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Estate tax marital deduction: don't "overqualify" (MS Word)
Estate tax marital deduction: don't "overqualify" (.pdf)
Estate tax marital deduction: don't “overqualify”
Dear Reader:
You recently asked about the role of the marital deduction in your
estate plan. In this connection, it's important to understand one
danger this deduction poses: that of “over-qualifying” for it.
There are no limits on how much of a marital deduction your estate
can qualify for. Thus, if your entire estate goes to your surviving
spouse, your estate will owe no federal estate tax. Many taxpayers
take this simple approach. In the long run, however, it can cost
your family hundreds of thousands of dollars in extra estate taxes.
Here's what's involved.
Every individual is entitled to a “unified” credit entitling him to
transfer $3.5 million in cash or property free of federal estate
tax. (The estate tax is scheduled to be repealed on January 1, 2010,
and to be reinstated, with a $1 million exemption, on January 1,
2011.) Property doesn't have to be transferred to the individual's
spouse to qualify for this credit. A husband and wife, therefore,
can transfer a total of $7 million ($3.5 million each) to their
children (or other beneficiaries) in 2009, free of estate tax. If
the first of them to die leaves everything to the surviving spouse,
however, he will have failed to take advantage of his unified
credit. At the later death of the spouse, assets with a value of
$3.5 million passing to the children will be “sheltered” by her
credit, but the rest of the “parental” estate will be taxed.
Example (1).
Harry dies in 2009 with an estate of $7 million, which he leaves in
its entirety to his surviving spouse, Wilma. Harry's estate has no
estate tax liability due to the marital deduction. Wilma dies later
in 2009 with the $7 million comprising her estate. (For the sake of
simplicity, assume that there will be no appreciation in the value
of the property after Harry's death.) After applying the unified
credit that applies in 2009, the estate tax bill for Wilma's estate
will be $1,575,000.
Example (2).
The facts are the same as above except that Harry leaves only $3.5
million to Wilma and leaves the balance of his estate ($3.5 million)
to their children. In this case, Harry's estate will still owe no
estate tax due to the combined effect of the marital deduction and
unified credit. At Wilma's later death, her estate will be $3.5
million, instead of the $7 million in the first example. Now, after
applying the unified credit that Wilma's estate will be entitled to,
the estate tax bill will be zero. By keeping $3.5 million of Harry's
estate from qualifying for the marital deduction, $1,575,000 in
estate taxes are avoided.
Property passing to the spouse.
One reason an estate may overqualify for the marital deduction is
that property may go to the surviving spouse automatically—that is,
not under the taxpayer's will. Two common examples are jointly owned
property and life insurance.
If a married couple owns property jointly with survivorship rights,
the surviving spouse obtains complete ownership by operation of law
outside the estate. Under the estate tax rules, half the value of
the property is included in the gross estate but qualifies for the
marital deduction since it goes to the surviving spouse. Similarly,
if the surviving spouse is the beneficiary of life insurance which
is included in the estate, the marital deduction applies.
Accordingly, to avoid “overqualifying” for the marital deduction, it
is important to know what property is already targeted to go to the
surviving spouse. Then steps can be taken within your estate plan to
make sure enough assets are set aside to take advantage of the
unified credit.
If you are hesitant to remove $3.5 million or more of your assets
from your spousal bequest for fear of leaving your spouse with
insufficient property to meet her needs after your death, special
arrangements can be made to achieve your goals. One way is to place
assets in trust with your spouse receiving the income interest for
life and with your children receiving the assets at the spouse's
death. The trust can be set up to avoid qualifying for the marital
deduction at your death, thus avoiding inclusion in your surviving
spouse's estate at her death.
If you wish to discuss how you can save perhaps hundreds of
thousands of dollars using the estate planning technique described
above, or to explore other estate planning techniques, please call
us at your earliest convenience.