11. Marital Deduction

Question 1

Marital Deduction

Definition

Answer 1

Decedent’s estate can deduct an unlimited amount for qualifying bequests or transfers of property to a surviving spouse.

1. Includes a same-sex spouse
2. Parallels the marital deduction for gift tax.
3. Surviving spouses who are not U.S. citizens are subject to special rules.

Question 2

Marital Deduction

Qualifications

Answer 2

1. Property must be included in the decedent’s gross estate.
2. Property must pass to the decedent’s spouse.
3. Must not be a terminable interest, unless an exception applies.
   
   1. A terminable interest is an interest that ends upon an event or contingency. In other words, the spouse initially gets the interest in the property, but this interest will terminate upon some event (such as the surviving spouse’s death), and then the interest will pass to someone else. A life estate is a classic example of a terminable interest.

Question 3

Marital Deductions

Exceptions to Terminal Interest Rule

Answer 3

• When the only condition is that the survivor live for a period not exceeding six months, the marital deduction is allowed if the surviving spouse actually lives for the period specified and receives the property.
• When a spouse receives a life estate coupled with a general POA
• When there is a bequest to the spouse of income from a charitable remainder annuity trust or a charitable remainder unitrust and the spouse is the only non-charitable beneficiary
• Other exceptions include certain marital trusts by statute

Question 4

Marital Deductions

Straight Bequests

Answer 4

1. First spouse leaves everything to the surviving spouse.
2. The decedent’s estate gets a 100% marital deduction. The property will be included in the gross estate of the second spouse to the extent the second spouse has not consumed or given away the property before death.
3. Advantages
   
   1. Simple and inexpensive
   2. Surviving spouse gets unfettered control over the assets
4. Disadvantages
   
   1. May overqualify estate if the first spouse to die does not take advantage of the applicable credit amount
   2. Total estate tax between the two spouses may be higher if all property is bequeathed to surviving spouse

Question 5

Marital Deduction

Qualified Terminable Interest Property Trust (QTIP)

Answer 5

1. Allows a terminable interest to be passed to a surviving spouse and the property to still qualify for the marital deduction
2. Election is made on Form 706
3. Requirements
   
   1. Income from the trust must be payable to the surviving spouse at least annually for life.
   2. The value of the trust assets must be included in the gross estate of the surviving spouse when she dies, valued on the DOD of the second spouse.
   3. The surviving spouse is not usually given a general POA.
4. Usually, first spouse to die has specified the ultimate recipient of the property (the remainderman) in the trust document
5. Sometimes called a C trust or a Q trust; often used in second marriages to protect assets for the children of the first marriage

Question 6

Marital Deduction

Power of Appointment (POA) Trust

Answer 6

1. Allows a terminable interest to be passed to the surviving spouse and the property to still qualify for the marital deduction
2. No election required, as with QTIP
3. Requirements
   
   1. Income from the trust must be payable to the surviving spouse at least annually for life.
   2. The surviving spouse is given a general POA over the property during life or at death.
   3. The assets remaining in the trust will be included in the gross estate of the surviving spouse when he dies.
4. First spouse to die does not control the ultimate disposition of the property because the surviving spouse has a general POA and can designate who will receive the remainder interest in the trust
5. Sometimes called an A trust

Question 7

Marital Trust

Bypass Trust

Answer 7

1. Purpose is to take advantage of the applicable credit amount when the first spouse dies.
2. Property transferred to the bypass trust does not qualify for the marital deduction
3. A common scenario is for the first spouse to leave at death everything to the surviving spouse except for the applicable exclusion amount, which is transferred into a bypass trust.
   
   1. The trust can be designed to allow the surviving spouse to invade the trust for health, education, maintenance, and support (HEMS).
   2. When the surviving spouse dies, the trust is not included in her gross estate, and the property passes to the remainder beneficiaries
4. A bypass trust can be used instead of an outright bequest to nonspouse heirs who are not sophisticated or mature enough to handle the property. The choice of the trust over the outright bequest does not save any tax dollars; it simply provides the transferor with some peace of mind.
5. Often, highly appreciating assets are placed in a bypass trust to freeze the value for estate tax purposes at the death of the first spouse.
6. A bypass trust is also called a credit equivalency trust, a credit shelter trust, a family trust, or a B trust.
7. The appeal of bypass trusts may be reduced because of the portability of the estate tax exemption.
   
   1. A portion of estate exemption not used by the estate of the first spouse to die may be available to the surviving spouse

Question 8

Marital Trust

Use of Disclaimers

Answer 8

1. Allows the spouse to disclaim part of the estate, which would then go to the bypass share.
2. A specific direction to disclaim is not necessary in the will.
3. Allows more flexibility in the estate.
4. If the spouse disclaims the property, his control over the property is minimized.
5. Because a disclaimer has to be made within nine months of the spouse’s death, the surviving spouse may find it difficult to give up property at a time when the surviving spouse may not be feeling very secure

Question 9

Marital Trusts

Alien Surviving Spouses

Answer 9

1. Unlimited marital deduction is disallowed if the surviving spouse is not a U.S. citizen.
2. However, unlimited marital deduction is available, for a decedent alien spouse leaving assets to a citizen spouse.
3. Marital deduction is allowed if the spouse becomes a U.S. citizen before the due date for filing the federal estate tax return (Form 706) and has been a U.S. resident at all times since the decedent’s death. The spouse also must have been a U.S. resident at the time of the decedent’s death.
4. Marital deduction is allowed for property placed in a qualified domestic trust (QDOT) that passes to a non-U.S. surviving spouse.
   
   1. Trust document requires at least one trustee to be U.S. citizen or U.S. corporation
   2. Trustee has right to withhold estate tax on distributions of corpus
   3. Executor must make irrevocable election on IRS Form 706 (Estate Tax Return)

Question 10

Marital Deduction Calculation

Answer 10

1. An unlimited marital deduction is allowed for testamentary transfers to a surviving spouse.
   
   1. Has the effect of treating a married couple as one economic unit for gift and estate tax purposes
   2. Applies in both separate/common law and community property states
2. Generally, the marital deduction is determined on the basis of the gross estate value of the asset transferred to the decedent’s surviving spouse.
3. The marital deduction is reduced by any liabilities, such as mortgages and death taxes, that reduce the amount of property transferred to the spouse at death.
4. An interrelated marital deduction is required in some estates.
   
   1. Some state death tax systems do not allow a marital deduction for certain property transfers, such as qualified terminable interest property.
   2. If state death taxes are charged against marital property, the net amount passing to the surviving spouse is reduced, thus reducing the marital deduction
   3. As the marital deduction is reduced, the likelihood of paying federal estate taxes increases, especially if the decedent’s applicable credit amount has been exhausted because of prior gifts or bequests to nonspouse heirs.
   4. If the additional federal estate tax is paid out of assets transferred to the surviving spouse, the marital deduction is further reduced. In essence, an interrelated marital deduction is required

Question 11

Overqualifying the Estate

Answer 11

1. Overqualification occurs when the first decedent spouse in effect uses too much marital deduction at death.
   
   1. Marital deduction reduces the decedent’s taxable estate.
   2. If too much marital deduction is used, the decedent’s taxable estate will be reduced below the applicable exclusion amount, resulting in a waste of the applicable credit amount.
   3. Consequences of overqualification may be reduced by the portability provision; the applicable exclusion amount not used by the first spouse to die may be available to the surviving spouse.
2. Overqualification can be avoided by leaving some of the decedent’s assets in his taxable estate at death.
   
   1. A bypass trust can be used to leave assets in the decedent’s estate.
   2. Alternatively, the decedent can leave assets in his taxable estate by bequeathing the assets directly to an heir other than the surviving spouse.

Question 12

Underqualifying the Estate

Answer 12

1. Underqualification occurs when the first decedent spouse in effect uses too little marital deduction at death.
   
   1. Marital deduction reduces the decedent’s taxable estate.
   2. If too little marital deduction is used, the decedent’s taxable estate will exceed the applicable exclusion amount, resulting in estate tax being due at the first spouse’s death.
2. Underqualification can be avoided by leaving some of the decedent’s assets to his spouse at death.
   
   1. A marital trust can be used to leave assets to the decedent’s spouse.
   2. Alternatively, the decedent can leave assets to his spouse by bequeathing the assets directly to the surviving spouse