What Is The Unlimited Marital Deduction?
The unlimited marital deduction allows you to deduct the value of property you give to your U.S. citizen spouse from your estate and may reduce potential federal gift and estate tax that may be owed. This deduction, in effect, treats married couples as one economic unit. It can be a powerful estate planning tool because there is no limit to this deduction and you could conceivably leave your entire estate to your spouse tax free.
The unlimited marital deduction allows you to shift wealth between spouses without incurring gift or estate taxes and maximizes the benefits that result, such as:
- Preserving the benefit of each spouse's applicable exclusion amount: Each spouse is entitled to the applicable exclusion amount, and neither spouse's exclusion should be wasted. Each spouse should make maximum use of the shelter provided by the applicable exclusion amount ($11,580,000 in 2020, $11,400,000 in 2019).
Tip: In 2011 and later years, the unused applicable exclusion amount of a deceased spouse is portable and can be used by the surviving spouse. Portability of the exclusion may provide some protection against wasting of the exclusion of the first spouse to die.
Example(s): Jack and Cathy are married and Jack has an estate of $20 million. Assume an applicable exclusion amount of $11,580,000, a 40 percent top tax rate, portability, and values stay constant. Cathy dies first. Cathy's estate elects to transfer Cathy's unused exclusion to Jack. At Jack's death, Jack's $20 million estate is sheltered by his $23,160,000 applicable exclusion amount (Jack's $11,580,000 exclusion amount and Cathy's $11,580,000 unused exclusion) and no estate tax is due.
Caution: The unused exclusion of a deceased spouse is not indexed for inflation after the death of the spouse. However, property passing to a surviving spouse may continue to grow after the death of the deceased spouse. Leaving all property to the surviving 1spouse who then uses both spouses' exclusions could lead to extra estate taxes in some cases.
Example(s): Dave and Ann are married and Ann has an estate of $20 million. Assume an applicable exclusion amount of $11,580,000 (that will be indexed for inflation after the first spouse dies), a 40 percent top tax rate, portability, and values (other than any unused exclusion) double overtime after the first spouse dies. Dave dies first. Dave's estate elects to transfer Dave's unused exclusion to Ann. At Ann's death, Ann's $40 million estate is greater than her $34,740,000 applicable exclusion amount (Ann's $23,160,000 exclusion amount and Dave's $11,580,000 unused exclusion), and estate tax of $2,104,000 is due.
Example(s): If Ann instead had transferred $10 million to Dave prior to his death, Dave's $10 million estate would have been fully sheltered by his $11,580,000 applicable exclusion amount (assuming Dave transfers the $10 million to a credit shelter trust or to beneficiaries other than Ann) and Ann's $20 million estate would have been fully sheltered by her $23,160,000 applicable exclusion amount, and no estate tax would be due at either death.
Tip: A by-pass trust (or credit shelter trust) is an alternative to protect both spouses' applicable exclusion amount.
- Equalizing the size of your estates: The benefit resulting from equalizing the amount of property subject to tax in each spouse's estate is the product of the estate tax rate schedule being graduated. The best result is achieved when both estates are subject to the same marginal tax rate.
Tip: In 2013 and later years, a federal gift and estate tax rate of 40 percent generally applies to taxable amounts in excess of the applicable exclusion amount. In those years, there may be no advantage to equalizing estates in order to avoid graduated tax rates.
Tip: Community property estates are already equalized to the extent of the community property.
- Deferring the payment of any estate taxes until the death of the surviving spouse: If you can't avoid paying taxes altogether, at least you can delay them. This can reduce the estate taxes owed and preserve the maximum amount of property for your spouse to use during his or her lifetime.
How Does a Transfer of Property Qualify For The Unlimited Marital Deduction?
Certain requirements and conditions must be met to qualify for the unlimited marital deduction:
- You must be a U.S. citizen or resident at the time you make the transfer
- Your spouse must be either: (1) a U.S. citizen at the time the transfer is made, (2) a U.S. citizen before the day on which the estate tax return is due and a resident of the United States at all times between the date of your death and the date your spouse became a citizen, or (3) the property must be transferred to a qualified domestic trust (QDOT) at the time of your death • The recipient of the property must be your spouse at the time you make the transfer
- The property transferred to your spouse must be included in your taxable estate
- The remaining property, at your spouse's death, must be included in your spouse's estate for estate tax purposes, if estate tax is imposed in the year of your spouse's death
- The property transferred to your spouse must not be a terminable interest (this is the terminable interest rule)
Technical Note: A "terminable interest" is a legal term for a property interest that will end or fail upon the happening of an event or with the passing of a given period of time. This means that the property will be in your spouse's hands only temporarily and then will pass to someone else. Life estates, reversions, remainders, annuities, patents, and copyrights are all terminable interests.
Tip: There are exceptions to the terminable interest rule. The most notable exception is qualified terminable interest property (QTIP). The most common example of QTIP is the QTIP trust. A QTIP trust allows you to pass a lifetime income stream to your spouse but also name other family members as the ultimate beneficiaries.
How Do You Use The Unlimited Marital Deduction?
For lifetime gifts, the unlimited marital deduction is allowed for the year in which you make the gift for gift tax purposes. Generally, if all the gifts you make in a given year qualify for the unlimited marital deduction, you are not required to file a gift tax return for that year.
What If Your Spouse Is Not a U.S. Citizen?
The unlimited marital deduction is not available to non-U.S. citizen spouses unless: (1) your spouse is either a U.S. citizen at the time the transfer is made, (2) a U.S. citizen before the day on which the estate tax return is due and a resident of the United States at all times between the date of your death and the date your spouse became a citizen, or (3) the property is transferred to a QDOT at the time of your death.
Tip: The unlimited gift tax marital deduction is not available for a gift to a spouse who is not a United States citizen. However, the annual gift tax exclusion for such a gift is increased from $15,000 to $157,000 (in 2020, $155,000 in 2019) if the gift would otherwise qualify for the marital deduction if the spouse were a United States citizen.
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