The federal estate tax marital deduction is one of the most important estate planning tools available to a married couple. The basic marital deduction rule is that, upon the death of the first spouse, the value of any interest in property passing to the surviving spouse is deducted from the decedent spouse’s gross estate. This means that the amount passing to the surviving spouse escapes taxation in the decedent spouse’s estate.
There is no limitation on the value of property that can qualify for the marital deduction. By transferring sufficient assets to the surviving spouse in the proper manner, estate tax liability upon the first spouse’s death can be completely avoided.
At first view, the estate tax marital deduction may seem to be a government giveaway. It is not. The advantage afforded is not the total avoidance of estate tax on the transferred property but, rather, the deferral of such tax. The marital deduction requires that the transfer of assets to the surviving spouse be made in such a way that those assets are exposed to estate tax liability in the surviving spouse’s estate.
The obvious advantage of deferring the estate tax liability is that the surviving spouse will have the use of the tax dollars that would otherwise have been paid to satisfy the tax liability of the first spouse’s estate. The deferral of tax liability also postpones the possible need to sell off assets that the surviving spouse might wish to preserve in order to obtain funds to satisfy the tax liability.
Transfer by Will
A key decision is the selection of the type of transfer to be made to the surviving spouse. The simplest form of transfer that qualifies is the outright transfer of assets by will. The problem with such a transfer is that it saddles the surviving spouse with the responsibility of managing the assets and also exposes him or her to possible pressures from relatives, creditors, or charities to transfer the property for their benefit.
Transfer by Trust
The marital deduction law permits, with no loss of the deduction, the transfer to the surviving spouse in trust. There are two basic types of trusts that have become the standard means for taking advantage of the deduction without burdening the surviving spouse with the problems of outright ownership of the first spouse’s estate.
The first type of trust is known as a “power of appointment trust.” The property is placed in trust under the will, giving the surviving spouse a life interest in the income generated by the trust and a power to give the assets in question to anyone, including to himself or herself or to his or her estate. This power can be restricted so as to be exercisable by the surviving spouse only by will and still qualify for the marital deduction.
The second type of trust, rather than giving the surviving spouse the power to ultimately dispose of the assets, permits the decedent spouse to designate the ultimate recipients of the property qualifying for the marital deduction. This trust is known as the Qualified Terminable Interest Property (QTIP) trust. The surviving spouse must receive a lifetime income interest in the property. No one other than the surviving spouse may have any rights in the trust assets during the surviving spouse’s lifetime. The decedent spouse’s personal representative must elect QTIP treatment on the estate return. The crucial feature of the QTIP trust is that the decedent spouse retains the ability to control the course of ownership of the assets qualifying for the marital deduction.
Coordination with the Lifetime Credit
It has become standard estate planning practice to coordinate the estate tax marital deduction with the unified credit against the estate tax. The unified credit against the federal estate tax allows an individual to pass a certain amount of assets free from estate tax liability regardless of the identity of the recipients. For decedents who have died in 2002 or who die in 2003, that amount is $1 million; for decedents dying in 2004 and 2005, the amount is $1,500,000; for those dying in 2006 to 2008, the amount that can pass tax-free is $2,000,000; and for 2009, the amount is $3,500,000. In a will, the amount allowed to pass tax-free is normally transferred under what is known as a “credit shelter” or “by-pass” trust. Then, the transfer under the marital deduction rules is made so as to prevent the taxation of the remaining assets.
Clearly, in the case of a married couple owning sufficient assets to make estate taxation a possibility, estate planning must take into account the marital deduction rules and the associated tax savings. Given the complex nature of the many rules involved, you should always seek the guidance of a qualified attorney for any estate planning needs.