2011 AM question 1 (revocable trust)

Part A(i) goal is to minimize total tax. The irrevocable trust does not need to pay estate taxes whereas the revocable trust needs, but why the answer says revocable trust minimize taxes? Thanks.

does anyone else think this question makes no sense? how do you have the authority to even sell stock in an irrevocable trust anyway? you gave up the assets. the only way you can possibly sell any assets has to be in the revocable trust.

PLEASE do a search - has been discussed.

Prophets - that is an interesting point, but don’t overanalyze as the question told you what was gonna happen. In CFAI land, they are alaways right (haha)

The reason it minimizes taxes is because they are SELLING now, so cap gains taxes are the same in either port. One of the ports is also subject to an estate tax, where the other one is not. So to minimize TOTAL taxes (including future) you would want to clear out the portfolio with the estate taxes to have the lowest value so that upon death there is less value to be taxed. If you sold out of the other portfolio you don’t save anything upon death because there were no estate taxes anyhow and no need to reduce the estate value to minimize them.

Great, thanks Mark.

i agree and see your point. it took me like 5x reading this question just to understand what exactly they were saying.

candidly my response on the exam probably would have been that this question makse no sense, the curriciulum says you give up control under an irrevocable trust, it’s up to the trustee, therefore it has to be done in the revocable. i’d like to know what country this is that has an irrevocable trust where you can go and change the assets like this, because i might move there then.

IDK if i get partial credit or zero credit, but that was my first reaction that this is an implausible scenario. it’s also what i wrote when i took the mock of this exam.

I’m on your side, but let’s choose our battles and pass this bitch.

yea, I got the same question

Can’t you be the trustee of an irrevocable trust even though you gave up the assets? That makes perfect sense to me to be able to direct a trade? You just can’t change the beneficiaries and crap, unless Im mistaken.

The revocable pays estate taxes upon death, which is based on the market value of the trust. So why would you pay a capital gains tax this year, then pay the wealth tax when you die? The wealth tax will be the same whether you realize a cap gain this year or not, as its based on market value.

The irrevocable only pays capital gains tax in the transaction, so you dont have to be worries about paying taxes on the cap gains and then the wealth tax upon death.

You basically opting to pay 2 taxes rather than 1 if you chose the revocable.

I agree CFAI answer is right, but I still have a doubt on its reasoning.

“For the revocable trust, the cost basis of investments inceases to market value on the date of Becker’s death,…”.

What does it mean? No capital gain tax at his death if not to sell the shares today? Thanks.

IMO, at death no capital gain tax, but estate tax of 20% for the total value (including cost base and capital gain) is applied. The net tax estate value (market value) become new tax base for future capital gain taxes.

I got it wrong mainly because my brain doesn’t function as well when the 60-Seconds stopwatch is next to my ear. But if I had thought it through, I would have concluded that the correct answer is “Irrevocable”

If you assume that the “total taxes” we are asked to calculate includes both current and deferred taxes, then…

Sale in Revocable

Income tax on revocable (1000 -100) x 20% = 180 Estate tax on revocable (2000 - 180) x 20% = 364 Income tax on irrevocable (2000 - 200) x 20% = 360

Total taxes 904

Sale in Irrevocable

Income tax on revocable (none due to step up) Estate tax on revocable (2000 x 20%) = 400 Income tax on irrevocable (1800 x 20%) = 360

Total taxes 760

I may have made some mistakes above, but the basic logic should be correct.

I still dont get this…at all, anyone?

I had a different interpretation of this question. The question to me was misleading as it states the he has two immediate objectives so my assumption was what was the immediate effect of the sale from a tax perspective, so i chose “both equally”

This was a very confusing question indeed. I got it wrong too and wrote ‘both the same --> under both methods a tax liability will be triggered’.

I think the author wanted to show that Becker is better off if he sells 1 mln of his shares now rather than in the future when his estate will be greater, which, in turn, will trigger a higher tax liability.