CHAPTER TEN
Transfers to/for a Spouse

Objective:  Transfer to a spouse to enable her

to have financial support during the

survivorship period from the entire marital

estate (without dilution for federal estate tax).

If the federal estate tax applies ($5.250 mil.+) to

the estate of first spouse to die: 

• how transfer to spouse to possibly avoid estate tax at death of first spouse to die; 

• treatment at subsequent death (or gift) of surviving spouse?  Only tax postponement?

Who is a Surviving Spouse?                       p.3

Does a surviving spouse include a “common law” spouse? How define a “common law” spouse?  Remember the Bosch Case re state law relevance? State law as determinative?

Rev. Rul. 76-155, p.3, where 3/40ths of the estate received by person arguing spousal status – not spousal status for estate tax purposes.

Consider “civil unions,” same-sex marriages, and DOMA, §3,  & the marital deduction. 

Windsor case (p.6) – SCOTUS – 2013    

Determining the Net Marital Deduction Amount

Code §2056(b)(4)(A) concerns the reduction of marital deduction by any burden of estate tax.

Estate of McCoy, p. 6, “equitable apportionment”, i.e., applicable only to those assets producing an estate tax liability?  But, contrary tax allocation instructions in the trust agreement?  Note:  assets both in probate estate and trust estate.

Held:  no apportionment to the MD portion.

See Texas Probate Code, §322A (Ch. 3).

Determining MD Amount – Administration Expenses

Code §2056(b)(4)(B) re reduction of marital deduction by burden of debts.

Estate of Hubert, p. 15:   no reduction for administration expenses paid from estate income.  Only “material limitations” on the income right are noted in determining (reducing) the value of interest passing to surviving spouse.  

Note subsequent regulations (p.17) – estate transmission expenses reduce MD transfer.

Cf., estate management expenses (not reducing the MD amount); e.g., investment advisor costs.

Subsequent inclusion in surviving spouse’s estate

Premise that marital deduction only permits deferral until surviving spouse’s death – unless the surviving spouse spends or gives away the property during her survival period.

How much estate tax exclusion for the surviving spouse?  Start with the statutory exclusion - $5.250 million for 2013.

What if the first spouse did not use all of his exclusion?  Portability of the unused portion to the surviving spouse.  See Code §2010(c)(2)(B) re “deceased spousal unused exclusion amount.”

Next slide

DSUEA described;
See 2010 Tax Act, §303(a)

Code §2010(c)(4) identifies DSUEA as lesser of:

1) Basic exclusion amount, or

2) Deceased spouse’s exclusion amount less the

exclusion used by the estate of deceased spouse.

Example:  Husband dies in 2013 & makes

taxable transfers of $3 million & no taxable

estate. At wife’s subsequent death:  her $5

million exclusion and his unused exclusion of

$2.25 million equals $7.25 million available.

continued

Conditions for using the DSUEA

Deceased spouse’s estate files estate tax return & election for amount that may be claimed by surviving spouse.

Tax basis step-up will be available to estate of surviving spouse;  cf., credit shelter trust where no basis step-up but protection from post-death appreciation being included in estate of spouse.

DSUEA from 1^st spouse disappears if remarriage by surviving spouse.

Options for Transfers to Surviving Spouse

See Code §2056(c)  concerning property transfer mechanics:

1) Bequest or devise to spouse

2) Inheritance

3) Joint tenancy & surviving spouse

4) General power of appointment to spouse

5) Life insurance proceeds to beneficiary spouse.

6)  P/A and QTIP trusts – §2056(b)(5)&(7).

The “Terminable Interest” Rule                            p.20

Code §2056(b)(1)(A) disallows marital deduction for “nondeductible” terminable interest, e.g., to “wife for life, remainder to children.”

Exceptions: Code §2056(b)(5) – life estate & general P/A; (6) life insurance; (7) QTIP; and (8) CRT.

Also, the “estate trust” option (where assets into probate estate of surviving spouse).

The “Six Months Survival Condition”

Code §2056(b)(3) – exception to the terminable interest rule:  where (1) the interest is conditioned on spouse survival for six months, and (2) the event of non-survival does not occur.

Purpose of this rule (under state law)?

Heim, p. 21 – California statute restricting “survival until estate distribution.”

No “savings clause” availability here (Cal Prob. Code § 1036) – since no MD gift intent (p.27).

Correct?  How present evidence here?

Life Estate – Power of Appointment Trust     p.29

Code §2056(b)(5) –

1)   All income for life, payable at least annually (& not limited by a standard);

• Payable to spouse only;

• General power of appointment to the surviving spouse or that spouse’s estate. Causes inclusion when she dies.

• No other person has any powers over the disposition of the trust property.

This structure enables the MD at his death.  

Code §2056(b)(5)
“Right to Income”       p.29

Is an income payment delay permissible during a reasonable probate administration period?

What if unproductive property (e.g., raw land or non-dividend stock) is held by the trust for the surviving spouse?

What if the property held by the trust for the spouse is a personal residence?

See Rev. Rul. 69-56, p. 31 – re fiduciary powers over receipts and disbursements (although net income annually to spouse requirement).

The “Specific Portion” Limitation                   p.35

Code §2056(b)(5) provides for distribution of income from all “or a specific portion.”

Northeastern Pennsylvania Bank, p.35

Can the fair market value of a $300 per month payment be quantified? 

How much is includible in the surviving spouse’s subsequent gross estate? 

See Code §2056(b)(10) – only fractional or percentage basis gifts are MD eligible. Why?

The §2056(b)(5) Power of Appointment Requirement

P.  40.  For marital deduction eligibility the surviving spouse must have a general P/A (intervivos or testamentary). 

Why pick a power only exercisable at the death of the powerholder?  What income tax effect if holding an intervivos P/A? – See Code §678.

Provide a special P/A during life and a general P/A exercisable at death?  What structure for exercising the power at the time of death?  Include a “default clause”?

QTIP Arrangements
Code §2056(b)(7)        p.42

Requirements for MD eligibility under this alternative:

• Property passes from decedent.

2)   Surviving spouse has a qualifying income interest for life.

• A “QTIP” election is made.  This election causes the subsequent inclusion of the MD trusts assets in the surviving spouse’s gross estate at her subsequent death - Code §2044.

QTIP Income Distribution Requirements        p.42-3

Required current income distributions - no power to accumulate income in the trust.

No power to another to appoint the property away from the surviving spouse.

No discretion permitted concerning income distributions, e.g., “accustomed manner of living.”  No “ascertainable standard” can be applicable to income distributions.

QTIP Trust as IRA Beneficiary                 p.43

Purpose of an IRA:  income deferral;  subject to the “minimum distribution” rules.

Purpose of the marital deduction:  current income distribution required for QTIP.

What happens if the entire IRA is distributed to the MD trust?  Liquidate the IRA (into trust)?

Rev. Rul. 2006-26, p. 43, query re status of  the “qualifying income interest.”   next slide

Rev. Rul. 2006-26, p.43

Does the distribution provision satisfy the QTIP spousal income requirement?

• Adjustments are permitted re income and principal under Uniform P&I Act for determining income amount.

• Unitrust income determination

• State law “traditional” definition of income

Spouse needs authority to access all the IRA income.

The “Stub Period” Income Problem                      p.50

Example:  All income was distributed for the prior year on Jan 2.  Spouse dies on Jan. 10.  QTIP trust provision states that all Jan. 2-10 income is to go to remainder beneficiary. Why?

Estate of Rose Howard, p.50 – did the spouse have a “qualifying income interest” for life?  How solve this issue in the planning context?

Does a “duty of consistency” apply? What is a “duty of consistency”?  Is the problem solved by the Treasury regulations?

Marital Deduction for a Texas Homestead?    p.55

Kyle case, p. 55 - MD eligibility for 25% of the residual share of estate received in an exchange for her surrender of Texas homestead rights?

Is the “homestead right” less than a “life estate”?  See Texas Constitution re the status of the homestead right – must continue to use as the homestead; cannot abandon; the homestead right is “personal.”  P.60

Is the will “rewritten” in the will contest settlement process?  p.62. 

Was a QTIP election essential here?

Post-death QTIP Election Flexibility                   p.62

Clayton case, p. 63 – MD & “by-pass” trusts.

What is the effect of an executor’s authority to make a QTIP election as to distribution of some or all of the property in an estate settlement?

Was this authority a “power of appointment” which negates QTIP eligibility?  No, p. 78.

Held:  MD was available for the elected portion - .563731 of the securities as funded into the “B” (QTIP) trust.

Response to the Clayton case                            p.80

Reg. §20.2056(b)-7(h), Example 6 – provides that, where executor can elect portion of a trust as QTIP, the executor is not considered to have a power to appoint property to another person.

Therefore, QTIP eligibility exists for the property transferred into trust for the spouse.

Protecting Against Drafting Errors            p.81

Include a “savings clause”?  What effect of a “generic statement of intent”?

What if merely providing in the will (or revocable trust agreement) that a trust is to be established consistent with the statutory requirements of the QTIP provisions?

Tax Effects at Death of  Surviving Spouse        p.81

1)  Inclusion of the QTIP trust assets in the gross estate of the surviving spouse – Code §2044.

• Where is the estate tax payment to be sourced from?  P. 81.  How is the estate tax amount attributable to the included QTIP assets determined? See Code §2207A. Note the “stacking,” not proportional, approach to making this determination. Waive this reimbursement?

Make a protective QTIP election?                     p.83

Should the QTIP election be made?  

The election is irrevocable.

Consider: Risk of the surviving spouse dying shortly after the QTIP election (Howard case)?

Is a “protective election” available?  Only if a bona fide issue exists; and, the protective election is irrevocable.

Limited protection:  delay filing estate tax return for 1^st spouse’s estate until time limit.

Disposition of Qualifying Income Interest       p.83

Code §2519 specifies that the disposition of any part of the income interest is treated as a gift transfer of all interests in the QTIP property – except the qualifying income interest transfer (§2511 applies here).

What is the  purpose of this rule?

How collect the gift tax owing in this situation? See §2207A(b) (a gift tax provision in an estate tax statute).

Spouse Buys Remainder Interest    p.83

Possible option to subvert IRC §2519?

What if the remainder interest is terminated?  See Rev. Rul. 98-8 (p.83) concerning a transaction for consideration? Is §2519 still applicable?  Yes,  in substance a “commutation” has occurred here, treated as a sale/disposition for §2519 purposes.

What is a “commutation”?

Here:  Gift is made of the value of the remainder interest & §2519 applies.

Determining the Amount of Gift On Transfer     p.86

Gift amount is reduced by the recoverable gift tax (§2207A(b)).  An interrelated computation is necessary.

What if the spouse pays the gift tax (rather than seeking reimbursement from trust)?  A further gift is made (in amount of foregone gift tax)?

See Morgens case (p.87) re inclusion under §2035(b) for the gift tax paid by the recipients of the QTIP remainder.

Disclaimer Trusts
p.87

Assume the assets will be included in a QTIP trust unless the surviving spouse elects to reject (i.e., disclaim) the QTIP benefits.  The assets would (if a disclaimer is made) then go to a non-qualifying trust, e.g., a transfer exposed to estate tax at the 1st death (but subject to unified credit availability). Cf., Clayton case.

This technique was used as “patchwork” during 2010 until estate tax was restored.

What is the probability of the widow’s disclaimer?

Charitable Remainder Trusts                        p.88

Code §2056(b)(8) provides for a qualified charitable remainder trust. 

Useful where (1) a surviving spouse and (2) no surviving children/grandchildren.

See §664 re CRAT or CRUT details.

What if a QTIP trust and the “remainder to charity” (i.e., not satisfying the §2056(b)(8) requirements, but §2056(b)(7) & election made) – inclusion in the surviving spouse’s estate, but a charitable deduction later?

The “Estate Trust”
p.85

No QTIP qualification – because no required income distribution.  Why structure a trust with no mandated income distribution? Why limit the spouse’s current income?

But the income tax rate for the trust is higher.

What if the assets are distributable to the spouse’s probate estate at her death?

Additional probate costs when she dies. And what happens to these assets under her will?

Note Rev. Rul. 75-128, p. 89, only an undefined part is includible in the probate estate and no “estate trust” eligibility (since a P/Appt). 

Correct result here?

Marital Deduction Formula Clauses         p.90

What is the objective of the MD formula clause?

Assume unified credit = $5.25 million (2013).

• Assume the total value of the combined estates is less than $5.25 million.

• Assume the total value of the combined estates is $5.25-10.50 million.

• Assume the total value of the combined estates is in excess of $10.5 million.

What happens if community property?

What if the unified credit amount changes?

Using an Equalization Formula                   p.93

Alternative considerations:

• Balance the two estates for two “runs up the bracket ladder” for estate tax – but how much progressivity exists at the top bracket (after the unified credit)?

• Cf., “time value of money” for the deferred estate tax – but what if a low interest rate/investment return during the estate tax deferral period?

Note Smith case (p. 93) and Howard (earlier).

Allocation to the Residuary Estate        p.93

Who should be the beneficiary of  the

“residuary estate”?

Choices for this distribution:

• “Credit shelter” trust assets

• Marital deduction trusts assets

What are the considerations for making this

choice concerning the recipient of the residuary

estate?  The larger portion?

Using a Formula Approach
to Allocate                  p.93

Objective in using a formula approach?

- (1) Provide for a zero tax at the death of first spouse, but (2) fully utilize the unified credit.

-  Must account for other transfers outside the primary marital deduction gift transfer (e.g., prior gifts and specific bequests reducing the remaining unified credit amount).

- How implement when the unified credit is a changing amount (or uncertain)?

Correcting An Erroneous Formula Approach      p.95

Rev. Proc. 2001-38 - An unnecessary (irrevocable) QTIP election – when the estate tax liability is not reduced.    E.g., (1) taxable estate (before the MD) is less than the exclusion amount (i.e., no estate tax  would be imposed).  Or, (2) an unnecessary QTIP election made for credit shelter trust. Election is “null and void.”

Election is not “null & void” where a partial QTIP election is necessary for tax protection.

Effect of treatment as invalid: no subsequent §2044 or §2519 inclusion (relevant for the surviving spouse’s subsequent estate).

Funding Marital and Non-Marital Gifts              p.97

Which assets should be picked to fund:

                     (1) the MD trust, and

                     (2) the credit shelter/family trust?

Wasting assets, e.g., depreciating property?

High-income, low appreciation property?

Fixed dollar obligations?

High appreciation potential assets?

Funding the Pecuniary Formula Gift                p.97

Estate tax qualification considerations:

Rev. Proc. 64-19, p. 98;  Objective:  gift must be funded at date of distribution values – either (1) “no less than” amount of pecuniary bequest or (2) “fairly representative” of appreciation or depreciation of the estate assets.

Not relevant to (1) fractional share, (2) specific bequest; (3) cash bequest; or, (4) no discretion re assets in kind.

What is the objective of this Rev.  Proc.?

See TX Probate Code, §378 (rescue provision).

Revenue Procedure 90-3
p.100

Pecuniary bequest to child and payment on basis of FMV at the time of the distribution. 

The residuary bequest to surviving spouse (after fulfilling the pecuniary bequest) may be significantly diminished by an asset value decline for the entire estate.

Held:  the residuary bequest is not a nondeductible “terminable interest.”

Funding the Fractional Share Bequest          p.102

How distribute fractional (or percentage) interests in each property?  Remember the % interest in the Clayton case.

What if a fractional share interest in a property is distributed to one party and not to another at the same time?  How adjust the fractional share formula for future distributions to the beneficiaries?

Income Tax Issues When Funding Bequests     p.103

E.g., transfer of an appreciated asset to satisfy an obligation on executor to distribute a “pecuniary amount” from the estate.

Is the accrued gain in the distributed asset to be recognized for FIT purposes?

Cf., any FIT gain recognition treatment when the distribution of appreciated property is made to satisfy a factional share bequest?  What if the shares in each distributed asset are not proportionate?

What treatment of any “DNI” distribution? If a DNI distribution, what is the income tax basis for the distributed asset?  See §643(e).

Transfer to Non-Citizen Spouse?              P.103

No marital deduction for an estate transfer to a non-citizen spouse (whether on not U.S. resident).  Solve with a QDT (qualified domestic trust) - enabling marital deduction but later estate tax inclusion at the death of the surviving spouse. 

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