I. (50% of grade)

A. You have been retained by Mark and Mindy Lewis, a married couple, to do their estate plans. You have determined that each has been married before and that each has two children from the prior marriage. They do not have any children in common. Mark is a schoolteacher who makes about $55,000 per year. Mindy is lawyer who makes $400,000 per year. Assets in Mark's name which have been acquired by him with his earnings have a value of $175,000. Assets in Mindy's name which have been acquired with her earnings have a value of $1,200,000. They appear to be very happily married and say that they consider their marriage a partnership both in emotional and financial terms.

All of their children are young adults ranging in age from 18 to 23. Mark and Mindy agree that at the death of the survivor their property should be divided equally among their four children.

You have determined that planning for using the marital deduction and taking advantage of the unified credit in both of their estates will be most advantageous for them and their children. Please explain to them in writing the advantages of using the marital deduction in their estates and the minimization of estate and gift taxes through use of a credit shelter trust where it would be appropriate. (I am simply asking you to explain in words that would be understandable to a lay person the advantages of marital deduction planning in a situation such as the Lewises have presented to you.)

C. B. Carter, a single person, transferred securities worth 20,000 to an irrevocable trust on September 1, 1998. The trust provided that all income was to be paid to her son. James, until he reached the age of 25 at which time the entire trust principal was to be paid to James. If he died prior to reaching the age of 25, the trust principal was to be paid to his estate. Assume that James was 20 years old at the time of the transfer and that the value of his right to income from the trust was $4,800 on September 1, 1998.

1. What is the amount of the annual exclusion available to Carter for her gift to the trust?

2. What could Carter have done to increase the amount of the annual exclusion available for the gift? What problems might be created for James if Carter maximizes the annual exclusion?

II. (50% of grade)

Colleen Best died in a plane crash last year. At her death she had a large estate consisting of interests in property as set out below. She was survived by her two children, Rachel and Tim. Her husband, Michael, was killed in the same plane crash. You have determined the following facts regarding Colleen's holdings at her death. Note that she had other assets that passed by her will, but that the questions asked in this part of the exam relate only to the interests set out below.

1. In settlement of a lawsuit brought by her children, the airline's insurer paid $800,000 for its liability in her death. This amount was made up of $700,000 for Colleen's wrongful death and $100,000 as compensation for her pain and suffering since there was some evidence that she had not died immediately in the crash. The plane crashed in a remote area, and several passengers, including Colleen and Michael, appeared to have moved after the crash impact. All passengers were dead by the time rescuers got to the crash site.

In 1985 Colleen's father died leaving a will that devised the residue of his estate to his trustee. The trustee was directed to divide the trust assets into two equal trusts. Under one trust, all income was to be paid to Colleen for her life. At her death the trust was to end, and the principal was to be distributed to her issue who survived her, or if no issue survived her, the principal was to be distributed to her brother, Matt, or his estate. Under the other trust, all income is payable to Matt for his life, and at his death the principal is to be distributed to his issue who survive him. If no issue survives him, the principal is to be distributed to Colleen or her estate. At Colleen's death her trust ended and her children became entitled to its principal. Matt survived Colleen, and his trust continued. At Colleen's death, Matt was married and had two children, ages 21 and 12.

In 1994 Colleen created an irrevocable trust for the benefit of her son, Tim, who was retarded. She expected that he would some day require institutional care and qualify for state aid. The trust was intended to be a supplemental needs trust which would provide benefits to Tim over and above care provided by the state. The trust provided that all income was to be accumulated and added to principal. The trustee, Providence Bank, was given the power to make distributions of principal for Tim's benefit in its discretion but only for purposes other than those provided by the state. No distributions could be made for Tim's support, maintenance or health care to the extent those were provided through state aid. At Tim's death, the trustee was directed to distribute the trust assets to Colleen if she was then living, and if she was not, to Rachel. Colleen retained the power to appoint a new trustee, including herself, if Providence Bank ceased to act as trustee, but at the time of her death, Providence was still trustee of this trust.

In 1996 Colleen bought a life insurance policy on the life of her husband, Michael. At the same time Michael bought a life insurance policy of Colleen's life. Colleen held all powers of owner with respect to the policy on Michael's life, and he had all powers on the policy on her life. Both policies were payable at the death of the insured to Rachel. Immediately before the plane crash that killed both Colleen and Michael, each policy had a value of $11,000. The death benefit payable on each is $100,000.

Colleen's mother died in 1987, leaving a will in which she directed that property be held in trust with Colleen as sole trustee. Under the terms of this trust, the income is to be divided equally between Colleen's children with the remainder to go to their issue upon the death of the last surviving child of Colleen. If Colleen's children are not survived by issue, the trust principal is to go to Colleen or her estate. Colleen was authorized as trustee to invade principal in her discretion for the benefit of either of her children. Because she did not want Tim to have significant interest in trust when he sought to qualify for state aid, Colleen had exercised this power to make distributions of principal of over $100,000 to Rachel thereby reducing the principal of this trust at Colleen's death to $20,000. In addition to the power to invade for her children, Colleen also had the power to withdraw $10,000 from the principal of the trust each year "if her support in her lifestyle required it." At her death Colleen was the trustee of this trust, but had never exercised her power to withdraw principal from the trust for herself.

In 1998 Michael purchased 200 shares of common stock in Hitech, Inc. for $20 per share. He used earnings from his employment to make the purchase and took title in joint tenancy with rights of survivorship in himself, Colleen and Rachel. At Colleen's death the stock had a value of $30,000.

In 1996 Colleen loaned $15,000 to her brother, Stan, to help him out of some financial difficulties. Stan had always been her favorite relative even though he never seemed to get along well in life. Her will provided that any unpaid amount of the debt owed by Stan at Colleen's death was forgiven. At her death Stan had not paid any principal on the loan.

Colleen's will provided that a part of her estate be distributed to a trustee who was directed to pay all income from the trust to Michael monthly if he survived her. The trustee was also given the power to invade principal of the trust for Michael "for his health, comfort and support." At Michael's death, the trustee was directed to distribute the remaining trust principal and any undistributed income "to those of my issue whom he appoints in his will." In default of such appointment, the trustee is directed to distribute the trust assets to Rachel, if she is living, and to Rachel's issue if she is not. The will also contains the following provision:

"If my husband and I die under circumstances where the order of our deaths cannot be determined, my husband shall be presumed to have survived me."

Questions:

A. As to each of items 1 through 7 above, state whether and to what extent anything is includable Colleen's gross estate for estate tax purposes. Be sure to explain your reasoning.

B. As to item 8, state whether the interest given to Michael qualifies for the marital deduction in Colleen's estate.