AEP Taxation in Estate Planning 1 — Questions and Answers

Question 1: Which federal tax is directly associated with transferring property at death?

Income tax
Gift tax
Estate tax (Correct answer)
Sales tax

Correct answer: Estate tax

The federal tax directly associated with transferring property at death is the estate tax. This tax is levied on the total value of a deceased person's assets, including cash, real estate, stocks, and other property, before distribution to heirs. It is distinct from income tax, which applies to earnings, and gift tax, which applies to transfers made during life.

Question 2: Which of the following is NOT subject to federal estate tax?

Property held in a revocable trust
Life insurance owned by the deceased
Jointly owned property
Life insurance not owned by the deceased (Correct answer)

Correct answer: Life insurance not owned by the deceased

Life insurance proceeds are generally included in the deceased's taxable estate if the deceased owned the policy or had incidents of ownership at the time of death. However, if the life insurance policy is neither owned by the deceased nor payable to their estate, such as a policy owned by another individual or an irrevocable life insurance trust, the proceeds are typically not subject to federal estate tax in the deceased's estate. This is a common estate planning strategy to remove assets from the taxable estate.

Question 3: What is the annual exclusion amount for gifts under the federal gift tax (as of recent IRS rules)?

$10,000
$15,000
$17,000 (Correct answer)
$25,000

Correct answer: $17,000

As of recent IRS rules (specifically for 2023, and often updated annually), the annual exclusion amount for gifts under the federal gift tax is $17,000. This means an individual can give up to $17,000 per year to any number of recipients without incurring gift tax or using up any of their lifetime gift tax exemption. This amount is adjusted periodically for inflation.

Question 4: What does the step-up in basis rule apply to?

Income earned after death
Assets sold before death
Inherited assets (Correct answer)
Life insurance proceeds

Correct answer: Inherited assets

The step-up in basis rule applies specifically to inherited assets. When an asset is inherited, its cost basis for the beneficiary is "stepped up" to its fair market value on the date of the decedent's death, rather than the original purchase price. This rule is highly advantageous for beneficiaries, as it can significantly reduce or even eliminate capital gains tax if they choose to sell the asset shortly after inheritance.

Question 5: Which tax applies when a person gives over the annual exclusion amount to another individual?

Estate tax
Capital gains tax
Gift tax (Correct answer)
Sales tax

Correct answer: Gift tax

When an individual transfers assets to another person during their lifetime, and the value of that transfer exceeds the annual gift tax exclusion amount, the federal gift tax applies. While the donor is generally responsible for paying the gift tax, they can use a portion of their lifetime gift and estate tax exemption to cover the taxable gift, thereby avoiding immediate payment of the tax. This tax is distinct from estate tax, which applies at death, and capital gains tax, which applies to profits from asset sales.

Question 6: How is a Qualified Personal Residence Trust (QPRT) used in estate planning?

To sell real estate quickly
To protect assets from lawsuits
To reduce estate and gift taxes (Correct answer)
To manage rental properties

Correct answer: To reduce estate and gift taxes

A Qualified Personal Residence Trust (QPRT) is an estate planning tool specifically designed to reduce the value of a primary or secondary residence for estate and gift tax purposes. The grantor transfers their home into the QPRT for a specified term, retaining the right to live there rent-free during that period. At the end of the term, the home passes to the beneficiaries, and its value for gift tax purposes is discounted, effectively removing the future appreciation of the property from the grantor's taxable estate.

Question 7: What is the generation-skipping transfer (GST) tax designed to prevent?

Charitable donations
Direct transfers to children
Transfers to spouses
Avoidance of estate tax via skipping generations (Correct answer)

Correct answer: Avoidance of estate tax via skipping generations

The Generation-Skipping Transfer (GST) tax is a federal tax designed to prevent wealthy individuals from avoiding estate taxes by transferring assets directly to grandchildren or later generations. Without the GST tax, assets could bypass one or more generations, thus avoiding estate tax at each skipped generation's level. This tax ensures that wealth transfers are subject to taxation at each generational level, maintaining the integrity of the estate tax system.

Question 8: Which of the following is true about marital deductions in estate planning?

They are capped at $1 million.
They apply only to siblings.
They are limited to non-citizens.
They allow unlimited transfers between spouses (Correct answer)

Correct answer: They allow unlimited transfers between spouses

The unlimited marital deduction is a fundamental principle in U.S. estate and gift tax law. It allows spouses to transfer an unlimited amount of assets to each other, either during their lifetime or at death, without incurring federal gift or estate tax. This deduction is designed to ensure that married couples can manage their assets without immediate tax implications, deferring any potential estate tax until the death of the surviving spouse.

Question 9: What is the purpose of the federal estate and gift tax exemption amount?

To limit property ownership rights
To charge taxes on all transfers
To provide a tax-free threshold for asset transfers (Correct answer)
To fund Social Security benefits

Correct answer: To provide a tax-free threshold for asset transfers

The federal estate and gift tax exemption amount establishes a specific threshold for asset transfers. This amount represents the total value of assets an individual can transfer during their lifetime or at death without incurring federal gift or estate tax. Transfers exceeding this exemption amount are generally subject to taxation, making it a crucial component for tax-efficient estate planning.

AEP Taxation in Estate Planning 1

Which federal tax is directly associated with transferring property at death?