Friday March 29, 2024
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1.3.4 Marital Deduction
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Marital Deduction
Unlimited Marital Deduction: Since 1981, there has been an unlimited marital deduction.
Deceased Spouse Unused Exclusion Amount (DSUEA): In December of 2010, the Tax Relief Act of 2010 created the Deceased Spouse Unused Exclusion Amount (DSUEA).
QTIP Trusts: The most commonly used marital deduction trust is a Qualified Terminable Interest Property (QTIP) trust.
QTIP-Pooled Income Fund: A pooled income fund does not explicitly qualify for a marital deduction even if the surviving spouse is the only income recipient.
Unitrust and Annuity Trust: A charitable remainder unitrust or a charitable remainder annuity trust for a surviving spouse also qualifies for the marital deduction.
CRT-QDOT: A non-citizen spouse does not qualify for the unlimited marital deduction.
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Unlimited Marital Deduction
Since 1981, there has been an unlimited marital deduction. Individuals who are married may transfer any assets outright to a surviving spouse, with the entire transfer qualifying for a marital deduction. Since it is desirable to preserve the value of the applicable exclusion amount for the first spouse to pass away in a bypass or family trust, a common plan is to fund a bypass trust to the maximum amount and transfer the balance of the estate outright or in trust to the surviving spouse.
There may be some estates for which it is preferred to balance the estates of the two spouses, rather than transfer the maximum amount into the bypass trust. The "maximum-bypass" plan could result in virtually the entire estate being held in the bypass trust, with no assets subject to management or control by the surviving spouse. Thus, some counsels are choosing to balance the estate, rather than to fund the bypass trust at the maximum level.
If a transfer for a spouse is in trust, then it is essential to comply with the terminable interest rules. Reg. 20.2056(b)-1. If an interest will terminate or fail because of a contingency or a lapse in time, then the interest or trust will not qualify for the marital deduction. However, there are several "safe harbor" trusts that are specifically designed to qualify for the charitable deduction.
Deceased Spouse Unused Exclusion Amount (DSUEA)
In December of 2010, the Tax Relief Act of 2010 created the Deceased Spouse Unused Exclusion Amount (DSUEA). This provision allows a surviving spouse to add the deceased spouse's unused applicable exclusion amount to his or her exclusion amount.
There are benefits with either use of marital portability or a credit shelter and marital trust. With transfer of assets to the surviving spouse and a total estate less than twice the applicable exclusion amount, the property remains untaxed in the surviving spouse's estate due to the first spouse's DSUEA and also receives a step-up in basis. This step up in basis may save beneficiaries capital gains tax when they sell those assets. However, with a bypass trust, there is opportunity for growth of the assets and for creditor protection. In addition, the children of the first marriage are protected from a subsequent remarriage by the surviving spouse. If he or she passes away and passes assets to his or her second spouse, the children of the first marriage may be disinherited.
In January 2013 Congress passed ATRA, which made marital portability permanent.
QTIP Trusts
The most commonly used marital deduction trust is a Qualified Terminable Interest Property (QTIP) trust. The QTIP trust has three basic rules. The surviving spouse must receive all income from the trust, the income must be distributed at least annually and any invasion of trust principal must be for the benefit of the surviving spouse. Reg. 20.2056(b)(7).
The property in the QTIP trust will qualify for the marital deduction in the first estate and then will be included in the estate of the surviving spouse. Reg. 20.2044-1(a).
The QTIP trust is commonly used to qualify for the marital deduction, provide income and principal for the surviving spouse and then benefit the children of any earlier marriages. Since the distribution of the remainder is governed by the will or revocable trust of the first spouse to pass away, the children of his or her earlier marriages will normally receive the QTIP trust principal.
However, it is also possible to use the QTIP to benefit charities selected by the first spouse to pass away. If the QTIP remainder is transferred to charity, then the surviving spouse's estate will receive a charitable deduction. Sec. 2055(a). One drafting strategy that allows children to make the decision with respect to charity is to provide for a contingent transfer to charity. If the children should disclaim, then the QTIP assets may be distributed to the qualified named charities. The disclaimer also can enable children to influence the charitable distributions if the disclaimed charity is a donor advised fund or supporting organization.
QTIP-Pooled Income Fund
A pooled income fund does not explicitly qualify for a marital deduction even if the surviving spouse is the only income recipient. However, a QTIP election may be made for the pooled income fund (PIF). Reg. 20.2056(b)-7(d)(5). The QTIP-PIF election will entitle the estate of the first spouse to receive a marital deduction. When the surviving spouse passes away, the assets will be distributed to charity and will qualify for a charitable estate deduction.
Unitrust and Annuity Trust
A charitable remainder unitrust or a charitable remainder annuity trust for a surviving spouse also qualifies for the marital deduction. Sec. 2056(b)(8). However, for the unitrust or annuity trust to qualify, it must include only the surviving spouse as a recipient of the annuity or unitrust amount. If the charitable remainder trust includes a potential guaranteed term of years for children, is a one life plus term of years trust or a trust for both surviving spouse and child, then there is no marital deduction.
The unitrust for surviving spouse is generally used in estates that have substantial liquidity. The surviving spouse holds sufficient assets outright or in a QTIP trust to provide for his or her "rainy day" needs and the balance of the estate may be transferred to the unitrust or annuity trust. If the balance of the estate includes an IRA or other IRD (income in respect of decedent) assets, these are generally excellent funding assets for the charitable trust. The income from the IRD assets will flow through the unitrust or annuity trust to the surviving spouse for life. When he or she passes away, the remainder is distributed to charity. This method avoids both the potential estate and income taxes on the IRA or other IRD assets.
CRT-QDOT
A non-citizen spouse does not qualify for the unlimited marital deduction. However, if a qualified domestic trust (QDOT) is created with a U.S. trustee, then the trust may qualify for the marital deduction. In addition, the QDOT may be combined with a CRT. A CRT-QDOT functions similarly to a CRT for a surviving spouse. When the first spouse passes away, there will be a marital deduction. Reg. 20.2056A-2(b); PLR 9244013. After the surviving spouse passes away, the remainder is distributed to charity and, thus, qualifies for a charitable estate deduction.
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Private Letter Rulings
PLR
200006052 Charity Disclaims - Assets Pass to Surviving Spouse:
Decedent passed away with a joint will. The will distributes the estate to spouse outright with a provision that half of the assets would be distributed to the child of decedent if spouse remarries. If child passes away prior to that time with no issue, there would be a contingent transfer to charity.
PLR
200541038 Reformed Statutory Trust Qualifies for Marital:
Dominic died testate, survived by Samantha and two children. Samantha elected under state law to waive any distribution as set forth in Dominic's will and instead take a distribution under state law. Under state law, Samantha's statutory share was one-third of Dominic's personal property and one-third of the real property up to $25,000 plus a lifetime income stream held in a statutory trust.
PLR
200743001 Donations to QTP Constituted a Valid Election to Treat as Ratably Made Over Five-Year Period:
Donor contributed $X to each of eight separate qualified tuition program (QTP) accounts for each of her eight grandchildren. Donor reported all gifts on her timely filed Form 709.
PLR
201112001 QTIP Election is Null and Void:
Decedent created a living trust. Upon his death, the trust was divided into a marital trust and a family trust. The marital trust was funded with as much of the taxable estate as necessary to eliminate the estate tax from decedent's estate.
PLR
201118007 Severance and Partial Gift of QTIP Trust:
Decedent created a marital trust with the net income to be paid to Spouse for life. Any remaining assets are distributed to Decedent's then-living issue as appointed by Spouse. If Spouse does not exercise this limited power of appointment, each share will be distributed to Decedent's then living children or their issue if deceased.
PLR
201242002 IRS Allows Trust Severance, Reverse QTIP Election:
Decedent died, survived by Spouse, Son and grandchildren. Article IV of Decedent's will provided that upon her death the residue of the estate should pass to Trust.
PLR
201552010 Service Grants Extension to Elect Portability:
Decedent died on Date 1, survived by Spouse. The value of Decedent's gross estate is less than the basic exclusion amount in the year of Decedent's death including any taxable gifts made during life.
PLR
201618004 Portability Election Extension Granted:
Decedent died on Date 1, survived by Spouse. In order for Spouse to obtain the benefit of portability of Decedent’s deceased spouse unused exclusion (DSUE) amount, Decedent’s estate was required to file a Form 706 within nine months of Decedent’s death.
PLR
201632014 Extension Granted to Make Portability Election:
Decedent died on Date 1, survived by Spouse. In order for Spouse to benefit from Decedent’s deceased spouse unused exemption (DSUE), Decedent's estate was required to file Form 706 within nine months of Decedent’s death. Decedent’s estate failed to file Form 706 to make the portability election before the due date.
PLR
201647004 Extension to Make Portability Election Granted:
Decedent died on Date 1, survived by Spouse. In order for Spouse to obtain the benefit of portability of Decedent's deceased spouse unused exclusion (DSUE) amount, Decedent's estate was required to file a Form 706 within nine months of Decedent's death.
PLR
9244013 QDOT and Unitrust:
Taxpayer desired to create a charitable remainder unitrust (CRUT) for himself and his spouse. However, his spouse was not a U.S. citizen and therefore did not qualify for the Sec. 2056(b)(8) marital deduction. Taxpayer planned to fund the CRUT with separate property and retain a testamentary right of revocation. The CRUT included the required provisions for a qualified domestic trust (QDOT) under Sec. 2056A(a).
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Related Topics on Marital Deduction
1.2.5
Marital Deduction:
Since 1981, there has been an unlimited marital deduction. Sec. 2523(a). This unlimited marital deduction allows free transfer of assets between spouses. This free transfer is very helpful in balancing estate sizes to make full use of the available exemption equivalent in each estate.
McCoy:
In Estate of John David McCoy et al. v. Commissioner; T.C. Memo. 2009-61; No. 5521-07 (19 Mar 2009), the tax court determined that the Utah tax apportionment statute applied and preserved the full marital deduction for a surviving spouse.
Foster:
In Estate of Ellen D. Foster et al. v. Commissioner; T.C. Memo. 2011-95; No. 16839-08 (27 Apr 2011), the Tax Court denied deductions for discounts claimed on marital trusts and then added a substantially discounted value for a potential claim.
Morgens:
In Estate of Anne W. Morgens et al. v. Commissioner; No. 10-73698 (3 May 2012), the 9th Circuit affirmed a Tax Court decision. The Tax Court ruled that a transfer of a QTIP trust remainder using a net gift method to heirs created a gift tax. Because the transferor passed away within three years, the gift tax was includable in her estate and substantially increased the amount of estate tax.
Windsor CA2th:
In Edith Schlain Windsor v. United States et al.; Nos. 12-2335, 12-2435 (2nd Cir. 2012), the court affirmed a District Court decision that awarded an estate tax refund to the survivor of a same-sex couple.
Theo Clara Spyer and Edith Schlain Windsor were married in Canada in 2007. Spyer passed away in 2009. The IRS denied a marital estate deduction based upon Section 3 of the Defense of Marriage Act (DOMA). The District Court reviewed the applicable law and determined that DOMA violated the equal protection clause.
The Bipartisan Legal Advisory Group of the United States House of Representatives (BLAG) retained counsel and appealed the decision of the District Court. BLAG maintains that there is a rational basis for DOMA that is sufficient to uphold its constitutionality.
In a split decision, two Circuit Court Judges determined that same-sex marriage partners qualified as a "quasi-suspect class" and therefore should receive heightened scrutiny. Under this standard, DOMA violates the equal protection clause.
BLAG maintained that Congress had a rational basis for preserving traditional marriage. However, the Circuit Court determined that the rationale for the Defense of Marriage Act was not sufficient under the heightened scrutiny standard and affirmed the District Court award of the estate tax refund.
Dissenting Judge Straub argued that DOMA does not violate the Fourteenth Amendment's equal protection guarantee. In his view, the question of marriage should be determined by Congress and the American people, rather than by the courts.
Judge Straub referred to decisions by 11 Circuit Courts of Appeals that have refused to grant sexual orientation an elevated form of scrutiny. Because he would apply the rational basis test to DOMA, it passes the equal protection standard.
Kite:
In Estate of Virginia V. Kite et al. v. Commissioner; T.C. Memo. 2013-43; Nos. 6772-08, 6773-08, (7 Feb 2013), the Tax Court held that termination of a QTIP trust was a taxable gift.
Windsor:
In United States v. Edith Schlain Windsor; No. 12-307 (26 Jun 2013), the Supreme Court held that the Defense of Marriage Act (DOMA) violates the equal protection clause of the Fifth Amendment. Under the decision, Edith Windsor qualified for a marital deduction in the 2009 estate of Thea Spyer.
Sower:
In Sower, Estate of Minnie Lynn et. al. v. Commissioner; No. 32361-15; 149 T.C. No. 11 (11 Sep 2017), the Tax Court held that the IRS could recalculate a deceased spouse unused exclusion (DSUE) even though the estate was closed.
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