Estate Tax Planning and the Marital Deduction
Most couples prefer to maximize the share of their estate that passes to their beneficiaries. That means minimizing estate tax obligations is a goal in almost every plan. This raises the issue of how to minimize estate taxes when the law and the value of property can change on a regular basis.
Do you have to revisit your estate plan with every change in the tax code? There are ways to make an estate plan flexible enough to account for many potential changes to the law and your estate.
The Marital Deduction Explained
The marital deduction is intended to protect surviving spouses from incurring massive tax liability. According to the IRS, “all property that is included in the gross estate and passes to the surviving spouse is eligible for the marital deduction.”
Basically, transfers from a decedent spouse to a surviving spouse will not involve tax liability until the surviving spouse also passes. The marital deduction has citizenship restrictions, but for those who qualify, the size of the estate doesn’t matter.
The Estate Tax Exemption Explained
Whether or not an estate is subject to federal taxation depends on its size. In 2022, any estate valued at less than $12,060,000 is exempt from estate taxes. That number has increased by nearly $7 million over the past decade. It is also expected to go down sharply in the near future.
As it stands, the estate tax exemption will be changed to an inflation-adjusted $5 million at the start of 2026. With an estate tax rate of 40%, that change would mean an additional $2.824 million in tax liability for an estate at the $12.06 million figure.
Marital Share Funding Formulas Explained
In order to put the estate tax exemption to its best use, the first decedent’s estate must be divided into marital and non-marital shares. Marital share funding formulas are methods by which estates can be divided into these shares. The formula chosen dictates how the assets are divided.
Marital Disclaimers Explained
One type of marital share funding formula is the marital disclaimer trust. The disclaimer trust creates the flexibility necessary to ensure that the estate is divided for maximum estate tax avoidance.
The first decedent’s estate passes all property to the marital share. The surviving spouse then disclaims some portion of the property. The disclaimed property is distributed to the non-marital share as a trust. That trust can be used for the benefit of the surviving spouse or for other beneficiaries.
By allowing the surviving spouse to dictate how much property to put into the marital disclaimer trust, the estate plan doesn’t need to predict the value of the property or the estate tax exemption amount in advance. It also allows the surviving spouse to make decisions based on his or her financial situation.
How Does This Help?
When the first decedent passes, the surviving spouse disclaims property in the amount of the estate tax exemption, whatever it is at the time. That is the non-marital share. The remaining property goes to the marital share. This guarantees that the estate of both spouses combined will get the full benefit of both of their estate tax exemptions.
Without the marital disclaimer trust, things would go differently. In the example below, George and Maria can use a marital share funding formula as part of their estate tax planning to reduce their estate tax burden by $4,824,000.
Without a marital share funding formula: George and his wife, Maria, each own half of their $25 million estate. George dies in 2022, when the estate tax exemption amount is $12.06 million. Maria dies in 2026, when the estate tax exemption amount is only $5 million, the inflation-adjusted amount then in effect. Their estate plan leaves the first decedent’s estate to the surviving spouse with everything going to their children at the surviving spouse’s death.
When George dies in 2022, his $12.5 million portion of the estate passes to Maria estate-tax free under the unlimited estate tax marital deduction. Because all of George’s $12.5 million passes to Maria under the marital deduction, when Maria dies in 2026, the applicable $5 million exemption amount will only protect $5 million of the $25 million estate. Applying a 40 percent estate tax rate, Maria’s estate would owe $8 million in estate tax.
Example with a marital share funding formula. The facts are the same as in the above example, except that George and Maria’s estate plan uses a marital funding formula that divides George’s estate into marital and nonmarital shares. At George’s death, $12.06 million is apportioned in trust to the nonmarital share, using all of George’s estate tax exemption amount, and the remaining $440,000 is apportioned to the marital share. When Maria dies in 2026, her estate will be worth $12,940,000, consisting of her $12.5 million portion of the estate and the $440,000 apportioned to the marital share. Maria’s $5 million estate tax exemption amount in 2026 will protect $5 million of Maria’s $12.94 million estate. Applying a 40 percent estate tax rate, Maria’s estate would owe $3,176,000 in estate tax.
Tax Benefits and Flexibility
The primary benefit of a marital disclaimer trust is flexibility. The surviving spouse gets to decide what property to disclaim into the non-marital share. Tax benefits are available, but they can be put aside if the surviving spouse so chooses. The fact that the marital disclaimer trust is optional allows people to address the changing realities of life.
Requirements and Drawbacks
There are elements of marital disclaimer trusts that must be met to use this strategy. Surviving spouses must disclaim the assets immediately. If the surviving spouse accepts the assets or tries to control what is done with those assets before or after they have been disclaimed, the tax exemption benefits are lost.
The first spouse to pass must have marital disclaimer provisions in their estate plan to create the benefit. If not, the act of disclaiming the assets will simply cause them to pass on to the next-in-line beneficiaries, rather than the marital disclaimer trust.
Estate Planning Options, Including Marital Disclaimers
Estate planning has many tools available to help people reduce or avoid estate taxes. Estate tax planning strategies can be complex. It is important to work with an experienced attorney who has the estate tax knowledge to put you on the right path.
At the Law Office of Janet L. Brewer, you can get the thorough estate planning advice you need. With the right help, you can decide whether a marital disclaimer trust is the best way to accomplish your estate planning goals.
We have the experience to craft a plan that will protect your family and your assets. Call 650-850-5826 or send us a message to schedule a consultation.
* Additional planning is needed if the surviving spouse is not a U.S. citizen.
