The concept of marital deductions is simple, spouses should be able to leave their property and assets to their surviving spouse without taxation by the government when they die. That is exactly what trusts for marital deductions do — they allow a spouse to leave their property and assets to their surviving spouse without being subject to an estate tax.
Section 2056 of the Internal Revenue Code (“IRC”) is the main federal law that allows for a marital deduction to prevent a surviving spouse from paying taxes on a deceased spouse’s estate. However, the deduction does not cover the entirety of the deceased spouse’s estate. Thus, surviving spouses must rely on other federal laws in order to make sure that the estate left by their deceased spouse is not taxed.
Unlike the Federal Code, marital deduction trusts protect both spouses’ separate estates, instead of only the deceased spouse’s estate. Further, marital deduction trusts allow for a married couple to pass the entirety of their estate to their surviving spouse, tax free. Marital deduction trusts accomplish this by allowing spouses to put their property in a trust with their spouse as the beneficiary. Then, upon the death of either spouse, the surviving spouse then has the right to use the property and assets held in the trust.
Further, when the surviving spouse dies, the assets and property in the trust are not included in their estate. This means that the surviving spouse’s federal taxes will not be as high as they would have been if the property and assets were not held in a trust and included in their gross estate. Thus, the marital trust also shields the estate of the surviving spouse from taxation when passing the remaining trust property on to the named beneficiaries, such as children.
The requirements for all the different types of trusts vary by state. Generally, in order to create a valid trust the following requirements must be met:
- Testamentary Capacity: In order to create a valid trust, the settlor (person that creates the trust) must have proper mental capacity to create the trust. This means that they must intend to create a trust expressed with any necessary formalities of the state, such as the trust being in writing;
- Identifiable Property: The trust property must be specifically identifiable, meaning there must be a sufficient enough description to know what property or assets are to be held;
- Identifiable Beneficiary: There must be an identifiable beneficiary;
- Legal Trust Purpose: Trusts created for an illegal purpose are not valid. For example, a trust created to defraud creditors will likely be declared invalid by a court.
In addition to the above requirements, there are additional requirements for creating trusts for marital deductions. Generally, the surviving spouse must be able to demonstrate that:
- They were the trust’s only beneficiary during their lifetime. This means that they must demonstrate that they were the only person who received any property, assets, or funds from the trust during their lifetime; and
- They must demonstrate they have the right to distribute trust property when they die.
Alternatively, a spouse may once again demonstrate that all income generated by the trust was passed to them annually during their lifetime. However, unlike a normal marital deduction trust, that spouse may then specify who gets the remaining trust property when the surviving spouse dies. In legal terms, this is known as a qualified terminable interest property trust (“QTIP trust”). QTIP trusts are commonly used in cases where the spouses have children from previous marriages or in second marriage cases.
Once again, if a trust for marital deductions fails to meet all of the requirements above, the trust will likely be declared invalid by a court. This means that the married couple will not be able to take advantage of federal tax deductions on the transfer of the estate.
It is important to note — a surviving spouse’s interest under the marital deduction trust must be unconditional. This means that when creating a trust for marital deduction, you cannot make provisions where benefits will cease if your spouse divorces you, gets remarried, or other similar conditions.
Marital deduction trusts permit the surviving spouse to designate beneficiaries, even after the creator of the trust has died. This means that the surviving spouse can choose who to leave the remaining trust property to, without the input of the other spouse. Thus, in more complex estates, such as estates where each spouse has children from a previous marriage, a marital deduction trust may not be the best option. This is due to the fact that the surviving spouse may choose not to include children from a previous marriage in the distribution of the remaining trust assets and property.
As can be seen, creating a valid marital deduction trust can be a complex process. Thus, it is in your best interests to contact a knowledgeable and well qualified estate attorney in your area. An experienced estate attorney can inform you if you qualify for a marital deduction trust.
They can also ensure that you comply with federal and state tax requirements when drafting the trust. Further, in the event that a dispute arises over trust property, the attorney can represent you in court.