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state Planning Final Case #2 Kenny and Melissa Background Kenny, age 62, and Melissa, age 23, have been dating for about a year and a half. Kenny and Melissa met when Kenny was on a vacation in the south of France. Melissa was a beautiful French artist selling paintings at the market by Kennys hotel. After a month-long romance, Kenny asked Melissa to return to the United States with him. Although not a United States citizen, she has maintained residence in the United States for 15 months. While they have no current plans to marry, they recently found out that Melissa is expecting her first child. Although no paternity tests have been conducted, both Kenny and Melissa are confident the child is Kennys. When they found out Melissa was pregnant, Melissa moved into the 4 bedroom home Kenny owns so they could prepare for the baby, whom they plan to name Kole. To prove to Melissa that he was serious about them being a family, Kenny gave Melissa $5,340,000 in a money market account last month. The money market account is the only asset Melissa owns. Kenny also purchased a $2,000,000 life insurance policy on his life and named Melissa as the beneficiary. Kenny was previously married and has two children from that marriage, Kati, age 38, and Karli, age 28. Both girls are happily married and have children of their own. Kati has two children, Cody, age 3, and Kali, age 13. Karli was unable to have children of her own; therefore, she adopted a little girl, Riley, age 2, from Russia last year. Kenny and his first wife, Liz, have been divorced for ten years and are not on speaking terms. After their marriage, Kenny was required to pay Liz alimony in the amount of $10,000 per month. When the court order expired at the end of last year, Kenny felt bad so he continues to give Liz $10,000 per month on the first of each month. Although Kenny has high blood pressure, he is otherwise healthy. Melissa has never been married. She is in excellent health, and learned just a few days ago that they are having a baby boy, who is expected to be healthy. Kenny is retired and owns The Bungalow, a local bar and grill, while Melissa is currently unemployed. Kenny and Melissa live in a community property state. Kennys mother, Carrie, also lives with him. Carrie is 82 and in failing health. She was recently diagnosed with Parkinsons disease. While she is unable to feed or bathe herself, she is expected to live for several more years. Carrie has already spent all of her retirement assets and relies exclusively on Social Security. The only substantial asset she owns is a life insurance policy covering her life. The policy has a $100,000 death benefit and is not a modified endowment contract (MEC). The policy does not have a named beneficiary. For estate planning purposes, Kenny estimates the following expenses at his death: 1. The last illness and funeral expenses are expected to be $100,000. 2. Estate administration expenses are estimated at $180,000. 2013 Money Education 1 Estate Planning Final Case #2 Wills Melissa does not have a will. Kenny has written two wills in his lifetime. The first will was a statutory will executed during his marriage to Liz, and dated September 1, 1990. The second will is a handwritten will he wrote right after his divorce, but it is not dated. For the second will, Kenny did not want to seek advice from an attorney so he basically copied the first will and replaced the names. The second will is only signed by him and was not witnessed. Liz still has an executed copy of the first will and the second will is in the bottom of Kennys sock drawer. No one, other than Kenny, knows the second will exists. Kennys Last Will and Testament, drafted and executed during his marriage to Liz. I, Kenny, being of sound mind and wishing to make proper disposition of my property in the event of my death, do declare this to be my Last Will and Testament. 1. I have been married but once, and only to Liz with whom I am presently living. Out of my marriage to Liz, two children were born, namely Kati and Karli. I have adopted no one nor has anyone adopted me. 2. I leave all assets to my wife Liz. 3. In the event that Liz predeceases me or fails to survive me for more than six (6) months from the date of my death, disclaims, or otherwise fails to accept any property bequeathed to her, I give my estate to my children. 4. In the event that any of my children should predecease me, die within six months from the date of my death, disclaim, or otherwise fail to accept any property bequeathed to him or her, then such interest will pass to the said legatees descendants, otherwise his or her share of all of my property of which I die possessed shall be paid equally among my surviving children. 5. I name my wife, Liz, to serve as the executor of my estate with full seizin and without bond. 6. I direct that the expenses of my last illness, funeral, and the administration of my estate shall be paid by my executor as soon as practicable after my death and allocated against the residual estate. 2013 Money Education 2 Estate Planning Final Case #2 Kennys Last Will and Testament, handwritten after his divorce. I, Kenny, being of sound mind and wishing to make proper disposition of my property in the event of my death, do declare this to be my Last Will and Testament. 1. I have two children, namely Kati and Karli. I have adopted no one nor has anyone adopted me. 2. I leave all assets to my children. 3. In the event that any of my children should predecease me, die within six months from the date of my death, disclaim, or otherwise fail to accept any property bequeathed to him or her, then such interest will pass to the said legatees descendants, otherwise his or her share of all of my property of which I die possessed shall be paid equally among my surviving children. 4. I name my daughter Kati, to serve as the executor of my estate with full seizin and without bond. 5. I direct that the expenses of my last illness, funeral, and the administration of my estate shall be paid by my executor as soon as practicable after my death and allocated against the residual estate. Current Year Gifts to Grandchildren Kenny made the following gifts to his grandchildren during the current year: Seeing how Kennys mom outlived her assets, Kenny is afraid his grandchildren may have the same fate. To assist them with their retirement income, Kenny decided to establish a trust for the children. The trust is an irrevocable trust and he funded it in the current year with $400,000. The trust will accumulate income until each grandchild reaches age 50. When a grandchild reaches age 50, he/she will begin receiving an annuity for their life. When all of the grandchildren die, if there is any remaining assets then the trustee may distribute those assets to a charitable organization of his choosing. Kenny sent a check in the amount of $6,000 directly to Kalis private school to pay her tuition. Kenny also gave both Cody and Riley $6,000 each. Assume Kenny previously paid gift tax of $1,362,518 in 2013, for taxable gifts of $4,892,908.57, made in 2012. These were his first taxable gifts. 2013 Money Education 3 Estate Planning Final Case #2 Kennys Statement of Financial Position (After the Gift to Melissa) Notes to Financial Statements: 1. Assets are stated at fair market value (rounded to even dollars). 2. Liabilities are stated at principal only (rounded to even dollars). 3. The Bungalow was valued last week for insurance purposes. The valuation includes $100,000 for the land and $1,400,000 for the business. 4. The qualified plan has Liz listed as the designated beneficiary. The Investment Portfolio is a Transfer on Death (TOD) account with Kati and Karli as the listed beneficiaries. 5. The adjusted basis of the personal residence is $200,000. 6. Kenny received the vacation property as a gift from his grandfather, Grover. Grover purchased the vacation property for $10,000 and the FMV of the property at the date of transfer was $30,000. The FMV when Grover died was $60,000. The annual exclusion did not apply to the transfer and the gift tax paid was $14,700. 7. The boat is owned joint tenancy with rights of survivorship with Liz. They each contributed 50% of the purchase price. The Statement of Financial Position only reflects Kennys interest. 8. Kennys state does not have any statutes that invalidate bequests or beneficiary designations to prior spouses. 9. This statement is prepared after all the gifts were made, including the one to Melissa, and the gift tax has been paid for the 2010 gifts. 2013 Money Education 4 Estate Planning Final Case #2 Questions Answer the following questions. Assume the facts given in the fact pattern and that the 2014 estate and gift tax rates and annual exclusion apply to all transfers. (Numbers are rounded for convenience.) Assume today is January 1, 2014. 1. Assuming Kenny died today (January 1, 2014), calculate his gross estate. a) $3,000,000. b) $3,500,000. c) $4,862,518. d) $6,862,518. 2. Assuming Kenny died today, calculate his probate estate. a) $2,140,000. b) $2,200,000. c) $2,640,000. d) $3,500,000. 3. Assuming Kenny died today, calculate the Marital Deduction available for estate transfers to Melissa. a) $0. b) $1,000,000. c) $2,000,000. d) $2,140,000. 4. Assume Kenny died today (January 1, 2014), and (assume for this question only) that the estate tax liability due is $266,881, and Kati is appointed executor. Unfortunately, Kati forgot to file an Estate Tax Return (Form 706) and pay the estate tax due until 68 days after the returns due date. How much is the total penalty for failure-to-file and failure-to-pay? (Note this is not the actual estate tax liability due.) a) $4,003.22. b) $36,028.60. c) $40,032.15. d) $44,035.37. 5. Assume Melissa and Kenny had their baby today and named him Kole. Which of the following individuals is a skip person in relation to Kenny? 1. Riley 2. Kole 3. Melissa a) 1 only. b) 1 and 3. c) 2 and 3. d) 1, 2, and 3. 2013 Money Education 5 Estate Planning Final Case #2 6. What is the total Generation Skipping Transfers for the current year reduced by any available annual exclusions or qualified transfer exclusions? a) $387,000. b) $5,120,000. c) $5,532,000. d) $5,726,000. 7. Which of the following is true with regard to Kennys transfer to the trust benefiting the grandchildren? a) When distributions are made from the trust, the distributions will be taxable distributions. b) The transfer was a transfer to a direct skip. c) When the trust expires and the assets are distributed to a charitable organization, then the distribution will be a taxable termination. d) The trust is not subject to GSTT because of the charitable beneficiary. 8. Kenny is thinking about transferring his Investment Portfolio and the Bungalow to a dynasty trust for the benefit of his natural heirs. Which of the following statements is correct? a) Kenny cannot transfer the investment portfolio without Kati and Karlis consent. b) Kati and Karli would be appropriate trust protectors. c) Kenny can name himself as the trustee and continue to make all of the business decisions for the Bungalow during his life while removing the assets from his gross estate. d) Because of the blended family, generational subtrusts may be appropriate. 9. Assume for this question only, Kole was born today and Kenny was so excited after the delivery that he had a heart attack and died. Who would receive his probate assets under the will assuming the state follows the uniform probate law? a) Liz. b) Melissa. c) Kati, Karli, and Kole. d) It is unclear who would inherit the assets. 10. What is the amount of Kennys total taxable gifts for the year (less the annual exclusion and qualified transfers)? a) $5,250,000. b) $5,742,000. c) $5,896,400. d) $5,749,496. 2013 Money Education 6 Estate Planning Final Case #2 Use the following scenario to answer questions 11 through 15. Assume, for Questions 11 through 15 only, that Kenny and Melissa were married today. After getting married, they went straight to Kennys lawyers office to execute new wills. On the way home from executing a valid will leaving all assets to Melissa, Kenny and Melissa were in a serious car accident. Kenny was comatose for several days before dying. His unpaid medical expenses were $150,000. The day after Kenny died, Melissa gave Kennys children and grandchildren $22,000 each, and then she left for France to stay with her mother. Which of the following post-mortem elections would be available to Kennys executor? 11. A QTIP election for the assets transferred to Melissa. a) Yes, this election would be available. b) No, this election would not be available. 12. A deduction on Kennys final income tax return for the unpaid medical expenses. a) Yes, this election would be available. b) No, this election would not be available. 13. A split election for gifts Melissa made to Kennys children the day after Kennys death. a) Yes, this election would be available. b) No, this election would not be available. 14. Special use valuation for the Bungalow. a) Yes, this election would be available. b) No, this election would not be available. 15. Married Filing Jointly filing status for the current year. a) Yes, this election would be available. b) No, this election would not be available. 16. Kenny is considering transferring his life insurance policy to an ILIT. Which of the following statements is true? a) If Kenny included a clause that said, Kenny can change the beneficiary of the trust at any time to any person other than himself then the assets would be included in Kennys gross estate when he died. b) If the trust allows the trustee to lend money to Kennys estate at Kennys death, then the proceeds of the life insurance policy will be included in Kennys gross estate. c) Transferring the policy to the ILIT will eliminate the chance that the proceeds will be included in Kennys gross estate at Kennys death. d) If Kenny continues to pay the trustee an amount needed to pay the premiums on the policy, the proceeds will be included in his gross estate when he dies. 2013 Money Education 7 Estate Planning Final Case #2 17. Carrie would like to spend the few years she has left enjoying her life. She would like to use her life insurance policy to fund the remainder of her life. Which of the following statements is correct? a) If Carrie surrenders her policy for accelerated death benefits, she will be subject to income tax on the gain because she is not terminally ill. b) Carrie could exchange the policy in a 1035 exchange for an annuity without being subject to income tax on the transfer. c) If Carrie borrows from the policy, then the loan will be considered a taxable distribution. d) If Kenny purchases the policy from Carrie at the fair market value, he will receive the insurance proceeds income tax free at Carries death. 18. If Kenny were to die today, what would his taxable estate be? a) $3,010,000. b) $3,835,850. c) $4,010,000. d) $6,372,518. 19. If Kenny decided to sell the vacation property today for the Fair Market Value, what would his gain or loss be? a) $40,000. b) $70,000. c) $75,300. d) $80,200. 20. Assume for this question only that Melissa has a healthy baby boy and they name him Kole. The stress of the new baby deteriorates their relationship and Kenny and Melissa break up 6 months later. Kenny is ordered by the court to pay $2,000 a month in child support to Melissa which includes $4,000 a year for day care costs. What is Kennys yearly taxable gift to Melissa and how much is deductible for income tax? Gift Deductible (a) $0 $0 (b) $0 $4,000 (c) $24,000 $0 (d) $24,000 $4,000 21. Assume Kenny had charitable inclinations and decided he wanted to bequeath something to charity. Which of the following assets would be the most advantageous to leave to the charity considering the tax effects on other noncharitable beneficiaries? a) $60,000 in cash. b) $60,000 in qualified plan assets. c) $60,000 in portfolio assets. d) The boat. 2013 Money Education 8 Estate Planning Final Case #2 22. Assume for this question only that Kenny and Melissa had the baby today. When Kenny returned home, Kennys neighbor, Stue Farm, came over. Stue is the local insurance salesman and he immediately convinced Kenny he needed to buy a new life insurance policy on the babys life. The policy has a $10,000 death benefit. Kenny is the owner, the policy is on Koles life, and Melissa is the beneficiary. Assume Kenny paid his first premium payment then had a heart attack and died. Which of the following statements is correct? a) The interpolated terminal reserve plus any unearned premium will be included in Kennys gross estate. b) The death benefit will be included in Kennys gross estate. c) The replacement cost will be included in Kennys gross estate. d) The policy will not be included in Kennys gross estate because Kenny is not the beneficiary. 23. Assume Kenny and Melissa had Kole today and Kenny wanted to create a trust for Koles future benefit. Kenny would like to create a trust that allows him to make use of the annual exclusion. He wants the trust to accumulate income until Kole reaches age 21, at which point the entire trust will be distributed to Kole. Which of the following devices would be appropriate to accomplish Kennys goals? a) An UGMA device. b) An UTMA device. c) A section 2503(b) device. d) A section 2503(c) device. 24. Kenny is considering running for governor but is concerned that managing the Bungalow and his portfolio will cause a conflict of interest. Which of the following trusts would be an appropriate device to mitigate against the conflict of interest? a) A Totten trust. b) A political trust. c) A blind trust. d) A standby trust. 25. Kenny is considering changing his will today. He wants the new will to leave everything to Melissa. Which of the following statements is true? a) A no-contest clause could be added to discourage Kati and Karli from contesting the will. b) A simultaneous death clause could not be used to require Melissa to survive six months. c) A guardianship clause can be used to identify Kennys preferred legal guardian of Kole. d) A disclaimer clause allowing Melissa to disclaim the property in favor of Kennys children could be used to prevent overqualification of the estate.