Preserving and Transferring Wealth: The Marital Deduction

Since the marital deduction is unlimited, a bequest of all property to a surviving spouse will completely defer federal estate taxes until the spouse’s subsequent death. However, in certain instances, use of the maximum marital deduction may actually result in a higher overall estate tax. This is because estate taxes are like income taxes in that higher marginal rates are charged as the estate’s size increases. Use of the maximum marital deduction has the effect of lumping all the assets into the estate of the second spouse to die. Therefore, it may be better to use only the amount of marital deduction that will reduce the overall estate tax through bracket equalization and efficient use of each spouse’s unified credit.

Example:

Gilda Grave dies in 2006 and is survived by her husband and three children. Her will provides that her husband is to receive everything. Her estate is worth $2,000,000 ($2,100,000 in assets, less a $50,000 debt and $50,000 in administrative expenses).

Gross estate	x	$ 2,100,000
Less:	x	x
Debts	$ 50,000	x
Administrative expenses	__50,000	___(100,000)
Adjusted gross estate	x	2,000,000
Marital deduction (unlimited)	x	_(2,000,000)
Taxable estate	x	$________ 0

Upon Mr. Grave’s subsequent death, the estate tax on the property inherited from Mrs. Grave is computed as follows, assuming he consumed all income and the assets did not appreciate:

Property inherited from Mrs. Grave	$ 2,000,000
Estate tax before credits	$ 780,800
Unified credit (2006)	____345,800
Estate tax before other credits	$ 435,000

Thus, total taxes on the estate of $2,000,000 equal $435,000. If Mrs. Grave had left only the excess of the applicable exclusion amount ($1,000,000) to her husband, there would have been no estate tax due at the death of either spouse. This is due to the ability of each spouse to shelter up to $1,000,000 in assets through the use of their respective unified credits. Thus, $435,000 would pass to the Graves’ heirs instead of being paid in taxes.

Assets must be transferred to someone other than your surviving spouse to utilize the applicable exclusion amount. You may, however, want all your assets to be transferred to your surviving spouse to ensure there is sufficient income for his or her life. A credit-shelter trust may be used to transfer the value of the exclusion, or $1,000,000, from your estate to a trust with the net income payable to your surviving spouse. The beneficiaries of the principal assets, as designated in your will, would receive the property upon your spouse’s death. The trust could include a provision allowing the trustee to invade the principal assets of the trust for the benefit of the surviving spouse for distribution of

The above provisions would allow for the possible income needs of the surviving spouse and exclude the trust assets from the spouse’s estate at his or her death.

For estates with assets worth more than double the exclusion amount ($2,000,000), the decision as to whether to use a marital deduction of more than 50 percent depends on a number of factors, including

Most married individuals will probably choose to use the unlimited marital deduction to eliminate all taxes upon the death of the first spouse.

That is, all property in excess of the exclusion amount ($1,000,000) will be left to the surviving spouse either outright or in a qualifying trust. The primary benefit of such a plan, of course, is to provide the survivor with the use of funds that otherwise would have been paid by the decedent’s estate in the form of estate taxes.

To provide additional planning flexibility, the decedent’s will may also give the spouse or his or her executor the right to disclaim the bequest in whole or in part. This will allow the survivor to consider all relevant factors at that time and adjust the amount of the marital deduction, if necessary.