Free CFA Level III: Private Wealth Transferring the Wealth Practice Questions

A is correct. Probate is the court-supervised process of: (1) validating the deceased person's will (confirming it is legally valid and was the decedent's last will); (2) appointing an executor or personal representative to administer the estate; (3) identifying, inventorying, and appraising estate assets; (4) paying debts, taxes, and administrative expenses; and (5) distributing remaining assets to beneficiaries as directed by the will (or by state intestacy laws if there is no will). Probate is typically public, can be time-consuming (months to years), and may involve significant costs.

B is incorrect. Transferring assets through a living trust specifically avoids the probate process. Trust assets pass directly to beneficiaries under the trust terms without court involvement. This description is the opposite of probate.

C is incorrect. While estate administration includes paying the decedent's final income taxes and any estate taxes, "probate" refers to the broader court-supervised estate administration process, not specifically to tax calculation and payment.

A is correct. Non-grantor trusts are separate tax entities. Under the distributable net income (DNI) framework: income distributed to beneficiaries is deductible by the trust and taxable to the beneficiaries at their individual rates, while income retained by the trust is taxed at the trust's own rates. Trust tax brackets are highly compressed — the highest marginal rate (37%) is reached at approximately $14{,}450$ of income (2024), compared to over $600{,}000$ for individual filers. This means the $20{,}000$ retained income is taxed almost entirely at the highest rate.
Choice C is incorrect because the trust does not pay tax on all $50{,}000$ — the $30{,}000$ distributed to beneficiaries is deductible by the trust under the distributable net income framework. The trust-level deduction for distributions is a fundamental feature of trust taxation.
Choice B is incorrect because trust income is fully taxable — either to the trust on retained income or to the beneficiaries on distributed income. There is no general tax exemption or deferral for income earned within an irrevocable trust.

B is correct. In a QPRT, the grantor transfers a personal residence to an irrevocable trust while retaining the right to live in the property for a specified term. The taxable gift is the fair market value of the residence minus the present value of the grantor's retained term interest. Using the Section 7520 rate:
$$\text{Value of retained interest} = 5M \times \left(1 - \frac{1}{(1.05)^{10}}\right) \approx 5M \times (1 - 0.6139) = 5M \times 0.3861 = 1{,}930{,}500$$
$$\text{Taxable gift} = 5M - 1{,}930{,}500 = 3{,}069{,}500 \approx 3{,}070{,}000$$
The QPRT allows the 5 million property to be transferred at a discounted gift tax value of approximately 3.07 million, saving the client approximately 1.93 million in exemption usage. If the client survives the 10-year term, the property is completely out of her estate.

A is incorrect. $5{,}000{,}000$ would be the taxable gift if the property were transferred outright. The QPRT specifically reduces the gift value by the present value of the retained term interest.

C is incorrect. Continuing to use the property does not eliminate the taxable gift. The taxable gift is the remainder interest (the value of the property that will pass to the children at the end of the term), which is less than the full value but greater than zero.