The Marital Deduction –What You Need to Know

When you create, or update, your estate plan, it is important to take into account the impact federal (and state) gift and estate taxes could have on your estate. Failing to anticipate your estate’s tax obligation, and plan to limit that obligation, could result in your loved one’s receiving a significantly less valuable estate than you intended to pass down. If you are married, you may be planning to rely heavily on the marital deduction to avoid taxes; however, doing so creates its own set of problems. To help you better understand, an estate planning attorney at Nash Bean Brown & Ford, LLP explains what you need to know about the marital deduction.

What Happens after Your Death?

The estate you leave behind after you are gone will consist of all assets owned by you, or in which you had an ownership interest, at the time of your death. Before most of those assets can be passed down to intended beneficiaries or heirs of your estate, they must first go through the legal proves known as “probate.” Probate serves several purposes, including:

• Authenticating the decedent’s Last Will and Testament
• Identifying, locating, and valuing the decedent’s assets
• Notifying creditors of the estate and allowing them the opportunity to file claims against the estate
• Ensuring that taxes owed by the decedent and/or the estate are paid
• Transferring estate assets to beneficiaries and/or heirs of the estate

Federal Gift and Estate Taxes

All estates are potentially subject to federal gift and estate taxes. The tax is levied on the combined total of the value of all qualifying gifts made during a decedent’s lifetime and the value of all estate assets owned at the time of death. Although the federal gift and estate tax rate was once subject to change on a yearly basis, the American Taxpayer Relief Act of 2012 (ATRA) permanently set the tax rate at 40 percent. Without any additional deductions or considerations, that means a taxpayer could lose almost half of his/her estate to taxes!

Fortunately, every taxpayer is also entitled to make use of the lifetime exemption which is essentially a deduction taken prior to calculating the tax. Like the tax rate, the lifetime exemption limit was also subject to change – and did change – on a regular basis prior to the passage of ATRA. In 2012, ATRA set the lifetime exemption limit at $5 million, to be adjusted annually for inflation. For 2019, the lifetime exemption amount would be $5.49 million for an individual and $10.98 million for a married couple; however, President Trump signed tax legislation into law that changed the lifetime exemption amount for 2018 and for several years to come. Under the new law, the exemption amounts increased to $11.4 million for individuals and $22.8 million for married couples for 2019. These exemption amounts are scheduled to increase with inflation each year until 2025. On January 1, 2026, the exemption amounts are scheduled to revert to the 2017 levels, adjusted for inflation.

Where Does the Unlimited Marital Deduction Fit into the Picture?

If you are married at the time of your death, your estate has the option to make use of the unlimited marital deduction. As the name implies, the deduction allows a married taxpayer to leave an unlimited amount of assets to a spouse tax-free. Although this sounds like an awesome option, it often results in over-funding a surviving spouse’s estate.  Ultimately, it only delays the payment of federal gift and estate taxes in that case. For example, if your spouse passed away and left an estate valued at $15 million, even with the increased lifetime exemption amount for 2019, just over $4 million would be subject to estate taxes. Those assets could be gifted to you tax-free; however, your taxable estate has now increased by $4 million. If the assets you already own were of equal value to those your spouse owned, your $15 million estate is now worth $19 million. After applying your lifetime exemption, your estate would still owe estate taxes on the remaining $8 million. All that was accomplished through the use of the marital deduction was to delay – not avoid – paying federal gift and estate taxes.

Consequently, the marital deduction should only be used when proper estate planning was not done prior to the decedent’s death. Ideally, your estate plan should include tax minimization strategies that result in the transfer of wealth without incurring a tax obligation at all.

Contact a Estate Planning Attorney

For additional information, please join us for an upcoming FREE seminar. If you have additional questions or concerns about how the marital deduction fits into your estate plan, contact an experienced  estate planning attorney at Nash, Bean, Ford & Brown, LLP by calling 309-944-2188 to schedule your appointment today.