Peculiar Properties Included in the Gross Estate

Photo Credit: Hearst Castle California State Parks (grabbed from DailyMail.co.uk)

The Estate Tax is arguably one of the easiest topics in Taxation. However, it has one part that is not so easy to digest because the provision of law seems a little too abstract to law students and lawyers alike. Even CPAs find this subtopic hard to comprehend. But as the title suggests, we are going  dig deep into the peculiar properties included in the gross estate, the topic I am referring to as a bit too abstract...

In General

Section 85 provides that the gross estate includes all property of the decedent, real or personal, tangible or intangible, at the time of his death. The last clause is very important as that is the basis for the computation of the gross estate in regards to time. Whatever changes that happened after the death of the decedent are disregarded, so are the events taking place before his passing away.

As to location, all properties wherever situated are included in the gross estate if the decedent is a citizen or a resident but only those found within Philippine territory are included if he was a foreign nonresident.

The Tricky Part

From the 1941 classic movie, Citizen Kane.

We thought it is that easy but now comes the tricky part. There are certain properties that are no longer owned by the decedent at the time of his death but are still included in the gross estate.

Before we reveal what these properties are, we have to ask why. The reason for this is that Estate Tax is often evaded by taxpayers and, because the act is usually concealed, the discovery thereof can sometimes be difficult. Usually, the evasion of this type of tax involves the giving away or selling of properties to avail of the much lower Donor’s Tax or Capital Gains Tax or to avoid any form of tax altogether.

But you would encounter some properties that are quite expected. The code still includes them for clarification purposes only, although their inclusion may be argued as unnecessary.

Revelation of these Properties

It’s time to reveal what these properties are. In a nutshell, they are:

·        Transfers in Contemplation of Death

·        Revocable Transfers

·        Property Passing Under General Power of Appointment

·        Proceeds of Life Insurance

·        Transfers for Insufficient Consideration

·        Decedent’s Interests

·        Capital of the Surviving Spouse

Some of these properties are quite peculiar but that is precisely why we need this article to clear all ambiguities about them.

Transfers in Contemplation of Death

If a certain property was given away or sold before the death of the decedent, the general rule is that it is not included in the gross estate. However, there is an exception: if the transfer was made in contemplation of death, the property, although already in the hands of an heir or even a complete stranger, will still be included in the gross estate. These transactions are termed as “transfers in contemplation of death” (or TCDs for short) within the purview of Estate Tax. The pertinent tax provision is as follows:

(B) Transfer in Contemplation of Death. – To the extent of any interest therein of which the decedent has at any time made a transfer, by trust or otherwise, in contemplation of or intended to take effect in possession or enjoyment at or after death, or of which he has at any time made a transfer, by trust or otherwise, under which he has retained for his life or for any period which does not in fact end before his death (1) the possession or enjoyment of, or the right to the income from the property, or (2) the right, either alone or in conjunction with any person, to designate the person who shall possess or enjoy the property or the income therefrom; except in case of a bonafide sale for an adequate and full consideration in money or money’s worth. [Sec. 85]

These properties were transferred by the decedent for the purpose of avoiding estate taxes because the rates for this tax used to be higher than Donor’s and Capital Gains Taxes. Under the TRAIN Law, however, all the three taxes are now pegged at the same 6% tax rate already but considering that many people are not well-versed in taxation, there may still be instances where the decedents resort to these transactions unknowingly that, instead of minimizing their taxes, they’re actually forcing their taxes to be significantly higher. Read this article to find out why it is no longer wise to resort to this transaction.

Section 85 (B) has several parts. It would be wise to break this provision into these parts to get a better view of the properties considered as TCDs, viz:

(B) Transfer in Contemplation of Death. –

To the extent of any interest therein

of which the decedent has at any time made a transfer,

by trust or otherwise,

in contemplation of or intended to take effect in possession or enjoyment

at or after death,

or of which he has at any time made a transfer,

by trust or otherwise,

under which he has retained for his life

or for any period which does not in fact end before his death

(1)  the possession or enjoyment of,

or the right to the income from the property, or

(2) the right,

either alone or in conjunction with any person,

to designate the person who shall possess or enjoy the property or the income therefrom;

except in case of a bona fide sale for an adequate and full consideration in money or money’s worth.

Reading Section 85(B) is like going through Alice in Wonderland or taking a series of circuitous roads before reaching your destination, so if you’ve had a hard time understanding it, you’re not alone! It takes a lot of patience and several times of reading in order to finally store it in one's memory.

But one common element among these transactions is already encapsulated in its heading --- they are all transfers in contemplation of death. Most of these transactions take place weeks or months before the death of the decedent but there are certain transactions that may be excluded from the gross estate on the reason that the transaction was in fact a “bona fide sale for an adequate and full consideration in money or money’s worth.”

To determine if the transaction was in fact a sale or actually a fictitious contract, the BIR considers the following circumstances:

·        Decedent’s age and health at the time of the transfer (Was he terminally ill?)

·        Length of time between the transfer and the date of death

·        Concurrent making of a will or making of a will within short time after the transfer

     Where the BIR finds, after taking all these matters into consideration, that the transfer was motivated by the fear of death (or taxes), it will include the property in the gross estate even though it was already in the name of another person.

Revocable Transfers

A revocable transfer is a transfer where the terms of enjoyment of the property may be altered, amended, revoked or terminated by the decedent. The fact that the decedent did not exercise their power to revoke is not an issue. For as long as such right existed, the property will still be included in the gross estate even though it was already in the hands of a third person before the death of the decedent.

But where the transaction was in fact a bona fide sale for an adequate and full consideration in money or money’s worth, the transfer will be excluded from the gross estate.

Again, to better comprehend Sec. 85 (C), it would be wise to break it into several parts to understand all its details.

Transfers under a General Power of Appointment

    This is by far the most difficult of all the properties mentioned in Section 85, but may be explained through the following illustration:

Public Domain

“Doña Matilde transferred a property in Bagamanoc, Catanduanes to her sister, Doña Praxedes, under a general power of appointment. Turning 76 in February 1919 and with the knowledge that she will die in few years’ time, Praxedes signed a deed whereby she exercised her right under the GPA, transferring the property to her youngest grandson, the bunso, Señorito Clemente, under which she has retained the enjoyment of the fruits in the said Bagamanoc Hacienda. The said property will still be included in the gross estate of Doña Praxedes.”

A power of appointment refers to the right to designate the person who will succeed the property of a prior decedent. A general power of appointment is one which may be exercised in favor of anybody but a limited power of appointment can be exercised in favor of certain person or persons designated by the prior decedent. The property transferred through GPA is included in the gross estate but the one transferred through LPA is not.

However, not all properties transferred through GPA are included in the gross estate. Only those where the power was actually exercised under the situations mentioned in Section 85 (D) will be. To better understand this provision, I will break it down for you…

(D) Property Passing Under General Power of Appointment. – To the extent of any property passing under a general power of appointment exercised by the decedent:

(1) by will, or

(2) by deed executed in contemplation of,

or intended to take effect in possession or enjoyment at, or after his death, or

(3) by deed under which he has retained for his life

or any period not ascertainable without reference to his death

or for any period which does not in fact end before his death

(a)  possession or enjoyment of,

or the right to the income from, the property, or

(b) the right,

either alone or in conjunction with any person,

to designate the persons who shall possess or enjoy the property or the income therefrom;

except in case of a bona fide sale for an adequate and full consideration in money or money’s worth.

      As the last clause provides, Transfers under GPA are also subject to the Rule on Bona Fide Sales.

Life Insurance Proceeds

      Proceeds from Life Insurance are included in the gross estate if the beneficiary is:

·        the estate, his executor or administrator, regardless of whether or not the designation is revocable.

·        a third person and the designation is revocable.

       The Insurance Code states that the designation of a beneficiary is generally revocable unless the policy states otherwise.

Proceeds from accident and health insurances are not included in the gross estate.

Transfers for Insufficient Consideration

In the transfers in contemplation of death, revocable transfers or transfers under a GPA, the value included in the gross estate is the excess of the fair market value at the time of the decedent’s death over the consideration received.

If there was no consideration at all, the value to be included will be the entire fair market value of the property.

If the FMV is equivalent to the consideration, it will not be included in the gross estate and will be considered in the nature of a bona fide sales.

Decedent’s Interests

Section 85(A) provides that the decedent’s interests, whatever may be the nature, in a property will be included in the gross estate. For instance, if the decedent was a co-owner, his share in the co-owned property will be included in the gross estate.

In the case of a usufructuary, however, the rule is different. If after his death, the usufruct merged in the owner of the naked title, the property will not be included in the usufructuary’s gross estate (Sec. 87 [A]).

If, however, the usufructuary was succeeded by another usufructuary, the usufruct will be included in the gross estate of the first usufructuary, following the general rule in Section 85 (A).

Capital of the Surviving Spouse

The spouse’s share in the conjugal property is of course excluded from the gross estate.

Fin

From the 1941 classic movie, Citizen Kane.

I firmly wish that this simple article has enlightened my students and will also enlighten other law students, lawyers, tax practitioners and other people on what peculiar properties are included in the gross estate.

Bibliography: "Tax Made Less Taxing" by Ignatius Michael D. Ingles.