Credit for prior transfers can produce a significant reduction in estate tax.

• Author: Streer, Paul J.

The estates of decedents who received property from other decedents may be able to take a credit for Federal estate tax paid on the prior transfer. But the credit for prior transfers only applies to transfers that occurred within a specified period of time, and only to certain types of transferred property. This article examines property eligible for the credit and the complex rules regarding its computation.

Introduction

If a decedent receives property that was taxed in the estate of his transferor, Sec. 2013 allows a limited credit against his Federal estate tax liability based on the prior Federal estate tax paid on the transferred property, if the transfer occurred from 10 years before the decedent's death to two years after. The credit for prior transfers (CPT) is computed on Schedule Q of Form 706, United States Estate (and Generation-Skipping Transfer) Tax Return; the Form 706 instructions provide a worksheet. The CPT alleviates the inequity that would otherwise result if estate taxes were assessed on successive property transfers within a relatively short period of time.

Example 1: P died on June 1, 1996, leaving all of his property to Q.Q dies on Sept. 1, 1996, leaving all of his property (including the property inherited from P) to R. If Q's estate is not allowed relief from the two estate taxes otherwise paid (by P's and Q's estates), the value of the inherited property would be greatly reduced by Federal estate taxes. If the marginal estate tax rate in each case was 50%, the value of the property inherited by R would be reduced to 25% of the value of the property originally in P's estate.

This article will illustrate the CPT's operation and calculation, the types of transfers that qualify and planning issues involved in maximizing the CPT's value in an estate tax computation.

CPT's Operation

Under Sec. 2013(a), the CPT offsets all or part of the Federal estate tax paid with respect to the transfer of property (including property passing as a result of the exercise or nonexercise of a power of appointment) to a current decedent by or from a person who died within 10 years before, or two years after, the decedent. If the prior decedent ("the transferor") died more than two years before the current decedent, the CPT is reduced as follows:

* 20% if the transferor died within the third or fourth year preceding the decedent's death.

* 40% if the transferor died within the fifth or sixth year preceding the decedent's death.

* 60% if the transferor died within the seventh or eighth year preceding the decedent's death.

* 80% if the transferor died within the ninth or tenth year preceding the decedent's death.

For CPT reduction purposes, Regs. Sec. 20.2013-1 (c) defines "within" to mean "during"; thus, if a death occurs on the second anniversary of another death, the first death is deemed to have occurred within two years of the second death. The CPT may also be available if the transferor dies within two years after the current decedent. This can occur if the transferor transferred property to the decedent during his lifetime, but the property was later included in the transferor's gross estate because he retained some prohibited control over it.(1)

Example 2: N placed property in trust, retaining a life estate in trust income with the remainder to his daughter M or to her estate. M predeceased N by 18 months. The trust property is includible in both M's and N's estates because of the retained income interest, but the CPT will be available to M's estate.

Property Transfers

A CPT is available only if there is a "transfer" of property by or from the transferor to the decedent. According to Regs. Sec. 20.2013-5(b), this means any passing of property (or an interest in property) under circumstances causing the property to be included in the transferor's gross estate; property transfers eligible for the CPT include:

* Specific bequests.

* Transfers made pursuant to statutory spousal rights at death.(2)

* Transfers made to either a surviving joint tenant (under a joint tenancy) or to a surviving spouse (under a tenancy by the entirety).

* Transfers made to the beneficiary of life insurance proceeds.

* Transfers made to the survivor of an annuity contract.

* Transfers made to the donee of a general power of appointment.

* Transfers made to an appointee under the exercise of a general power of appointment.

* Transfers made to certain remainder interest holders who take property as a result of the nonexercise or release of a power of appointment.

The definition of "transfer" is very broad, and the above list is not all-inclusive; any passing of property or an interest in property qualifies as a transfer. For example, the amount paid to an heir in settlement of a genuine will contest is a direct "transfer" from the decedent to the heir and not a transfer to the heir from a third party. Therefore, the heir's estate can claim a CPT if all other requirements are met.(3)

What Is "Property"?

For CPT purposes, Sec. 2013(e) broadly...