2 Foreword This publication is designed to provide information in regard to estate planning and various estate tax reduction strategies. It is provided with the understanding that neither our company nor our representatives are engaged in rendering legal, accounting or other professional service. If legal advice or other expert assistance is required, the services of a competent professional should be sought. Anyone may so arrange his affairs that his taxes shall be as low as possible; he is not bound to choose that pattern which will best pay the Treasury. Honorable Learned Hand Federal Judge, Estate planning overview Introduction Intestacy For some, estate planning can be relatively What is wrong with intestacy? Dying without a will is significant if the decedent had simple, involving only a will or perhaps a simple trust. However, a relatively recent property, had a dependent child or parent, study found that about half of American desired a particular asset be left to a beneficiary, was not concerned about probate costs adults die without a will, meaning they have no personalized estate plan. 1 The and delays in settling the estate, or was not reasons for this are numerous. In fact, concerned about estate taxes or the management of assets following death. estate planning is a complex subject. Also, it deals with topics that most people Estate planning has been defined as naturally wish to avoid: the inevitability that planning necessary for the orderly of death and, in some cases, taxes. disposition of assets in accordance with This study will examine some of the the intent and desires of the owner of the primary reasons why estate planning is property. Since the primary estate planning objectives of every person can differ, appropriate, provide an overview of the federal transfer tax system, illustrate a case it becomes pure chance that the intent of study and review various techniques currently available to reduce estate tax costs. statutes will match your a state legislature codified in the intestacy objectives. 1 Survey on Estate Planning, conducted by Harris Interactive, for Martindale-Hubbell, It is written in the hope that, with this information, readers will be better prepared to examine their own financial situation and work more efficiently with the appropriate professional advisors. Most people want to feel like they are in control of their financial destiny. This report underscores that theme. Why the Need for Estate Planning? There are many reasons. We will look at four of them: problems caused by intestacy, estate costs, asset management and disinheritance. The cornerstone of every estate plan is the testator s will, by which the disposition of most individually owned property takes place. A will is appropriate even if substantially all of the assets are placed in a revocable trust (which has the effect of transferring property outside of the probate system, but not the tax system). The will can pour over assets that have not been retitled into a trust. A valid will can establish how and by whom the estate is to be handled. The probate process, which is simplified for small estates in many states, allows for the clear transfer of title to assets and a forum to dispose of debt obligations.
3 Estate Costs In the past, it has been common for estate costs to equal 10% to 60% of a gross estate. Typical costs include final burial expenses, probate and administration fees, debts, federal taxes and state taxes. For larger estates, the most significant of these can be the federal estate tax. The U.S. Treasury recently estimated that approximately $24 billion in federal estate, gift and generation-skipping taxes were generated in The Economic Growth & Tax Relief Recognition Act of 2001 made sweeping changes to the federal tax transfer system (the estate and gift tax and the generationskipping tax structures) and created a tax system with three features: relief, repeal and reappearance. The rate structure was reduced through The top marginal estate tax rate was 45% through 2009, dropped to 0% in 2010, increased to 35% in 2011 and 2012, but is scheduled to return to 55% in However, as of the spring of 2011 the President s budget proposal would cap the rate at 45% beginning in The Federal Estate Tax table above incorporates the federal credit (in 2011 the credit is $1,730,800, which is equivalent to $5,000,000 in taxable property). The federal credit for state death taxes has not been deducted from the table. Unification of the estate and gift tax exemption and rates are applicable in 2011 and This means the exemption for estate and gift tax purposes is $5,000,000. Generally, a Federal Estate Tax Return (Form 706) must be filed and taxes paid within nine months following a decedent s death & 2012 Federal Estate Tax Table Net Marginal Value of Rate On Estate/Gift Estate Tax* Excess $1,000,000 $0 35% $1,250,000 $0 35% $1,500,000 $0 35% $2,000,000 $0 35% $2,500,000 $0 35% $3,000,000 $0 35% $5,000,000 $0 35% $10,000,000 $1,750,000 35% $15,000,000 $3,500,000 35% $30,000,000 $8,750,000 35% $50,000,000 $15,750,000 35% $100,000,000 $33,250,000 35% *Estate taxes shown have been reduced by the 2011 tax credit of $1,730,800 Currently, some or all of the property in a decedent s estate may receive a new basis for income tax purposes equal to its fair market value at the date of death. This usually results in a step-up in basis that reduces or eliminates the capital gains tax if the estate or heirs sell the property. It should be noted that step-up in basis does not apply to those things that are considered income in respect of a decedent. This includes IRAs, 401(k)s, other qualified retirement plans and nonqualified deferred compensation plans. These may be subject to both estate and income taxes as discussed next. In general, for 2011 and 2012, a surviving spouse may use his or her own $5 million estate tax exemption in addition to any exemption not used by his or her most recent decedent spouse. This concept is known as portability of exemption for estate tax purposes.
4 Qualified Plan Taxation It is common for individuals to have accumulated significant assets in various qualified plans and IRAs. These retirement plans allow individuals to enjoy significant tax advantages during their lifetime (i.e., tax-deferred accumulation). However, at death, the taxation of a distribution from these accounts may be confiscatory. Taxes can include federal income and estate taxes. In 2011, the potential combined taxes on a retirement plan left to a family member (i.e., grandchild) by a single decedent can hit 68%, using the top tax brackets if taken as a single distribution. Thus, the heirs could receive no more than 32% of the plan value. Asset Management Most state statutes have lowered the age of majority to 18. But it is uncommon to find so young a person capable of effectively managing large sums of money and property. A good estate planning process can anticipate the need for professional management for various family members, regardless of their age. Unexpected Disinheritance It is relatively easy to see how children can be disinherited. Here s a hypothetical example. Tom and Linda Smith were married and had two children. Unfortunately, Tom died in an auto accident. Linda inherited his estate and remarried several years later. She purchased a house with her new husband, placing the property in joint names. Tragedy struck again when Linda died unexpectedly, without a will. The house passed by title (the deed said with rights of survivorship ) to her new husband, even though she may have paid for all of the home herself. The balance of her estate, under most state intestacy laws, would be split between her new husband and her children. There are estate planning techniques designed to deal with the issue of disinheritance. Special trusts may be created to provide for a surviving spouse and children of the prior marriage. But in our example, such planning, to be effective, should have taken place during Tom s lifetime. Unless their stepfather is willing to make a significant gift, Tom s children will be effectively disinherited.
5 Overview of the Transfer Tax System In general, transfers of property are taxed based on the fair market value of the property when the transfer occurs. With a few exceptions and exemptions, the lifetime transfers are combined with the transfers occurring at death and subjected to the tax rate noted earlier. Key exceptions to these rules include: 1. The Annual Gift Tax Exclusion. In 2011, under this exclusion, every individual can transfer, gift tax-free, up to $13,000 per year per donee. There is no limit on the number of donees. To qualify, the gift must be considered a present interest. Split-gifts by married couples are twice the amount (i.e., $26,000 in 2011). 2. The Credit. Each individual is allowed an estate tax credit. For 2011, the estate credit can be up to $1,730,800. This credit effectively allows an individual to make tax-free transfers of up to $5,000,000 (for 2011), at death. The credit calculation process is unified so that the maximum value to be transferred at death in 2011 is $5,000,000. That amount at death is reduced by the amount of the $5,000,000 credit equivalent that had been used during life. 3. The Marital Deduction. Transfers between spouses, during lifetime or at death, do not incur transfer taxes as long as the transferee spouse is a U.S. citizen. If the surviving spouse is not a citizen of the United States, special requirements must be satisfied in order for the marital deduction to be available. The use of an individual marital deduction, however, does not eliminate transfer taxation, but simply defers it. Careful planning can help avoid a common trap: shifting assets into a higher transfer tax bracket. 4. The Charitable Deduction. Transfers to qualified charities are allowed as a deduction from the estate and gift tax transfer system. Techniques are available that combine the tax advantages of charitable giving with the natural desire to provide for family members. 5. Life Insurance. A special rule exists for transfers of life insurance. If an insured gifts a life insurance policy insuring his or her life, he or she must live three years after the transfer has been made. Otherwise, the entire death benefit of the policy is includible in the gross estate of the insured donor. Generation-Skipping Tax The transfer tax system described above is generally designed to impose a tax on assets at each generation. The generation-skipping transfer tax (GSTT) is in addition to the estate and gift tax, and it is applicable to transactions designed to skip a generation. For example, when grandparents gift assets directly to grandchildren, each grandparent is entitled in 2011 up to a $5,000,000 exemption from this tax. This exemption amount is adjusted to match the estate tax credit. The tax rules for such transactions are complex, and poor planning can result in the amount of tax exceeding the value of the asset transferred.
6 Observations: 1. The marital deduction did not eliminate federal taxes, but simply deferred them to Mrs. Jones estate. Mr. Jones estate did not take advantage of a credit trust. 2. If Mrs. Jones had died first, in 2011, her estate would be unable to utilize $5,000,000; however, with portability* Mr. Jones may be able to use his and Mrs. Jones exemption equivalent amount for a total of $10,000, Life insurance owned by Mr. Jones payable to Mrs. Jones was effectively hit by estate taxes at her death. 4. The liquidity demand for $1,836,100 at Mrs. Jones death (tax of $1,542,100 plus probate/administrative costs of $294,000) may force a liquidation of the business interest. If the business had been specifically bequeathed to one child, the other children could be disinherited because of the tax costs. A case study Hypothetical Facts Mr. Jones is married and has three children, a daughter and two sons. He has a simple I Love You will, with all property to be transferred outright to his wife, if she is living, or in equal shares to his children, if she is deceased. Mrs. Jones has no significant personally owned assets. Four years prior to his death, Mr. Jones gave $20,000 to each of his children, treating them as split gifts ($10,000 from each spouse). At the time of his death, Mr. Jones has the following mix of assets: Savings/Investments $700,000 Residence and Personal Property $6,600,000 Life Insurance (to Mrs. Jones) $2,500,000 Business $5,200,000 Total $15,000,000 Mrs. Jones subsequently dies ten months (still during 2011) after her husband, leaving all property to her children, having made no additional taxable gifts. Here is how the federal estate taxes are computed for each estate: Mr. Jones Estate 2011 = $300,000 = $294,000 $15,000,000 Upon First Death All Property to Spouse Mrs. Jones Estate 2011 $14,700,000 Upon Second Death To Children Credit: $3,480,800 $14,406,000 Net Tax: $1,542,100 Net to Heirs $12,863,900 Plus Lifetime Transfers $60,000 *In general, for 2011 and 2012, a surviving spouse may use his or her own $5 million estate tax exemption in addition to any exemption not used by his or her most recent decedent spouse.
7 An Alternative Design Currently, the ability to use the benefits of portability* only last through Thus, the following design may be required after 2012 in order to save on estate taxes. If we assume the Joneses are interested in saving on estate taxes, here is an alternative design that should have little impact on their lifestyle, but make a significant difference to their family. The plan would call for Mr. and Mrs. Jones to create a two-part trust (one for the marital deduction, another for an amount equivalent to the credit = $250,000 Mr. Jones Estate 2011 $12,500,000 ($2,500,000 of insurance in trust) Upon First Death Taxable Estate to Credit Trust $5,000,000 Net Tax: $0 exemption). In addition, Mr. Jones would transfer his life insurance coverage (by gift) to an irrevocable trust designed to provide income after his death for Mrs. Jones, and after her death, pass assets equally to their three children. Let us also assume Mr. Jones uses part of the annual gift exclusion to pay for the premium and he does not exceed the exclusion. Since Mr. Jones lived more than three years after the transfer of insurance, his personal estate at death would be worth $12,500,000. Also, assume the exemption equivalent amount is $5,000,000. Upon First Death Marital Deduction Mrs. Jones Estate 2011 $7,250,000 Mrs. Jones Estate 2011 Observations: 1. Additional administrative probate savings may be available, depending on state law, if a revocable trust held Mr. Jones assets. 2. This alternative plan did not shift assets during lifetime to Mrs. Jones, so that the credit could be protected if she had died first if portability is not available. 3. The irrevocable life insurance trust can be designed so that the tax-free proceeds may be loaned to Mrs. Jones estate to pay estate costs (if any), or assets may be purchased from her estate so that her executor has cash to pay these costs. 4. Additional annual exclusion gifts could have been made during Mr. and Mrs. Jones lifetime to reduce their estates. 5. Advantages of this alternative plan = $1,004,350. = $145,000 Gross Federal Estate Tax $2,467,550 Credit: $1,730,800 $7,105,000 Net Tax: $736,750 Credit Trust $5,000,000 Life Insurance Trust $2,500,000 Total to Heirs $13,868,250 Net to Heirs $6,368,250 *In general, for 2011 and 2012, a surviving spouse may use his or her own $5 million estate tax exemption in addition to any exemption not used by his or her most recent decedent spouse.
8 Solutions: tax reduction strategies This portion of the report contains examples of estate tax reduction strategies. Each strategy is discussed only briefly and is not intended to give detailed information on such complex areas of estate planning. To determine if a strategy may apply to your situation, please consult a qualified estate planning professional. Wills A will is a basic estate planning document that permits individuals to transfer personally owned property to whomever they wish, rather than as provided under state intestacy laws. A typical simple will, for a married person, may contain the following provisions: 1. Payment of just debts and expenses; 2. Appointment of an executor; 3. Specific bequests; 4. Transfer of the estate to the surviving spouse; 5. If no spouse, then transfer of the estate to children or other heirs; and 6. Appointment of a guardian for any minor children. Credit Trust Will This type of will or trust structure is sometimes referred to as a bypass or credit shelter trust. The technique is designed to take advantage of the federal credit exemption equivalent ($5,000,000 in 2011). For a married couple, the plan takes full advantage of the marital deduction except for the credit exemption equivalent (which is placed in trust following the death of the first spouse). The tax savings arise at the death of the surviving spouse, since the credit trust is not included in that estate even though the surviving spouse may have been an income and/ or principal beneficiary of that trust. Pay a Tax to Save a Tax Where an estate has appreciating assets, there is a potential tax advantage to paying estate tax at the death of the first spouse by overfunding a credit-type trust. The advantage is that assets and the growth on these assets in this type of trust are not taxed in the surviving spouse s estate (when they are likely to be more valuable). The time value of money, by paying a tax at the first death, needs to be considered if this technique is used. Special language in the estate planning documents would be needed to take advantage of this technique. Revocable Trusts A revocable trust is created during the lifetime of the grantor. A trustee (often the grantor) initially holds property for the benefit of the grantor. It is not used to avoid income, gift or estate taxation. However, it is utilized in the following situations: 1. Where the grantor, during lifetime, wishes to provide for management responsibility over property; 2. Where the grantor wishes to assure continuity of management and income flow of assets in the event of death or disability; 3. Where a grantor desires privacy in the handling and administration of his assets during lifetime and at death; 4. Where the grantor wishes to minimize estate administration costs and delays at death; and 5. Where the grantor wishes to avoid ancillary administration of assets situated in other states by placing title in the trust.
9 Gifts Making a lifetime gift is often an effective way to reduce estate taxation. However, this technique is often overlooked. Economic necessity will temper one s willingness or ability to make significant lifetime transfers of wealth. It is common practice in the design of a financial plan to model the asset base and cash flow requirements of a potential donor before making significant gifts. This is a simple, but practical step used to assure the donor that he or she can afford to give up control of the assets. Gifts can be made outright or in trust. Many of the techniques that follow involve some form of gifting. The basic benefits of gifting include: Shifting the income and growth of an asset out of a higher income tax bracket; Shifting growth out of an estate; and Tax leverage. Even though the estate and gift tax rates are the same, the calculation process favors lifetime transfers (see the table below). The Tax Transfer System Comparison of Gift and Estate Taxes Total value of assets available: $5,400,000 Gift Tax* Tax base: net value of assets transferred $4,000,000 Gift tax: (tax rate) x (tax base) $1,400,000 Net transfer to donee: (total assets) (tax) $4,000,000 Estate Tax* Tax base: total value of assets available $5,400,000 Estate tax: (tax rate) x (tax base) $1,890,000 Net transfer to heirs: (total assets) (tax) $3,510,000 Irrevocable Trusts The irrevocable trust can be used to obtain certain income and estate tax savings not available to revocable trusts. The following goals may be accomplished through the use of an irrevocable trust: 1. Allowing insurance proceeds on the grantor s life to be available for family members estate tax-free; 2. Providing trust management for gifts to minors, without losing the benefit of the annual gift tax exclusion; 3. Avoiding one or two generations (or more in some cases) of estate taxes, all while providing management for family assets; and 4. Using the trust as a coordinating recipient of gifts and bequests for beneficiaries. Life Insurance Life insurance is a practical and popular planning tool to provide liquidity for any type of estate. The reasons for this relate to the basic mechanics of an insurance policy. Premiums are priced relative to policy proceeds. For a married couple, it is common to use second-to-die coverage for estate liquidity needs or wealth creation. But, if the insured owns the coverage or has incidents of ownership, the proceeds may be subject to estate tax. Therefore, life insurance should be owned outside of the estate in order to avoid inclusion of the proceeds for tax purposes. Placing life insurance in a properly structured irrevocable trust is one such way to accomplish this. *Assume Gift/Estate Tax Rate of 35%
10 Grantor Retained Interests (GRAT, GRUT and QPRT) A grantor retained annuity trust (GRAT) and grantor retained unitrust (GRUT) may be utilized to increase the benefit of gifts made to those in other generations. Typically, the donor makes a current gift to his children of the right to the trust assets at a specific date in the future and the donor retains the right, for a term of years, to receive the annuity or unitrust payments from the trust. If the donor survives the term of the trust, significant tax as well as other transfer cost reductions may be realized. For example, the assets in the trust may be excluded from the value of the donor s estate. Another type of grantor retained interest is a Qualified Personal Residence Trust (QPRT). Generally, a donor transfers an interest in his personal residence to an irrevocable trust in which he or she retains the right to use the property for residential purposes for a term of years. After the term of years expires, the residence passes to the remaindermen of the trust, typically a child or children. If the donor survives the trust s term, the residence may not be included in the value of his or her estate. Each of these techniques often takes advantage of the credit available during an individual s lifetime. The value of the gift is equal to the value of remainder interest. For example, a $1,000,000 house placed in a QPRT for 15 years by a parent age 65, assuming a 3% interest rate (assumed 7520 rate) will cause the donor to be treated as making a $396,710 gift. But no immediate tax would be due, since this is less than the lifetime credit exemption equivalent of $5,000,000 in Charitable Transfers There are a variety of techniques involving charitable transfers that may be used to accomplish specific objectives. To eliminate the federal estate tax burden for any size estate, the decedent only needs to leave all property to a qualified charity. Most people feel they cannot afford to do this because of family obligations. It may be possible to benefit a charity and family, while reducing estate taxes, using a charitable remainder trust. Private Annuities A private annuity may be effectively used in family situations where a parent wants to transfer an asset, such as a business interest, to the next generation, free of estate taxes. Typically, the parent sells the asset to his child. In return, the child promises to pay the parent an income for life. This is a legally enforceable contract right, but unsecured. Since the payments to the parent terminate at death, the annuity generally has no value, and therefore, is not included in the parent s estate. To be successful, the present value of the annuity payments has to be equal to the fair market value of the asset being sold. The child takes the risk of the parent living past life expectancy. The parent takes the risk that the child will not meet the current payment schedule. For example, at age 65, the parent has approximately a 20-year life expectancy. Assuming a federal discount rate (i.e., the 7520 rate) of 3%, the annual annuity generated by property worth $100,000 is $7,725. It should be noted that income taxes may be due at the inception of the transaction.
11 Self-Cancelling Installment Notes (SCIN) A SCIN is an installment debt obligation that, by its terms, is extinguished at the death of the seller. It is similar to a private annuity in that an asset is sold to the child on an installment basis. However, with a SCIN, the installments are shorter than the seller s life expectancy and the buyer (child) usually would pay a risk premium in the form of an above-market interest rate to the seller (parent) as consideration for the cancellation provision. Deferred gain on the installment obligation will be reported on the seller s estate income tax return. Family Partnerships/Limited Liability Companies (LLC) A family partnership/llc may be used to shift both the income tax burden and the appreciation of assets from parents to children or other family members. However, the benefit of income shifting to dependent children under 19 and dependent full-time students under 24 is limited, because such income generally will be taxed at the parents income tax rate. A parent may transfer a business interest to his or her children and keep family control of the business through an appropriately designed partnership/llc structure. Upon transferring the interest, the parent may receive a discount for gift tax purposes if the transfer is a minority interest or because of lack of marketability. Appreciation on that interest should not be includible in his or her estate, assuming a valid partnership has been established and the parent does not retain, directly or indirectly, liquidation, distribution, or other decision controls. Summary Individuals who have accumulated significant assets face a variety of issues in the transfer of their estate over the coming years. The estate taxes imposed on their personal assets can create major obstacles in how assets are passed on to family members, how assets are divided, as well as how the tax itself is paid. The estate tax is the last major tax the government may levy against an individual. An individual s estate that has been created through years of hard work may be significantly reduced upon his or her death. The material in this report was designed to outline the fundamental problems created by the federal transfer tax system and to explore various estate tax reduction strategies that may be used to effectively reduce the impact that estate taxes will have on one s estate. Estate planning is not a static event, but rather an ongoing process which, over time, can provide an individual with the ability to shift a greater portion of their assets to the next generation. Although estate taxes are a primary reason for one to plan, other issues exist which are equally as important in a properly structured estate plan. Spousal support, equalization among children, early inheritance, guardianship and asset management are all examples of issues that need to be addressed as part of an overall estate plan. The services of a qualified estate planning professional should be used to ensure that the issues relating to the transfer of one s estate are explained and planning options clearly outlined.
12 A century of integrity At Lincoln Financial Group, we have more than a 100-year-old heritage of helping people find solutions to their financial challenges with the same honesty, integrity, and responsibility that you d expect from our namesake. It s a legacy that we proudly and respectfully continue each day. The strength of Lincoln Financial today Lincoln Financial is one of the largest financial services companies in the country. We believe our continued commitment to strength and stability is indispensable to who we are and critical to your confidence in us. We are a proven industry leader in identifying and delivering sophisticated financial strategies and product solutions for the creation, preservation, protection, and enjoyment of wealth. We are committed to helping clients redefine their retirement because we don t believe retirement is an end it s an opportunity for everyone to start doing what they were meant for all along. Lincoln Financial Group is the marketing name for Lincoln National Corporation (NYSE:LNC) and its affiliates. Through its affiliated companies, Lincoln Financial Group offers: annuities; life, group life and disability income insurance; 401(k) and 403(b) plans; retirement savings plans; and comprehensive financial planning and advisory services. For more information, including a copy of our most recent SEC reports containing our balance sheets, please visit Any discussion pertaining to taxes in this communication (including attachments) may be part of a promotion or marketing effort. As provided for in government regulations, advice (if any) related to federal taxes that is contained in this communication (including attachments) is not intended or written to be used, and cannot be used, for the purpose of avoiding penalties under the Internal Revenue Code. Individuals should seek advice based on their own particular circumstances from an independent tax advisor. Securities and investment advisory services offered through Lincoln Financial Advisors Corp., a broker-dealer (member SIPC) and registered investment advisor. Insurance offered through Lincoln affiliates and other fine companies. In MI, securities and investment advisory services offered through Lincoln Financial Advisors Corp., a broker-dealer, registered investment advisor and insurance agency. In CA, insurance offered through Lincoln Marketing and Insurance Agency, LLC and Lincoln Associates Insurance Agency, Inc. and other fine companies. In WA, insurance offered through Lincoln Financial Advisors Corporation and LFA, Limited Liability Company and other fine companies. In UT, LFA Insurance Agency insurance offered through Lincoln affiliates and other fine companies Lincoln Financial Advisors Lincoln Financial Group is the marketing name for Lincoln National Corporation and its affiliates. CRN /11 General Note: Example numbers and amounts are increased to show impact of higher exemption amounts in 2011.
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TRANSFER OF HOME TO CHILDREN THE PROS AND CONS By Lois G. Andrews, Esq. and James L. Young, Esq. IMPORTANT NOTE: The purpose of this outline is to familiarize the reader with some of the various laws and
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Advanced Estate Tax Planning Techniques Introduction A basic estate plan includes a Will or Living Trust, an Advance Health Care Directive (also known as a Durable Power of Attorney for Health Care), and
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Transferring Business Interests to Family Members: Sale of Non- Voting Stock Interests to Grantor Dynasty Trusts Volume 5, Issue 9 Some of my clients have family-owned or closely held business interests
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CHAPTER 7 Transfers During Life & At Death DISCUSSION QUESTIONS 1. Explain how an intra-family sale of property can be an advantageous strategy for reducing an individual s gross estate. An intra-family
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