?r PRIWI@E OmIa: 1994-566-738



United States

Department of Agriculture

Forest Service

Southern Forest

Experiment Station

701 Loyola Ave., Rm.T-10210

New Orleans, LA 70113-1931

OFFICIAL BUSINESS

Penaity for Private Use $300

c

i

~_,,._, . . . “” -... “._^ .^.._ ,.,...” ,-_._ _...““._, .” ..,. ^._I._I,,._.____I_--.,,-..__.~._.,..,. -.,...-.-....~

‘9,,

i 1