I still don’t understand why revocable can minimize total taxes after reading the answer.
Objective - Sell USD 1MM of Buildco shares while minimizing total taxes
I understand realized CG taxes is the same for both, for unrealized CG and estate taxes:
If selling 1mm from revocable:
cost basis increased to MV on the date of Becker’s death -> 0 unrealized CG taxes
subject to estate taxes -> MV of 1mm on the date of Becker’s death * Te 20%
If selling 1mm from irrevocable:
cost basis unchanged -> (MV of 1mm on the date of Becker’s death - 200k)* Tcg 20%
no estate taxes
Below is from then answer :
Becker should sell the shares in revocable trust. Current taxes on realized CGs will be the same (20%* 1.8mm)
Assets in the irrevocable trust are not subject to estate tax. Assets in the revocable trust are subject to estate taxes upon Becker’s death, at which time the cost basis will be increased to MV.
Thus, total taxes are minimized by selling from the revocable trust
I’m totally lost. How do you derive that revocable can minimizing total taxes? Why am I seeing irrevocable has less taxes? Am I missing something here?
Q1 doesn’t talk about the beneficiary, so I didn’t even think past his death. Perhaps whoever eventually does realize those gains could have tax losses to offset them – it’s out of his control.
Now that you’ve made me go down a rabbit hole on the Q, it definitely would be clearer with the bold:
Objective 1: Sell USD 1.0 million of Buildco shares while minimizing total taxes PAYABLE UNTIL AND ARISING FROM HIS DEATH
I’m so thrown off by this Q. They didn’t mention anything about losses offset gain…If it’s not past his death, then the 1st fact “cost basis increased to MV on the date of Becker’s death” would be irrelevant, which means revocable and irrevocable are on an equal footing on CG taxes.
Now as irrevocable has no estate taxes vs revocable pays 20%, wouldn’t irrevocable be the choice?
So the questions was actually asking " Which trust should the 1mm be sold from" (revocable) instead of “Which trust can minimize total taxes” (irrevocable due to estate tax shelter)
The original question was " Which trust is more appropriate for the objective - Sell 1mm while minimizing total taxes", which is very vague to me. The answer can be completely opposite depending on how you interpret the question. Or is it just me?
IMO, this question is terribly worded. It’s not about testing your knowledge base, it’s about if you can read their mind.
It’s terrifying to me that that was the literal exam question that year. I remember the wording in the actual L1 exam being much crisper and clearer than any mocks. It felt as though top English editors had gone over it 10 times till you were reading perfect language. (I’m sure L2 was similar, but I wasn’t sure where or who I was during most of that day). If the language June 3 is this vague, and there’s some cohesiveness across the years to the L3 exam authorship, the only thing I can think of is to just hit all the AMs. Get inside their head. It’s the same with Ethics – you just have to enter their world through dozens or hundreds of anecdotes.
Agree, however if you go through all the past exams, not all them are that bad - I guess it depends on who designed the questions. 2010 and 2011 are among the worst ones. Some answers don’t even make sense. I’m wondering how CFAI write those questions…They should really at least make the language less vague vs let the candidates spin the wheels reading their minds, which is totally not a fair game.