Marital Deduction: Maximizing Estate Tax Savings

1. Finance 553 Unlimited Marital Deduction

2. Marital Deduction • Marriage – A single economic unit • Concept is that the “pair” functions as one economic unit • When consuming assets • When buying assets • When selling assets • When transferring assets via gift • Thus money and property to flow freely back and forth between the “pair” • Only remaining property at death of second spouse should be taxed (estate taxes) • This was not the case before 1981, why change it?

3. Marital Deduction • Transfers between spouses while living – unlimited marital deduction (no gift taxes) • Transfers to surviving spouse – unlimited marital deduction (no estate taxes at transfer) • All estate taxes paid at death of second spouse (taxes postponed until both are deceased but not avoided) • Cases where paying taxes early on estate (at death of first spouse) may be advantageous • Wealthy spouse puts “assets” in by-pass trust • Wealthy spouse uses one-time gift exclusion (doubles exclusion) • Example, $10,000,000 estate, half to B-Trust at first death

4. Marital Deduction • How does a couple qualify for unlimited marital deduction on transfers? • Couple must be married at time of first one to die • Divorced couples do not qualify • Separated couples qualify, why? • What property qualifies for unlimited deduction? • First, property must be passed to surviving spouse • Second, property must be included in estate of deceased spouse • Third, only the net value of the property qualifies for the unlimited deduction • Community Property only passes 50% to surviving spouse – and property is adjusted to FMV at date of death for both portions

5. Marital Deduction • The terminal interest rule • In general, only property that will be included in the estate of the surviving spouse is eligible for the unlimited deduction • Concept here is that the property will be in the estate of the second to die and taxes will be collected at that time • If property is outside the estate of the surviving spouse, the estate of the first to die must pay the necessary estate taxes • If the interest in the beneficiary interest terminates with the second in death, it is property with a terminable interest and not included in the estate of the second to die. • Annuity stream set up for surviving spouse where surviving spouse is the lone beneficiary • Exceptions – listed on page 407 and include, GPOAs, QTIPs and CRTs

6. Marital Deduction • General Power of Appointment (over a trust) • If only spouse has general power of appointment over the trust and • Can appoint the property to one’s self • Can appoint the property to one’s estate • Can appoint the property to one’s creditors • Or Can appoint the property to the creditors of one’s estate • Then property qualifies for unlimited marital deduction • Qualified Terminal Interest Property Trust (QTIP) • Allows deceased to control remainder beneficiary • Allows surviving spouse use of property and income from trust for remainder of surviving spouses life with required annual payment • Qualifies for unlimited marital deduction

7. Marital Deduction • Charitable Remainder Trust (CRT) • If surviving spouse is only non-charitable beneficiary • Qualifies for unlimited marital deduction • Charitable Remainder Trusts explained in Chapter 9 (see PowerPoint slides) • In General, terminable interest rule • Does not allow for unlimited marital deduction when • Another party receives an interest in the same property and • the other party has not paid due consideration for that interest • The rule implies that the “remainder” beneficiary is not the spouse and thus the property is not being transferred to the spouse at the death of the first to die (of the married couple)

8. Marital Deduction • Portability of One-Time Gift Tax Exclusion • Deceased Spouse’s Unused Exemption (DSUE) • Allows spouse to use both the deceased exemption and their exemption in the estate of the second to die • Doubles what a single estate can claim (federal) • Spouse can only use most recent marriage • Amy and Bill are married • Bill passes and never used exemption ($5,340,000) • Amy receives Bill’s unused exemption and at death can exclude twice her normal limit (2 x $5,340,000 = $10,680,000) • Amy remarries Clint • Amy loses Bill’s exemption and now can only use Clint’s unused exemption if he should pass first (Clint can use Amy’s…)

9. Marital Deduction • Non-citizen Spouse • The limited marital deduction is $145,000 (as of 2014) • This limited deduction is a one-time • Limit is because surviving spouse could return to “home” country with the assets and the assets would avoid estate tax • However, if surviving spouse “becomes U.S. citizen” before estate of deceased is settled and maintains residency in U.S. • Property qualifies for unlimited marital deduction • Qualified Domestic Trust (QDOT) • If trust is set up and subjects property to U.S. estate tax at death of second, trust retains sufficient assets to pay estate tax, one trustee U.S. citizen, cannot distribute principal without tax withholding, originator of trust must elect marital deduction for deceased’s estate

10. Marital Deduction • Two Other Vehicles for deductions (and exemptions) • A-B ByPass Trust – explained in Chapter 8 (see PowerPoint slides) • Irrevocable Life Insurance Trusts (ILIT) – will be explained in next chapter (Chapter 11)

11. Marital Deduction • What are the implications for Financial Planning? • What options are available to married couples? • Deductions • Postponement of estate taxes • Trusts and Property Transfers through a Trust • Terminal Interest Qualifications • How does a divorce impact these options? • Loss of deductions • Trust and Property in Trust • Community Property • How does a second marriage impact these options? • Loss of deductions from first spouse • Changes in beneficiaries of property, by law and via trusts