What Is the Gross Estate?
The gross estate refers to all property owned by you (or deemed to be owned by you) at the time of your death. When you die, your estate (the property and financial affairs you leave behind) must be settled. Your property must be passed on to your beneficiaries and your financial affairs must be wound up.
Usually, your personal representative (your "executor," if that person is named in your will) does this. One of the responsibilities of your personal representative may be to file a federal estate tax return (Form 706), paying estate tax due, if any. In order to calculate estate tax, your personal representative must determine the value of your gross estate. Understanding what the gross estate is may help you estimate and reduce estate tax liabilities.
The gross estate includes property and property interests — real or personal, tangible or intangible, of any description, wherever located — at the time of your death. Generally, property can be broken into two categories:
- Property you own outright or in trust, either solely or jointly
- Property you have given away, but in which you kept some interest or control
In Which Ways Can You Own Property Outright?
You can own property outright in different ways:
As a Single Owner
This includes property in which you have sole ownership.
As a Joint Owner with Another Person or Persons
You can hold property in concert with others, by either tenancy in common, joint tenancy, tenancy by the entirety, or community property. Your gross estate will include the value of your share of the property. Your share is measured in one of two ways:
- If property is owned as joint tenants or tenants by the entirety with your spouse, your share will be 50 percent of its value, regardless of who actually paid for it (as long as the property was acquired after 1976)
- If property is owned as joint tenants with anyone other than your spouse, your share will be measured by the percentage of your contribution to the purchase price
Example(s): In 1968, three brothers, Mark, Larry, and Charley, each chip in and buy a vacation home on the beach. The purchase price is $100,000. Mark pays $50,000 (50 percent), and Larry and Charley each pay $25,000 (25 percent apiece). Mark dies many years later. The fair market value (FMV) of the vacation home on the date of Mark's death is $200,000. Mark's share of the property includable in his gross estate is $100,000 (50 percent of the FMV).
Which Kinds of Property Can You Own Outright?
Property and property interests includable in your gross estate are the following:
General Property Interests
This is property that you usually think of as being owned by you. Generally, property interests correspond to property included in your probate estate. The interests include your right to income that you have earned but not received prior to death, such as deferred compensation, commissions, or bonuses. General property interests include:
- Real estate
- Bank accounts
- Household furniture and appliances
- Art objects and collectibles
- Notes and mortgages held by you
- Outstanding dividends declared, but not yet paid
- Postdeath salaries, commissions, and bonuses, or any other right to collect income
Technical Note: Your spouse has a legal right to some of your property (given by either dower or curtesy, community property, or statute). You can't take this right away from your spouse. This right prevents you from completely disinheriting your spouse (e.g., you can't make your spouse homeless). This right, however, does not prevent such property from being included in your gross estate (although, if your spouse is a U.S. citizen, the property you transfer to your spouse in a qualified manner is fully deductible under the unlimited marital deduction).
Certain Annuity Payments and Employee Death Benefits
Generally, annuity payments (the right to receive payments over a period of time) end when you die. Thus no value is includable in your gross estate. However, if there is a right to payments that includes a survivorship element (this may happen under a refund or period certain annuity), they will be drawn into your gross estate. The amount includable depends upon whether the continuing payments are payable to your estate or to a beneficiary. Most employee death benefits are also included in your gross estate.
General Power of Appointment
A power of appointment is the right, given to you by the owner of property, to decide who receives that property. It is usually given in relation to a trust.
Example(s): James sets up a trust and funds it with $250,000. The terms of the trust provide that, upon his death, James's wife, Lillian, is to receive the income interest in the trust for life. James also gives Lillian a general power of appointment, allowing Lillian to decide who gets the trust principal upon her death. James dies. Lillian receives the income interest from the trust for the next five years. Lillian's health begins to fail. Lillian has two sons: Jimmy, who is running for mayor, and Billy, who drinks too much. Lillian appoints the principal of the trust to Jimmy in her will. Lillian dies. Jimmy receives the trust principal and is elected mayor.
A general power of appointment includes the right to give the property to yourself, your estate, your creditors, or the creditors of your estate. Because you have the right to declare yourself as the owner of the property, the Internal Revenue Code treats you as if you are, in fact, the owner of that property. The value of property over which you hold a general power of appointment at the time of your death, as well as certain other property over which you had a general power of appointment during your life, is includable in your gross estate.
Certain Property Transferred to You by Your Spouse at Your Spouse's Death
Qualified terminable interest property (QTIP) transferred to you by your spouse at death is includable in your gross estate. QTIP is property from which you receive a qualified interest for life, but which passes to another beneficiary upon your death. The QTIP election would have been made by your spouse's personal representative to take advantage of the unlimited marital deduction.
Certain Insurance Proceeds
The value of life insurance proceeds is includable in your gross estate if, either at the time of your death or within the three years prior to your death, the proceeds were payable to your estate, either directly or indirectly, or you owned the policy, or you possessed any incidents of ownership. The three-year rule is imposed to discourage you from making this type of gift from your deathbed.
Example(s): In 2017, David took out a life insurance policy, naming his estate as the beneficiary. In 2018, David changed the beneficiary and owner to his daughter Lucy. David kept no incidents of ownership. Say David dies in 2020. The value of the proceeds will be includable in David's gross estate because his interest was transferred within three years of his death.
Technical Note: "Incidents of ownership" is a legal term that means any right to benefit economically or control the asset (e.g., name the beneficiary, surrender the policy, or borrow on its cash value).
Certain Tax Paid and Transfers Within Three Years of Death
Your gross estate must be increased by the amount of gift tax paid by you or your estate on gifts made by you within the three-year period ending on the date of your death. Again, the three-year rule is to discourage you from making gifts when death is imminent. Certain other property, which would have been includable in your gross estate under other specific code sections if you held it at death, will also be included in your gross estate if you transfer it within three years of your death. Your gross estate also includes any federal generation-skipping transfer tax you pay on any direct skip gifts you make at death.
What If You Give Property Away But Retain Some Financial Interest In It?
The IRS does not allow you to avoid estate tax by transferring the title to property to someone else and, at the same time, retain some rights to the property. With certain exceptions, the value of property is includable in your gross estate if, either at the time of your death or within the three years prior to your death, you had:
The Right to Enjoy the Property or the Income from It (This Right Is Called a Life Estate)
Example(s): Hal transfers the title to his home to his sons David and Ken with the condition that he is allowed to remain living in the home for as long as he lives. Hal dies. The value of the home is includable in Hal's gross estate because he retained an interest in the home, which will be treated as though he still owned it.
The Right to Regain the Property In the Event That the Person to Whom You Transferred the Property Dies Before You Do, and This Right Is Worth More Than 5 Percent of the Value of the Property (This Is a Right of Reversion)
Example(s): Bill signs over his stock in the power company to Jane for her lifetime. Upon her death, the stock is to revert back to Bill, if he is still alive. If Bill is not alive, the stock is to go to their son Bart. The value of Bill's right is worth more than 5 percent of the value of the stock. Bill dies. The value of the stock is includable in Bill's gross estate.
With certain exceptions, the value of property is includable in your gross estate if, at the time of your death, you had:
The Right to Alter, Amend, Revoke, or Terminate the Gift (This Is a Right of Revocation)
Example(s): Hal transfers some of his property into a revocable trust and names Jane as the beneficiary of the trust. Hal retains the right to alter, amend, revoke, or terminate the trust. Hal dies. The value of the trust is includable in Hal's gross estate.
Tip: The three-year rule does not apply to revocable trusts.
Tip: You may be able to limit the amount includable in your gross estate to the value of the retained interest through the use of a bona fide sale, a grantor retained annuity trust, a grantor retained uni-trust, or an intentionally defective irrevocable trust.
This material was prepared by Broadridge Investor Communication Solutions, Inc., and does not necessarily represent the views of The Retirement Group or FSC Financial Corp. This information should not be construed as investment advice. Neither the named Representatives nor Broker/Dealer gives tax or legal advice. All information is believed to be from reliable sources; however, we make no representation as to its completeness or accuracy. The publisher is not engaged in rendering legal, accounting or other professional services. If other expert assistance is needed, the reader is advised to engage the services of a competent professional. Please consult your Financial Advisor for further information or call 800-900-5867.
The Retirement Group is not affiliated with nor endorsed by fidelity.com, netbenefits.fidelity.com, hewitt.com, resources.hewitt.com, access.att.com, ING Retirement, AT&T, Qwest, Chevron, Hughes, Northrop Grumman, Raytheon, ExxonMobil, Glaxosmithkline, Merck, Pfizer, Verizon, Bank of America, Alcatel-Lucent or by your employer. We are an independent financial advisory group that focuses on transition planning and lump sum distribution. Please call our office at 800-900-5867 if you have additional questions or need help in the retirement planning process.
The Retirement Group is a Registered Investment Advisor not affiliated with FSC Securities and may be reached at www.theretirementgroup.com.