Writing the will is one of the best ways to maintain control over who inherits your property and who has a certain level of control over your financial assets after your death.
The IRS Code 2041 outlines the conditions under which owners of a property can specify the person or persons who will inherit their estate in their wills.
This section of the Internal Revenue Code stipulates that the holder of the power of appointment can choose themselves or other beneficiaries as the executors of this power.
Holders of the power of appointment are under obligation to pay estate taxes for the property even if they don’t exercise their power.
We’ll walk you through the IRS Code 2041 to help you comprehend its rules and applications.
Table of Contents
An Overview of the Internal Revenue Code
The Internal Revenue Code or Title 26 of the United States Code covers a broad spectrum of topics, including income tax, excise tax, payroll tax, and estate tax, among countless others.
Section 2041 of the IRC deals with an estate tax topic that defines who can use or appropriate property in the event of the owner’s death.
Code 2041 doesn’t define the tax obligations of the beneficiaries. Instead, it focuses on the definition and the limitations of the power of appointment.
However, holders of this power are treated as property owners for federal estate tax purposes even if they don’t exercise their power. In other words, you’ll have to pay estate taxes for the property you inherit even if you’re not its legal owner.
This section of the IRC doesn’t contain references to the minimum or maximum tax fees a holder of the power of appointment can pay for a property or estate.
Understanding the Power of Appointment
The IRS Code 2041 defines the power of appointment as ‘the power that allows the holder to appoint himself/herself, decedents, the estate, creditors or the estate’s creditors as the beneficiaries of the property the power of appointment covers.’ Section 2041 of the IRS refers to the general power of appointment, which is the vital element of Section 2056(b) that deals with martial tax deduction regulations.
General Power of Appointment
This IRS code is commonly used to create wills, although this power can be utilized if:
‘by a disposition which is of such nature that if it were a transfer of property owned by the decedent such property would be includible in the decedent’s gross estate under section 2035, 2036, or 2037.’
The term itself refers to a power that is ‘exercisable in favor of the descendant, the estate, the descendant’s creditors or estate’s creditors.’ The following limitations apply to the general power of appointment:
- The descendant must meet specific maintenance, health, support, and education standards before the general power of appointment can become effective.
- The general power of appointment won’t be recognized as such if the descendant must exercise the power in conjunction with the creator of the power.
- The general power of appointment won’t be deemed as such if the power was created prior to October 21, 1942.
The IRS Code 2041 affects how you file taxes indirectly because it doesn’t explicitly state the federal estate tax amounts you must pay if you’re assigned the power of appointment.
The default provision of the document that creates the general power of appointment is used if the person holding the power refuses to exercise it.
Special Power of Appointment
The most significant difference between the general and special power of appointment is that the holders of the special power of appointment cannot ‘dispose of the property in favor of himself/herself, the estate, his or her creditors or the estate’s creditors.
Hence if you give the special power of appointment to your sibling, they have the right to distribute the property among their children as they see fit. However, they cannot use the power to obtain ownership of the property themselves.
The special power of appointment can be nonexclusive or exclusive.
- Exclusive – The donee (a person who is given the power of appointment) can appoint property to one or more eligible members and exclude all other members.
- Nonexclusive – The donee is legally obligated to assign a particular portion of the property to all eligible members.
The property will be regarded as a gift for taxation purposes if the holder of the special power of appointment refuses to exercise the power.
Special power of appointment is often utilized to reduce the liability of generation-skipping transfer tax and create asset protection trusts.
The Meaning of the IRS Code 2041
Grasping the implications of the IRS Code 2041 doesn’t require a high level of familiarity with the US judicial and federal tax system.
This Section of the IRC indicates that the holders of a general power of appointment can choose how they want to exercise their power.
Depending on the context, the holders can choose to appoint property to themselves, opt to transfer its ownership to one or more people, or donate it to a charity.
The general power of appointment gives a holder the rights over the property that is only slightly removed from the ownership status.
Consequently if the holder of a general power of appointment dies before exercising the power, the property will be included in his/her estate tax obligations.
The property covered by a special power of appointment won’t be included in the holder’s gross estate if the holder dies before exercising the power.
In addition the IRS Code 2041 is often interpreted in conjunction with the following sections of the IRC:
- Section 2035 – Gifts Made Within Three Years of Death.
- Section 2036 – Property Transferred with Retained Life Estate.
- Section 2037 – Transfers Taking Effect After Death.
- Section 2038 – Revocable Transfers.
- Section 2039 – Annuities.
- Section 2040 – Jointly Owned Property.
- Section 2042 – Proceeds of Life Insurance.
Lapse of Power and Date of Creation
General and special power of appointments have certain limitations. The IRS refers to these limitations as lapses of power. The term suggests that the holder of the power who doesn’t exercise it before his or her death effectively releases the power.
However, this can only happen under two conditions:
- If the property in question exceeds the value of $5,000
- If the asset’s value is greater than 5% of the aggregate value at the time of the lapse of power.
The Date of Creation segment of Section 2042 indicates that the power of appointment is only effective if the will that created the power became effective on September 21, 1942, or afterward, provided that the person who created the will died before July 1, 1949.
Frequently Asked Questions
The five of five power of appointment applies to assets held within trusts. Beneficiaries retain the right to choose if they want to withdraw 5% of the assets in a trust or $5,000 per year. These withdrawals will be regarded as exercisable power of appointment for federal tax purposes.
The IRS Code 2041 doesn’t specify the maximum number of donees that can hold the power of appointment created by a will. However, most wills assign the power of appointment to a single person, who then appoints the beneficiaries.
The power appointment can expire in the event of the donee’s death. The lapse of power can only occur if the value of assets or properties exceeds $5,000 or 5% of their aggregate value.
Holders of limited or special power of appointments don’t own the assets, and as a result, they’re not required to pay estate taxes.
Contact a CPA
Section 2042 of the IRC deals mostly with the rights and obligations of the holders of the general power of appointments. Understanding this IRS code can be useful when drafting a will or learning to manage the property, estate, or other assets you inherited.
Go to choicetaxrelief.com or call 866-8000-TAX to schedule a free consultation with a CPA who can help you understand the federal tax implications of the IRS Code 2042.
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Author:
Logan is a practicing CPA and founder of Choice Tax Relief and Money Done Right. After spending nearly a decade in the corporate world helping big businesses save money, he launched his blog with the goal of helping everyday Americans earn, save, and invest more money. Learn more about Logan.
