7.1 Marital Deductions

Marital Deduction in Estate Planning

Overview of the Presentation

This presentation, authorized by Arizona State University and the Arizona Board of Regents, covers the concept of the marital deduction in estate planning. The key focus is on how this deduction can defer estate taxes until the death of the surviving spouse and the conditions under which it applies.

Unlimited Marital Deduction

  • The unlimited marital deduction allows for the deferral of estate tax payments until the death of the surviving spouse.

  • This mechanism mirrors the marital deduction applied to gift taxes.

  • Key Requirements:

    • The spouses must be legally married at the time of the first spouse's death.

    • Only the net value of the assets transferring to the surviving spouse is considered (this is calculated as the gross value less any applicable taxes, debts, and administrative expenses of the estate).

    • The property must be included in the gross estate of the second spouse unless it has been consumed or dissipated by that time.

    • Special rules apply for bequests to spouses who are not U.S. citizens, which may limit the marital deduction.

Qualification for Deduction

To qualify for the unlimited marital deduction, certain conditions must be met:

  • The property must be included in the decedent's estate.

  • The property must pass to the surviving spouse, which also includes same-sex spouses in accordance with prevailing legal standards.

  • The interest given to the surviving spouse must not be a terminable interest.

Terminable Interest Defined

  • A terminable interest in property occurs when the interest passing from the decedent to the surviving spouse is set to expire or terminate at a future point. This means that the surviving spouse's right to the property is not permanent and has conditions attached.

Exceptions to Terminable Interest

There are certain exceptions where a terminable interest can still qualify for the marital deduction:

  1. A survivorship clause allows the surviving spouse to inherit without needing to survive for more than six months. If the spouse survives beyond that period, the inheritance is valid.

  2. If the property includes a terminable interest combined with a general power of appointment, it becomes part of the surviving spouse's estate.

  3. Qualified Terminable Interest Property (QTIP) Trust allows the surviving spouse to receive income from the trust while ensuring that the trust principal passes to other beneficiaries upon the spouse's death.

  4. Charitable Remainder Trust (CRT) provisions where the spouse is the only non-charitable income beneficiary, as per IRC Section 2056.

Community Property Considerations

  • In community property jurisdictions, generally, only half of the property value is considered as belonging to the decedent.

  • If the decedent leaves property to the spouse, it qualifies for the marital deduction.

  • Both halves of the community property receive a step-up in basis at the date of death, which can reduce capital gains taxes on the property changes upon sale.

Portability in Estate Planning

  • The Tax Relief, Unemployment Insurance Authorization, and Job Creation Act of 2010 (TRA 2010) introduced the portability concept into estate tax planning.

  • The American Taxpayer Relief Act of 2012 (ATRA 2012) made portability a permanent feature of estate tax planning.

  • Key Elements of Portability:

    • The deceased spouse's unused exemption amount (DSUEA) must be elected by the executor and is reported on Part 6 of IRS Form 706.

    • Portability applies only to the “last deceased spouse” and this unused exemption cannot be transferred to a new spouse of the surviving spouse.

    • The DSUEA does not qualify for indexing adjustment for inflation.

    • The surviving spouse can utilize the DSUEA amount for lifetime gifting.

Marital Planning - Considerations and Pitfalls

  • Over Qualification:

    • Transferring excessive assets to a surviving spouse in a manner qualifying for marital deduction may lead to an increased overall estate tax exposure for the family, as it can waste the applicable exclusion amount.

    • Also bears the risk of the surviving spouse potentially remarrying, complicating estate matters further.

  • Under Qualification:

    • Conversely, insufficient asset transfer may expose the property to estate taxes at the death of the first spouse, leading to a burdensome tax liability.

State Estate and Inheritance Taxes

  • Some states impose additional estate or inheritance taxes, which can add to the overall tax liability beyond federal estate taxes.

  • Utilizing the marital deduction by passing estate assets to the spouse first can help avoid these state taxes. The surviving spouse might then make lifetime gifts directly to beneficiaries without incurring additional tax burdens.

Check Your Understanding

  • Review concepts discussed to ensure retention of information and comprehension of the complexities involved with marital deductions and estate planning strategies.