The "Marital Deduction" in Estate Tax

San Antonio Express-News November 14, 2006 Marital Deduction in Estate Tax copyright 2006, Paul Premack
Dear Mr. Premack: My wife and I are 72 and 73 respectively with no major health problems. We are retired and living on a comfortable retirement income. Our estate amounts to about $600,000, including mortgage free vehicles and a mortgage free home. Please provide an explanation of the "marital deduction" and how it would affect our estates for future tax purposes? – JEM The marital deduction is a feature of federal estate tax law that helps delay estate taxes until both spouses have died. It is available only to married couples, and then only upon the first death. It does not actually reduce estate taxes, and must always be thought of in concert with the other estate tax break called the exemption amount. The exemption amount defines how large an estate must be before it is subjected to the federal estate tax. This year, any estate valued at less than $2 million is exempt from estate tax. Generally, if the exemption amount eliminates the tax then a couple has no need to be concerned about the marital deduction. Here is how it works, in two different examples: Example 1: your situation. You have a community property estate of $600,000, so each of you has a net estate value of $300,000. Assuming you have Wills that leave your estates to each other, if you die first then your wife inherits your $300,000 estate. That inheritance is free of estate tax because the marital deduction eliminates estate tax on anything passing from one spouse to the other. Example 2: assume you had community property of $2,600,000, so each of you has a net estate value of $1,300,000. Assuming you have a Will leaving your estate to your wife, upon your death her estate grows to $2,600,000. That inheritance is estate tax free. The marital deduction eliminates estate tax on the $1,300,000 she inherited from you. But the marital deduction does not actually reduce the estate tax; rather, it delays the tax. In example 2 the surviving wife’s estate is $2,600,000. Because of the marital deduction she never lost a dollar to estate taxes. But when she dies, the marital deduction no longer helps and her estate of $2,600,000 exceeds the $2 million exemption amount. Thus, there is an estate tax when she dies of approximately $291,000. That tax was avoidable with more complex preplanning. If, instead of leaving everything to the surviving spouse on the first death, that couple had plans (in a Will or a Trust) to leave part of the estate to a tax shelter trust then they could have zeroed out the estate tax. Here is how it would work: The $1,300,000 belonging to the deceased spouse is split so that he leaves $600,000 to a shelter trust and $700,000 to his wife. The $700,000 is tax free under the marital deduction. The $600,000 trust is tax free using the exemption amount of the first spouse. Now the surviving spouse has a taxable estate of $2 million (her $1.3 million half and the $700,000 inheritance). When she dies, her heirs get the $2 million tax free using her exemption amount. They also receive the $600,000 trust set up by her husband which was already tax-free on his death. This planning saves $291,000 by properly combining the marital deduction and the exemption amount. Couples whose estates are below the exemption amount don’t need to worry about the marital deduction. Couples whose estates exceed the exemption amount need to realize that the marital deduction is only a way to delay taxes. They need to properly combine the marital deduction with the exemption amount to reduce estate taxes.
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Disclaimer: This column answers a specific legal question asked by an individual in Texas. The answer may or may not match your individual situation. Be careful not to treat this column as specific legal advice, as it may not meet your individual needs. It may give you a solid basis for discussion with your own attorney. You should consult with your personal attorney before you take any action on this or any legal issue. Also, please be aware that laws change, so this column is valid only as of the date it was published. This communication does not create an attorney-client relationship between the author and the reader.