2011 essay question #1

Hi all, I’m really struggling with the answer to #1-A in the 2011 morning exam. I knew the answer was Revocable for objective #1 simply because i knew Irrevocable was the choice for objective #2. But can someone please provide a clearer explanation for objective #1 being revocable? Since the revocable trust IS subject to estate tax while the irrevocable IS NOT, wouldn’t total taxes be HIGHER in the revocable trust??? Thanks in advance.

Just wanted to give this a bump…lots of new posts over the weekend and this has dropped way off the list already! thanks in advance for any responses.

You have the BuildCo shares which would increase to the current market value at death of Becker - in the revocable trust. If you sold them now from the revocable trust - the taxes would be based on current differnce between market value and the value at which shares would be sold.

There are two components to the tax.

  1. Estate tax paid at death.

  2. Capital Gains tax paid now on Sale of the asset. and there are unrealized capital gains as well.

Component 2 - remains the same across both options. (1 Mill of shares sold, 100 K cost basis -> so 180 K (900 * 0.2) in taxes).

But if the assets are sold from the revocable trust - the amount of assets in the trust get reduced - and as a result Component 1 gets reduced across the options.

So sell from revocable.

I recently worked this problem as well, and I also found it very confusing, like OP.

I understand the explanation @cpk123 provided, and it makes sense. Here’s what I get hung up on: the question states only that the shares are to be sold, not that the proceeds are to be spent or removed from the trust. There’s no indication what the proceeds are to be used for - I assumed it was to be sold for diversification purposes, which would certainly indicate that the assets would remain in the trust.

If the assets remain in the trust, it’s better to sell from the irrevocable trust. Selling from the irrevocable trust means recognizing capital gains now that you would otherwise recognize later. This is a smaller impact than selling from the revocable trust because in the revocable trust you would recognize capital gains that would not be recognized later (since the basis steps up with the estate tax that you have pay regardless).

Seems like another example of a question without sufficient clarity. It’s unnerving.

I offered my explanation here: http://www.analystforum.com/forums/cfa-forums/cfa-level-iii-forum/91330128

See if you agree.

Thanks for the more current link - I’ll respond over there.