When a person dies, the federal government levies an estate tax on the individual’s estate. Estate taxes are also called “death taxes” or “inheritance taxes.” These taxes are imposed when the decedent’s property or assets are transferred to another individual by will or by succession rules in state law.
The purpose of trusts for marital deductions is simple: spouses should be able to leave their property and assets to their surviving spouse without taxation by the government. 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 federal Internal Revenue Code provides a law allowing for a marital deduction so that the surviving spouse does not have to pay tax on the deceased spouse’s estate. However, the deduction only covers part of the estate.
Thus, surviving spouses must rely on other strategies to ensure the entire estate is not taxed. That is where marital deduction trusts come into play. They are a way to protect the entire estate from taxation. Marital deduction trusts allow a married couple to pass the entirety of their estate to their surviving spouse tax-free.
Marital deduction trusts provide another benefit not found in the Internal Revenue Code. The federal tax law protects only the deceased spouse’s estate. Marital deduction trusts protect both spouses’ separate estates. 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 has the right to use the property and assets held in the trust and will not have to pay any estate taxes.
Further, when the surviving spouse dies, the assets and property in the trust are not included in their estate. This means 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. Thus, the marital trust also shields the surviving spouse’s estate from taxation when the remaining trust property goes to the named beneficiaries, such as children.
What are the Requirements for Trusts for Marital Deductions?
The requirements for all the different types of trusts vary by state. Generally, to create any kind of valid trust, the following requirements must be me:
- Testamentary Capacity: To create a valid trust, the settlor (the person who creates the trust) must have the proper mental capacity to create the trust. Testamentary capacity refers to the ability of a person to make a valid will. Most states have an age requirement (usually 18 years old) and a mental capacity requirement. To have mental capacity, the testator must have the ability to know (1) the nature/extent of the property, (2) the natural objects of their property, (3) the disposition that their will is making, and (4) the ability to connect all of these elements to form a coherent plan
- Necessary Formalities: The trust must meet any state requirements for formalities of a trust, such as the trust being in writing
- Identifiable Property: The trust property must be specifically identifiable, meaning there must be a sufficient description to know what property or assets are to be held in the trust
- 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 was designated to receive any property, assets, or funds from the trust during their lifetime
- They must demonstrate that the trust gives them the right to distribute trust property when they die
A marital deduction trust can take one of two forms: a life estate coupled with a general power of appointment or a Qualified Terminable Interest Property trust (a “QTIP trust”). (A life estate falls under the umbrella of property law and grants a person the use and ownership of a piece of real property for their lifetime.)
To give the surviving spouse the broadest possible use of the trust property, the trust-making spouse can give the surviving spouse a “general power of appointment” over the trust. This gives the surviving spouse the power to direct the trustee (often themselves) to distribute the trust property and assets. The power could be unlimited or limited to a specific dollar amount or a certain percentage of the trust.
In contrast to a general power of appointment, a QTIP trust restricts the surviving spouse’s power to decide who the final beneficiaries of the trust will be. This gives the first-to-die spouse complete control over who gets the property when the surviving spouse dies.
QTIP trusts are commonly used in cases where the spouses have children from previous marriages or in second-marriage cases to prevent the surviving spouse from excluding the first spouse’s children from the trust after the first spouse has died.
If a trust for marital deductions fails to meet all of the requirements above, a court will likely declare the trust invalid. In this case, the married couple cannot take advantage of federal tax deductions on the estate transfer.
What Else Should I Know about Trusts for Marital Deductions?
A surviving spouse’s interest under the marital deduction trust must be unconditional. This means that when creating a trust for the marital deduction, you cannot make provisions where benefits will cease if your spouse divorces you, gets remarried, or any other conditions.
As mentioned above, some marital deduction trusts permit the surviving spouse to designate beneficiaries, even after the trust’s creator has died. This means that the surviving spouse can choose who to leave the remaining trust property to without the input of the spouse who set up the marital trust.
This comes up in cases where each spouse has children from a previous marriage or other relationship. The surviving spouse can designate their own children as the sole recipients of the surviving estate and can exclude the testator’s children from the distribution of the remaining assets and property. A marital deduction trust may not be the best option in such cases.
Should I Hire an Attorney for Assistance with Marital Deductions?
As can be seen, creating a valid marital deduction trust can be a complex process. Thus, contacting a knowledgeable and well-qualified trust attorney in your area is in your best interests.
An experienced trust attorney can inform you if you qualify for a marital deduction trust and will ensure that your trust complies with federal and state tax requirements. Further, if a dispute arises over trust property, the attorney can represent you in court.