Marital Deduction Trusts
Marital deduction trusts are created to take advantage of favorable estate tax treatment of gifts to spouses. More favorable treatment is given to spouses who are United States citizens than to spouses who are citizens of other countries, but even in the latter case, trusts can be created to minimize estate taxes. The effect of using marital deduction trusts is to defer estate taxes until after the death of the second spouse, and potentially, given the graduated tax brackets, to minimize the estate taxes paid by a couple. The tax benefits are achieved by the interplay of the estate tax exclusion amount and the marital deduction.
The federal estate tax is imposed on the transfer of a decedent’s taxable estate, which is the gross estate less allowable deductions. I.R.C. §2001. Each estate is allowed a credit that excludes a portion of the taxable estate from tax. See I.R.C. §2010(c). In 2007 and 2008, the exclusion amount is $2 million. In 2009, that amount the exclusion amount will increase to $3.5 million. In 2010, the estate tax is scheduled to be repealed entirely for one year, only to return in 2011 with a $1 million exclusion amount. (The exclusion amount applied to any given estate will be reduced by the decedent’s lifetime taxable gifts.)
The gross estate includes the value of all property in which the decedent held an interest at the time of death. I.R.C. § 2031(a). It includes assets held in the decedent’s own name, in joint tenancy, assets owned by the decedent that pass by beneficiary designation, property over which the decedent held a general power of appointment, I.R.C. § 2041, and certain items transferred by the decedent during lifetime, including property in which the decedent retained an interest for life, I.R.C. § 2036, a reversionary interest that exceeds five percent of the value of the transferred property, I.R.C. §2037, or property over which the decedent held a power to amend, revoke or terminate the gift. I.R.C. § 2038. The value of a marital trust that was created for the decedent by a predeceased spouse is included in the gross estate, I.R.C. §2044, as are life insurance policies transferred within three years of death, I.R.C. §2035(a), and gift taxes paid on gifts made within three years of death. I.R.C. §2035(b).
The gross estate is reduced by deductions, among which is the marital deduction, which is our focus today. There is an unlimited marital deduction for property that passes outright from a decedent to a surviving spouse who is a United States citizen. I.R.C. § 2056(a). There is also an unlimited marital deduction for property that is held in a continuing trust for the sole benefit of the surviving spouse, provided that the ontinuing trust meets certain requirements.
Trusts that use marital deduction trusts for estate planning purposes typically divide after the decedent’s death into two parts: one part holds the amount of assets that is sheltered by the decedent’s available estate tax exclusion amount (often referred to as a “credit shelter trust”); and anything over and above that amount is used to fund the marital trust. The decedent’s surviving spouse may be a beneficiary of the credit shelter trust, but may not have unlimited control over that trust, because too much control would lead to the inclusion of the assets of the credit shelter trust in the surviving spouse’s estate. See, e.g., Treas. Reg. §20.2041-1. If the surviving spouse is a trustee of that trust, the trust should provide that discretionary distributions to him or her are limited to an ascertainable standard or provide that a co-trustee would make those discretionary distributions to the spouse. (Pursuant to R.S.A. 564-B:8-814, a surviving spouse who is the trustee and beneficiary of a trust may exercise discretion to distribute to himself or herself only subject to an ascertainable standard, unless the trust is a power of appointment marital trust, as discussed above. However, the better practice is to set forth that limitation in the trust document itself.)
Following the death of the surviving spouse, the assets in the credit shelter trust will pass without estate tax to the remainder beneficiaries of that trust. The assets in the marital trust, if any, will be subject to estate tax in the surviving spouse’s estate. I.R.C. § 2044. After payment of estate tax, the remaining assets of the marital trust will pass to the remainder beneficiaries designated by the first decedent-spouse, or in accordance with a power of appointment exercised by the surviving spouse.
- Maureen C. Dwyer
Barradale, O'Connell, Newkirk & Dwyer, PA
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