How Does an Estate Tax Marital Deduction Work?

estate tax by KB CPA services

Estate planning is complex enough as an individual, but when you’re planning as a married couple, it can bring about even greater challenges. Collaborating as a unified partnership for the future of your shared estate means that both of you will have specific priorities to incorporate into the plan. Some common concerns might include the burden of costly estate taxes and ensuring financial security for the surviving spouse. In such cases, exploring the estate tax marital deduction could be a worthwhile endeavor. Here’s some foundational information to consider before determining whether the marital deduction is a suitable component for your estate planning strategy.

It is advisable to engage the services of a financial advisor who can provide expert guidance in crafting an estate plan that caters to the needs and goals of both you and your spouse.


What Is the Estate Tax Marital Deduction?

The estate tax marital deduction, also known as the unlimited marital deduction or simply the marital deduction, serves as a valuable tool in estate planning, particularly for certain married couples. It enables one spouse to transfer assets to their partner without incurring any tax liabilities. The marital deduction is computed based on the overall gross estate. The total value of assets passed on to the surviving spouse is deducted from this amount, resulting in the marital deduction. This inter-spousal transfer can take place during the lifetime of the couple or after the passing of one spouse, as stipulated in a will.

The estate tax marital deduction applies to both estate and gift taxes, and it is governed by Section 2056 of the Internal Revenue Code.


Who Qualifies for the Estate Tax Marital Deduction?

The marital deduction applies regardless of how the property or assets are transferred to the surviving spouse. This can encompass methods such as beneficiary designations, intestate succession, or other means. However, there are certain prerequisites that must be met for the marital deduction to apply.

First and foremost, the individuals involved must be legally married. Additionally, there must be a surviving spouse who is set to inherit the property. This property must originate from the decedent’s gross estate and must be transferred directly, without any terminable interest.

An example of a terminable interest would be if the decedent left assets to their surviving spouse but with a limit on the duration of ownership. In such a case, it would result in a life estate, with the beneficiary unable to designate subsequent heirs. However, an exception to this direct transfer rule is the qualified terminable interest property (QTIP), which allows the grantor to provide for the spouse while still ensuring that the assets pass to specific beneficiaries upon the surviving spouse’s demise.

It’s worth noting that non-U.S. citizen spouses are not eligible for the marital deduction. Instead, a qualified domestic trust (QDOT) can be established, allowing the marital deduction to be applied to assets placed within the trust. This enables a non-citizen spouse to access the assets.


How Does the Estate Tax Marital Deduction Work?

We’ve established that the marital deduction involves deducting assets from the transferor’s gross estate, permitting the surviving spouse to inherit them without incurring estate taxes. This deduction also applies when the decedent gifts the property, either through a direct transfer or by placing it into a trust. If a trust is used, the surviving spouse must have access to the trust’s income throughout their lifetime and possess the power to designate beneficiaries of the assets. A QTIP trust can be a useful vehicle in managing this aspect.

It’s important to understand that the marital deduction only defers the estate and gift taxes; they will eventually be due when the surviving spouse passes away. The tax liability at that time depends on the estate’s size.


Estate Tax Marital Deduction: Key Considerations

While the marital deduction can be a suitable choice for certain estates, it may require additional support to make it the right option for your specific situation. Alternatively, the marital deduction might not align with your needs at all. Regardless of whether you need to reinforce your choice or explore alternative methods to minimize estate planning costs, there are other exemption and deduction options you can leverage.

For the year 2022, estates exceeding $12.06 million for individuals and $24.12 million for married couples are subject to estate taxes. In 2023, these limits increase to $12.92 million and $25.84 million, respectively. If your estate does not surpass these thresholds, you will not face federal estate tax when your spouse passes away. However, if you intend to utilize the marital deduction, your partner’s lifetime exemption is forfeited, as it cannot be transferred to the surviving spouse. This can pose challenges for larger estates, as the surviving spouse will only have their own exemption value to shield the combined assets.

To address this, if the lifetime exemption is not beneficial, you can consider implementing the credit shelter provided by an A/B Trust. The credit shelter can alleviate concerns about the lifetime estate tax exemption since the amount of assets left to the surviving spouse under the marital deduction will be reduced. It is advisable to consult with a financial professional before incorporating trusts into your estate plan.

While trusts can offer flexibility, concerns about beneficiary status may still arise. If you wish to ensure that your children or other individuals eventually benefit from your estate, you can opt for a QTIP, as previously discussed.

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