Marital Deduction

The Estate Tax
Husband and Wife Marital Deduction

Husband and Wife:

• For a husband and wife, there is an unlimited marital deduction available which will allow property of the first spouse to die to pass to the surviving spouse without the payment of estate tax, thus preserving the property to support the survivor. To the extent that the assets are not consumed, they may be taxable in the survivor’s estate. The surviving spouse may take advantage of any estate tax deduction unused in the estate of the first spouse to die.
• Marital deduction:
  • If a bequest to a spouse is a dollar value either as specified or ascertainable by formula, the estate may have a taxable gain or loss if the bequest is satisfied in appreciated or depreciated property. This can be avoided by phrasing the bequest in terms of a share of the estate. A marital deduction is permitted between domestic partners following the holding that a provision relating to his in the Defense of Marriage Act has been held to be unconstitutional. The issues of domestic partners are currently being litigated in various courts.
• Computation of the marital deduction:
  • The valuation of property passing to a surviving spouse is based on fair market value as of the valuation date. Adjustments must be made for administrative expenses. These expenses fall into 2 classes, transmission expenses, the appropriate share of which reduces the marital deduction, and management expenses, which do not reduce the marital deduction unless they are allocable to other property. Transmission expenses include: all expenses arising by reason of the decedent’s death, such as fiduciary commissions, legal fees, appraisal fees, will construction and contest costs. Management expenses include: interest expense, brokerage commissions, and investment advisory fees. A mandatory direction in the will that expenses and taxes be paid out of the nonmarital share or a provision granting the executor discretion to do so preserves the full deduction. If there is no such provision, the residual estate bears the estate tax without apportionment among specific legatees.
• Property passing to spouse:
  • If property is included in the decedent’s estate, it does not matter how the surviving spouse acquires it. It could be acquired by gift, bequest, intestacy, survivorship, operation of law, antenuptial agreement, compromise of will contest, election of statutory share (the share to which a surviving spouse is permitted and which such spouse is entitled to take, even if the will provides less.), or written disclaimer by another within 9 months of the death which results in property passing to the surviving spouse. Property held by the decedent and the surviving spouse by the entireties is included at ½ of its value, but if it passes outside of the estate through a trust, it must be converted to ownership by the surviving spouse so that it passes as probate property in order to qualify for the marital deduction. The deduction is limited to the value of probate assets actually passing to the surviving spouse. In the case of simultaneous death, the decedent’s spouse is considered as surviving if the will or local law so provides. A clause in the will that the spouse is considered as predeceasing controls as to bequests except as to joint property. Under the Uniform Simultaneous Death Act each joint tenant is treated as having survived as to his or her own interest.
• Terminal interests:
  • A terminal interest is one that terminates upon the lapses of time or the happening or failure to happen of some event or contingency, if any remaining property passes to a person other than the surviving spouse. If the surviving spouse receives a terminable interest in property; the marital deduction is lost as to that property. The most common terminable interest is an income trust which may qualify for the marital deduction if it qualifies under special rules. The device is frequently used along with a credit shelter trust, which passes property outside of the estate to the children. Since the property in this trust never passes to the surviving spouse, it is not part of his or her estate and passes directly to the children tax free so long as it is within the exemption in the decedent’s estate.
• Qualified terminal interests:
  • If the surviving spouse receives a trust allowing income (without limitation) for life and only the power to invade corpus for his or her benefit(the ability to invade for a child or anyone else defeats the qualification), and the decedent irrevocably elects this treatment on the estate tax return, the interest which the surviving receives, although it is a terminal interest never the less qualifies for the marital deduction and passes free of estate tax. Such an interest is called a Qualified Terminal Interest Property (QTIP).
• Funding the QTIP:
  • The Qualified Terminable Interest can be a trust, or an annuity such as a joint survivor annuity, or an IRA (but care should be taken to allow the payment in equal installments rather than in a lump sum which would trigger income tax to the trust). If an IRA is used to fund the QTIP, the payments to the survivor may be limited to the minimum annual distributions or may be directly to the surviving spouse outside of any trust. The surviving spouse then rolls the payment into an IRA free of income tax until age 70 1/2 .
• Alien spouse:
  • The marital deduction is allowed only if the surviving spouse is an American citizen or becomes one before the estate tax return is due (within 9 months from the date of death plus an additional 6 months on extension) and was a U.S. resident from the date of the decedent’s death, or unless the decedent leaves the bequest to the surviving spouse through a qualified domestic trust (QDOT). If a trust to the surviving spouse would otherwise qualify for the marital deduction it may be reformed to meet the special requirements for the QDOT. The QDOT or reformed spousal trust may be created by the decedent, the executor or the surviving spouse. The QDOT election must be irrevocably elected on the estate tax return. The surviving spouses assignment to a QDOT must be made before the estate tax filing date, and the transfer must be completed before the estate is closed.
• Joint ownership:
  • One half of property held jointly with a surviving spouse with the right of survivorship or as tenants by the entireties is included in the decedent’s estate. If property is held jointly with the right of survivorship with anyone other than a surviving spouse, the entire value of the property is includable in the estate of the first to die unless the decedent can show that part or all of the consideration paid for the property came from a co-tenant. The exclusion ratio is the proportion that the surviving co-tenant’s consideration bears to the total acquisition costs plus capital additions. A surviving co-tenant’s liability on a mortgage is treated as that co-tenant’s consideration. A bond owned by the decedent but payable on death to another is fully included in the decedent’s estate for estate tax purposes. For property held as tenants in common, the decedent’s estate includes only his or her fractional share of the value less any applicable minority discount.
• Spousal rights:
  • Dower is the common law right of the wife to a share of her husband’s property upon his death. Courtesy is the husband’s interest in the wife’s estate. Both have been abolished in Pennsylvania and replaced by a spousal statutory share, which the surviving spouse can take against the will of the deceased spouse. Such statutory share does not produce any exclusion from the estate of the decedent. A surviving spouses’ election of the statutory share may be eligible for the marital deduction so long as it is not a terminal interest. In the case of a divorce, the surviving spouse’s right under an equitable distribution statute, such as the Pennsylvania statute, and the divorce occurs within before or one year after a written settlement is signed, the post-death payments are deductible by the estate. If the payments are commuted on the remarriage of the surviving spouse, and this occurs, the deduction is limited to what has been paid. Special rules apply to insurance payable to a surviving spouse and or to children.
• Tax computation:
  • This computation is complex and should be handled by professionals. Deductions are allowed for transfers to spouse, the marital deductions, for charitable bequests, the charitable deduction, and by various specific deductions, if and to the extent actually paid, and paid before the expiration of the time the estate tax return is due, including extensions. Claims for refunds can be made within the specific statute of limitations for the same, and if the amount of the refund cannot be determined within that period, a protective claim can be filed in order to preserve the right to the claim. There are special tax rates for members of the armed forces who die in combat and for people who died in terrorist attacks on 9/11/2001 and in Oklahoma City in 1995. Events following the decedent’s death may be considered when determining the value of decedent’s estate. These mattes have been heavily litigated, and final regulations have been issued clarifying some of these matters.