Taxation of Estates and Gifts
Currently, the applicable exclusion amount is $10,000,000 plus the cost-of-living adjustment (so $11,400,000 in 2019). 26 U.S.C. § 2010(c)(3)(B)–(C). This allows an exclusion of that amount for everyone. (This exclusion is accomplished through the applicable credit amount.)
- Read problems carefully! They may have an older year and thus a lower exclusion amount.
- Funeral expenses
- Administration expenses
- Claims against the estate
- See 26 CFR § 20.2053-4.
- Pending lawsuits against the estate usually cannot be deducted, but it is possible to file a protective claim with the IRS which will let one get a refund if it is paid.
- Promises or agreements can only deducted if contracted for in exchange for full and adequate consideration. 26 U.S.C. § 2053(c)(1)(A).
- Unpaid mortgages
- See 26 CFR § 20.2053-7.
So, the exclusion amount is currently about $22,000,000 per couple. It is currently fully portable and it does not matter how it is planned.
Planning under a non-portability regime
Since the non-portability rule is still used and may be returned to, it is still important to learn.
In order to maximize each spouse's applicable exclusion amount, the amount of the first spouse to die's applicable exclusion amount (~$11,000,000) is placed in a trust that does not qualify for the marital deduction.
This "bypass trust" fully exhausts the decedent's applicable exclusion amount, but is not included in the surviving spouse's estate because it only gives the right to all income from the trust and the power of appointment for her "health, education, support, or maintenance." (I.e., not a general power of appointment)
Any remaining property is given directly to the surviving spouse or to a trust that does qualify for the marital deduction. This "pecuniary marital bequest" will then use up the surviving spouse's applicable exclusion amount when she dies.
- The way this is drafted is with a pecuniary marital bequest formula provision.
A pecuniary marital bequest formula provision says to give one's spouse "the least amount necessary to obtain a marital deduction sufficient to reduce the federal estate tax payable to the lowest possible amount."
- This will give all the property in the estate minus the applicable exclusion amount.
To qualify for the marital deduction:
- The property interest must be included in the decedent spouse's gross estate.
- An interest must pass from the decedent spouse to the surviving spouse.
- The interest must not be a terminable interest.
- The surviving spouse must be a US citizen.
In general, if a surviving spouse gets an interest that will terminate or fail by the lapse of time or by the occurrence or non-occurrence of an event or contingency and a third party will possess it afterwards because of a transfer from the decedent, the deceased spouse's estate cannot take a marital deduction. 26 U.S.C. § 2056(b).
- Basically, you can't deduct a life estate or term of years given to a spouse.
If the interest can only terminate within six months after the decedent's death and the termination does not occur, this is not considered an interest which will terminate or fail on the death of such spouse. 26 U.S.C. § 2056(b)(3).
- This is made for simultaneous death provisions.
- The surviving spouse must be entitled to all the income from the interest for life.
- The income must be payable at least annually.
- The surviving spouse must have the power to appoint the entire interest to herself or her estate.
- The surviving spouse's power to appoint must be exercisable alone and in all events.
- Nobody has a power to appoint any part of the property to someone other than the surviving spouse.
Life insurance or annuity with power of appointment in surviving spouse is essentially the same thing as a life estate with power of appointment in surviving spouse except obviously it is life insurance or an annuity instead. 26 U.S.C. § 2056(b)(6).
Qualified terminable interest property is property which passes from the decedent, in which the surviving spouse has a qualifying income interest for life, paid at least annually, and which is elected under 26 U.S.C. § 2044. 26 U.S.C. § 2056(b)(7).