Handbook
• THE UNLIMITED MARITAL DEDUCTION TRAP
In addition to the exclusion amounts just discussed, spouses have the right to
distribute an unlimited amount to a surviving spouse without incurring any estate
taxes at all. This is called the Unlimited Marital Deduction. Unlimited means
unlimited: you could distribute $1 million or $10 million or any amount to your
surviving spouse without incurring estate taxes.
You might think then that all you have to do to avoid estate taxes would be to
distribute all your property to your surviving spouse. However, you would be
wrong and a mistake here could be very costly.
Let’s take an example. Let's say a married couple have a $1,500,000 net taxable
estate (i.e., $750,000 owned by the Husband and $750,000 owned by the Wife),
and they each have an exclusion amount of $1,000,000.
The Husband can use his $1,000,000 exclusion amount to distribute his $750,000
to his son or anyone else. The Wife can also use her $1,000,000 exclusion
amount to do the same. However, because spouses can distribute an unlimited
amount to each other (Unlimited Marital Deduction), the Husband decides to
distribute all his property to his Wife instead, when he passes away, so that the
Wife can continue to control and use the property for her own benefit.
However, here is the trap. When the Wife passes away she will now have
$1,500,000 (her $750,000 and her Husband’s $750,000) worth of net taxable
estate. Assuming her exclusion amount is still $1,000,000, the $500,000 over her
exclusion amount will be taxed at 40% or more. That would mean at least
$200,000 in estate taxes.
There’s a Trust that can help to avoid these estate taxes and still maintain some
control over the property for the benefit of the Wife. We’ll call it a Credit Shelter
Trust, although it’s also known by other names such as Marital Trust, Bypass
Trust or AB Trusts.
Here's how it works. Instead of the Husband giving all of his net taxable estate
($750,000) to his Wife, he puts it in a Credit Shelter Trust. The income of the
Trust is used for the benefit of the Wife during her lifetime and the principal is
distributed to the designated beneficiaries at her death. (The property the
Husband puts in the Trust is not counted towards the Wife's property because the
property is legally owned by the Trust and not the Wife.) When the Wife passes
away, she only has her $750,000 to distribute and it is also distributed without
estate taxes because of her $1,000,000 exclusion amount. Using the Credit
Shelter Trust, there are $0 estate taxes incurred.
Note: A spouse that is not a U.S. citizen is not entitled to an unlimited marital
deduction. Additional planning may be required in this situation.
