The Marital Deduction

— To Be Used Wisely —

The marital deduction is the most commonly used method of avoiding or minimizing estate and gift taxes on property transfers between spouses. As indicated by the word “marital,” this deduction is limited to spousal transfers. There are two types of transfers between spouses that qualify for the marital deduction.

The original type of spousal transfer qualifying for the marital deduction is the “no strings attached” transfer. It is the transfer of property from a husband to a wife (or vice-versa) that allows the recipient to enjoy and transfer the property without restrictions. Examples are:

  • A husband dying with a Will that transfers his assets to his wife outright and thus allows the wife to transfer the assets during her remaining lifetime or at her death without any restrictions on the second transfer.
  • Joint ownership of property between a husband and wife with rights of survivorship which allows the survivor to enjoy total and unrestricted ownership of the property upon the death of the first spouse.

Another type of spousal transfer qualifying for the martial deduction is the Qualified Terminal Interest Property (“QTIP”) transfer. This is a “restricted” transfer that qualifies for the marital deduction only if a federal estate tax election is made. The election is an agreement with the Internal Revenue Service that specifies the transferred property will be subject to a tax on a subsequent transfer of the elected property to other persons. In essence, the government says to the husband and wife, “We will not impose a tax on transfers between you. However, in exchange for not taxing these inter-spousal transfers, we want the ability to tax any subsequent transfers to your children or to anyone else.”

Examples of this “restricted” transfer are:

  • A husband dying with a Will transferring property in trust for his wife for her lifetime but prohibiting the wife from choosing who will receive the trust property following her death. The wife will receive all of the trust income as long as she lives, but she cannot choose who will receive the trust property at her death.
  • A husband dying with a Will providing a life estate for his wife in an apartment building and further providing that the remainder interest in the building will be transferred to his (or their) children at the wife’s death. The wife will receive the income from the apartment building as long as she lives, but she cannot change who will receive the apartment building at her death.

The QTIP provisions were established to address a problem in planning estate transfers in second marriage situations. Many remarried couples wanted to insure that their respective children would receive the estates they had accumulated during their first marriages. However, they also wanted to enjoy the tax advantages associated with the marital deduction for “no strings attached” transfers between spouses.

These QTIP provisions have also proven popular in transferring property between husbands and wives of first marriages. Three desirable goals can be accomplished by using a QTIP transfer: (1) no estate tax in the first estate, (2) total support of the surviving spouse for his or her remaining lifetime, (3) assurance that the assets of the first spouse to die will be distributed to his or her chosen beneficiaries following the death of the surviving spouse.

While there is no estate tax on qualifying transfers of property between spouses because of the current unlimited marital deduction provisions, there are many instances where spousal transfers should not use the unlimited marital deduction. The indiscriminate use of the unlimited marital deduction by a husband and wife can cause their children to pay several hundred thousand dollars of unnecessary estate taxes. How to use the marital deduction provisions of the federal estate and gift tax laws to their maximum advantage are questions that concerned persons should discuss with an attorney who is competent in the areas of estate planning and taxation.

Because of the latest changes in the estate tax laws the marital deduction will not be utilized as frequently as it has been in past years.

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