EC436 Jay Wilson
Problem Set 6 Fall 2015

1. The following questions are about the gifts and estate taxes. Use the 2015 rules on the class slides. Under these rules, gifts and bequests are both taxed at 40 percent, but this rate is only on the excess of gifts and bequests over the amounts that are exempt from taxation. Each parent can give a gift to any individual (not just children) without owing a gift tax, if the gift does not exceed 14,000 dollars a year (the “annual exclusion”). If it does exceed 14,000 dollars in a year, the parent can still avoid the gift tax by using the “unified credit.” (The word “credit” is misleading, because the unified credit is typically stated as a total amount of gifts and bequests that are exempt from taxation.)

(a) What is the maximum amount of bequests that two parents can give to their children without owing any estate tax?
(b) As noted above, you can avoid the tax on gifts by using the unified credit. If you use the unified credit to avoid taxes on a million dollars of excess gifts (i.e., gifts in excess of the annual exclusion amounts), then what is the maximum bequest that you can give without owing any estate taxes?
(c) Suppose your spouse also uses the unified credit to avoid taxes on a million dollars of excess gifts. What is the maximum total bequest that you and your spouse can give without owing any estate taxes?
(d) Suppose that your gifts and bequests to your children are so large, that any increase in either of them will be subject to the 40 percent gift and estate taxes. For an additional 12,000 dollar gift, calculate the gift tax payments. What is the total cost of giving this gift; that is, the sum of the amount your children receive and the gift tax payment?
(c) If, instead, you want to increase by 12,000 dollars the bequest that your children receive after the 40 per cent estate tax is paid, then how much must you increase your bequest so that the additional 12,000 is left for your children after estate taxes are paid? Show your calculation, and explain any difference between this amount and the total cost of the gift in part (c).
2. When Mitt Romney ran for President of the U.S., there were many accounts in news sources of tax avoidance strategies that he and other wealthy individuals have often employed. The following questions concern the strategy for avoiding gift and estate taxes described in the posted article, “Romney ‘I Dig It’ Trust Gives Heirs Triple Benefit,” which is located in the required readings folder.

(a) The article states, “Romney’s vehicle is known as an ‘intentionally defective grantor trust’ or by the acronym IDGT – hence the nickname: ‘I Dig It.’ Such trusts permit donors to give potentially unlimited amounts to children free of estate and gift taxes.” Explain carefully how these trusts get around the limits on tax-free gifts and estates imposed by the annual exclusion limit and the unified credit.
(b) Income generated by the assets in trusts is subject to taxes, and these taxes can greatly diminish the value of the assets in these trusts. (There are separate tax schedules for trusts, which reach the top personal income tax rates relatively quickly.) Yet the article explains that when highly-appreciated assets in the trusts were sold, the trust owed no capital gains taxes. Explain why. Finally, why does the article claim that the method to avoid these capital gains taxes actually represents two of the three benefits from an ‘I Dig It’ trust?
3. Another tax avoidance method used by Mitt Romney was to create a CRUT, which is short for “charitable remainder unitrust.” The posted article, “Romney Avoids Taxes via Loophole Cutting Mormon Donations,” describes how this trust works. (I’ve also included a slide describing CRUTs in the slides for lastWednesday’s class.) Briefly, the individual contributes assets to the CRUT, and the beneficiaries chosen by this individual receive the money when the individual dies. But the individual is allowed to withdraw a fixed percentage of the value of the assets in the CRUT each year. See the article for details. It emphasizes that there is often very little left for charities to receive after the individual dies. For another example associated with MSU, see

http://www.pathobiology.msu.edu/alumni-friends/development/gifts-you-can-make/charitable-remainder-trusts

(a) Basically, Romney contributed assets to the CRUT but then withdrew cash over the time. But why put money into this CRUT, only to take it out later? Using the article, describe all of the tax advantages that Romney obtained from using the CRUT.
(b) Changes in tax laws since Romney set up his CRUT have reduced somewhat the usefulness of CRUTs for reducing tax burdens. Identify these changes.

EC436 Jay Wilson
Problem Set 6 Fall 2015

1. The following questions are about the gifts and estate taxes. Use the 2015 rules on the class slides. Under these rules, gifts and bequests are both taxed at 40 percent, but this rate is only on the excess of gifts and bequests over the amounts that are exempt from taxation. Each parent can give a gift to any individual (not just children) without owing a gift tax, if the gift does not exceed 14,000 dollars a year (the “annual exclusion”). If it does exceed 14,000 dollars in a year, the parent can still avoid the gift tax by using the “unified credit.” (The word “credit” is misleading, because the unified credit is typically stated as a total amount of gifts and bequests that are exempt from taxation.)

(a) What is the maximum amount of bequests that two parents can give to their children without owing any estate tax?
(b) As noted above, you can avoid the tax on gifts by using the unified credit. If you use the unified credit to avoid taxes on a million dollars of excess gifts (i.e., gifts in excess of the annual exclusion amounts), then what is the maximum bequest that you can give without owing any estate taxes?
(c) Suppose your spouse also uses the unified credit to avoid taxes on a million dollars of excess gifts. What is the maximum total bequest that you and your spouse can give without owing any estate taxes?
(d) Suppose that your gifts and bequests to your children are so large, that any increase in either of them will be subject to the 40 percent gift and estate taxes. For an additional 12,000 dollar gift, calculate the gift tax payments. What is the total cost of giving this gift; that is, the sum of the amount your children receive and the gift tax payment?
(c) If, instead, you want to increase by 12,000 dollars the bequest that your children receive after the 40 per cent estate tax is paid, then how much must you increase your bequest so that the additional 12,000 is left for your children after estate taxes are paid? Show your calculation, and explain any difference between this amount and the total cost of the gift in part (c).
2. When Mitt Romney ran for President of the U.S., there were many accounts in news sources of tax avoidance strategies that he and other wealthy individuals have often employed. The following questions concern the strategy for avoiding gift and estate taxes described in the posted article, “Romney ‘I Dig It’ Trust Gives Heirs Triple Benefit,” which is located in the required readings folder.

(a) The article states, “Romney’s vehicle is known as an ‘intentionally defective grantor trust’ or by the acronym IDGT – hence the nickname: ‘I Dig It.’ Such trusts permit donors to give potentially unlimited amounts to children free of estate and gift taxes.” Explain carefully how these trusts get around the limits on tax-free gifts and estates imposed by the annual exclusion limit and the unified credit.
(b) Income generated by the assets in trusts is subject to taxes, and these taxes can greatly diminish the value of the assets in these trusts. (There are separate tax schedules for trusts, which reach the top personal income tax rates relatively quickly.) Yet the article explains that when highly-appreciated assets in the trusts were sold, the trust owed no capital gains taxes. Explain why. Finally, why does the article claim that the method to avoid these capital gains taxes actually represents two of the three benefits from an ‘I Dig It’ trust?
3. Another tax avoidance method used by Mitt Romney was to create a CRUT, which is short for “charitable remainder unitrust.” The posted article, “Romney Avoids Taxes via Loophole Cutting Mormon Donations,” describes how this trust works. (I’ve also included a slide describing CRUTs in the slides for lastWednesday’s class.) Briefly, the individual contributes assets to the CRUT, and the beneficiaries chosen by this individual receive the money when the individual dies. But the individual is allowed to withdraw a fixed percentage of the value of the assets in the CRUT each year. See the article for details. It emphasizes that there is often very little left for charities to receive after the individual dies. For another example associated with MSU, see

http://www.pathobiology.msu.edu/alumni-friends/development/gifts-you-can-make/charitable-remainder-trusts

(a) Basically, Romney contributed assets to the CRUT but then withdrew cash over the time. But why put money into this CRUT, only to take it out later? Using the article, describe all of the tax advantages that Romney obtained from using the CRUT.
(b) Changes in tax laws since Romney set up his CRUT have reduced somewhat the usefulness of CRUTs for reducing tax burdens. Identify these changes.