2.2 Gross Estate

• Library: A Lawyer's Guide to Estate Planning: Fundamentals for the Legal Practitioner (ABA) (2018 Ed.)

2.2 Gross Estate

The gross estate is the beginning point in determining what property is subject to the federal estate tax.¹ The gross estate includes both probate and nonprobate property and certain gifts made during one's lifetime. Probate property includes all property, real or personal, tangible or intangible, owned at death by the decedent, either in his or her sole name or in which the decedent owned an undivided interest that passes from the decedent to another by will, trust, or intestacy. Included are such properties as real estate, stocks, bonds, mutual funds, bank accounts, cash, vehicles, equipment, and household items. Non-probate property includes various types of property in which the decedent had an interest at death but that do not pass from the decedent to another by will, trust, or intestacy. Instead, such property passes to another by beneficiary designation or the titling of the property, such as jointly with survivorship, payable-on-death, or transfer-on-death accounts. These types of properties, some gifted properties, and a few other property interests require further explanation.

2.21 Gifts

Before 1982, any gift made by a decedent to another within three years of death was subject to inclusion in the decedent's gross estate. The gift was presumed to have been made in contemplation of death and was taxed as part of the decedent's gross estate. The only exception was when the executor could establish sufficient lifetime motives for making the gift, in which event the presumption was overcome and the gift was not included in the gross estate. When included in the gross estate, the gift was valued at its value at the date of the decedent's death, rather than the earlier date-of-gift value. Thus, for assets that had appreciated in value, this treatment negated all tax advantages of the gift. The Economic Recovery Tax Act of 1981 significantly changed the tax treatment of gifts. Now, with only those few exceptions discussed in the "cautions" in this chapter, a gift is not included in the gross estate, even if made within three years of death.²

Although a gift made within three years of death is not included in the gross estate, it is considered in the estate tax computation. Such a gift, and any other lifetime gifts made after 1976, is considered in the estate tax computation owing to the unified nature of the present estate and gift tax law.³ Regardless of when made, however, the gifts are valued in the estate tax computation at the earlier, date-of-gift value and not at the date-of-death value. Consequently, appreciation between the date of the gift and the date of death is not included in the estate tax computation.

Example: If a decedent made a $30,000 taxable gift in 2000 and died in 2018 when the gift property was valued at $50,000, the decedent's estate would consider the gift at its 2000 gift tax value in computing the current estate tax. Because the gift would have been reported, if any gift tax is paid on it, credit is given on the estate tax return for the previously paid gift tax. The effect of considering the gift in the estate tax computation is merely to push the estate higher up the progressive tax rate schedule owing to the earlier gift.

Planning Pointer 1

Property that is expected to increase in value is an excellent asset for gifting because the appreciation will escape taxation irrespective of when the gift is made. This can be seen in the prior example, in which $20,000 of appreciation escaped estate taxation.

Caution: There are several exceptions that must be recognized. Transfers within three years of death will be treated as part of the gross estate for the limited purpose of determining if the estate qualifies for the following special tax elections:⁴

1. The 35% of adjusted gross estate requirement for a Section 303 stock redemption to pay death taxes and administrative costs without the distribution being taxed to the estate as a capital transaction with the benefit of a stepped-up basis, rather than unfavorable dividend income tax treatment;
2. The 25% and 50% of the adjusted value of the gross estate requirement of the Section 2032A special use valuation for farms and closely held businesses;⁵ and
3. The 35% of adjusted gross estate requirement of the Section 6166 extension of time to pay the estate tax for estates consisting of a large interest in a closely held business.⁶

Clarification: These three sections are intended to aid individuals whose estates consist of a large interest in a farm or closely held business. To qualify for each election, the farm or closely held business must represent a certain percentage of the gross estate or the adjusted gross estate. The exceptions are designed to prevent an individual whose estate does not meet these percentage requirements from qualifying by making gifts shortly before death.

Caution: There is another series of exceptions that also must be recognized:⁷

1. Any gift tax paid within three years of death is included in the gross estate.
2. Life insurance proceeds received from a policy owned by the decedent and given by the decedent to another within three years of the decedent's death are included in the gross estate.
3. Property that would be includable in the gross estate under the following sections of the Internal Revenue Code is included in the gross estate when the property rights are relinquished within three years of death: Section 2036—transfers with a retained life estate, Section 2037—transfers taking effect at death, Section 2038—revocable transfers, and Section 2041—powers of appointment.

2.22 Transfers with Control Retained by Decedent

Transfers made by the decedent during his or her lifetime may be included in the gross estate if the decedent retained control of the transferred property. Sections 2036, 2037, and 2038 of the Internal Revenue Code are the sections that cause such transfers to be included in the gross estate. A transfer included in the gross estate owing to the application of one of these sections is usually included at the full value of the property. Reductions in value due to intervening interests, however, may be appropriate, depending on the nature of the particular interest involved.⁸ Also, the relinquishment of these retained controls by the decedent within three years of death will still result in the inclusion of the property in the gross estate at the full value of the property on the date of the decedent's death.

Section 2036 includes in the gross estate gratuitous...