Marital Deduction Planning

The unlimited marital deduction is one of the most powerful tools in estate planning. Under IRC Section 2056, a decedent can pass an unlimited amount of property to a surviving spouse without incurring federal estate tax. However, this deduction does not eliminate estate tax--it merely defers the tax until the second spouse's death.

The Unlimited Marital Deduction: How It Works

Requirements for the Marital Deduction

To qualify for the unlimited marital deduction, the following requirements must be met:

1. Legal Marriage: The decedent and surviving spouse must be legally married at the time of death
2. U.S. Citizen Spouse: The surviving spouse must be a U.S. citizen (or assets must pass to a Qualified Domestic Trust--QDOT)
3. Property Must Pass to Spouse: The property must actually pass from the decedent to the surviving spouse
4. Property Must Be Includible: The property must be included in the decedent's gross estate

Tax Deferral, Not Tax Elimination

The marital deduction does NOT eliminate estate taxes--it defers them. When property passes to the surviving spouse tax-free, it becomes part of the surviving spouse's estate and may be subject to estate tax when the surviving spouse dies.

Example: Harold dies with a $20 million estate. He leaves everything to his wife, Grace. Harold's estate pays zero estate tax due to the unlimited marital deduction. However, when Grace dies, her estate (which now includes Harold's $20 million plus any appreciation) may face significant estate tax if it exceeds the applicable exclusion amount.

The Terminable Interest Rule

The marital deduction is subject to the terminable interest rule under IRC Section 2056(b). A terminable interest is one that will terminate or fail upon the passage of time or the occurrence of an event.

General Rule

No marital deduction is allowed for terminable interests where:

• An interest passes to the surviving spouse that will terminate upon the occurrence of an event or passage of time
• After termination, the interest passes to someone other than the surviving spouse (or the spouse's estate)
• That other person received the interest for less than adequate consideration

Why the Rule Exists: The purpose is to prevent situations where property qualifies for the marital deduction but is not actually included in the surviving spouse's estate at the second death.

Exceptions to the Terminable Interest Rule

Several important exceptions allow terminable interests to qualify for the marital deduction:

1. Six-Month Survival Contingency

A provision requiring the spouse to survive for up to six months qualifies if:

• The survival period does not exceed 6 months
• The spouse actually survives the required period
• The condition is not contingent upon any event other than the spouse's death

2. General Power of Appointment (GPOA) Trust

Property qualifies if the spouse has:

• The right to all income, payable at least annually
• A general power of appointment exercisable in favor of the spouse or the spouse's estate
• No other person may have a power to appoint property to anyone other than the spouse

3. Qualified Terminable Interest Property (QTIP)

A QTIP trust qualifies if:

• The spouse receives all income for life, paid at least annually
• No person may appoint property to anyone other than the spouse during the spouse's lifetime
• The executor makes a QTIP election on Form 706 (covered in detail in G.60.1)

4. Charitable Remainder Trust with Spouse as Only Non-Charitable Beneficiary

A CRT qualifies for the marital deduction if the surviving spouse is the only non-charitable beneficiary for life.

Credit Shelter (Bypass) Trust Planning

A credit shelter trust (also called a bypass trust, B trust, or family trust) is designed to use the first spouse's applicable exclusion amount ($13.99 million in 2025; $15 million in 2026) to shelter assets from estate tax at both deaths.

How the Credit Shelter Trust Works

Upon the first spouse's death:

1. Assets equal to the unused exclusion amount fund the credit shelter trust
2. The surviving spouse may receive income and principal for health, education, maintenance, and support (HEMS standard)
3. Assets in the trust are excluded from the surviving spouse's gross estate
4. The trust passes to children or other remainder beneficiaries at the surviving spouse's death

Benefits of Credit Shelter Trusts

A-B Trust Structure

The A-B trust is the classic estate planning structure for married couples:

Trust A (Marital Trust)

• Funded with assets in excess of the applicable exclusion amount
• Qualifies for the unlimited marital deduction
• Included in surviving spouse's gross estate at second death
• Surviving spouse typically has broad powers

Trust B (Credit Shelter/Bypass Trust)

• Funded with assets up to the applicable exclusion amount
• Does NOT qualify for marital deduction (uses deceased spouse's exemption)
• Excluded from surviving spouse's gross estate
• Surviving spouse has limited access (typically HEMS standard)

A-B Trust Diagram

A-B-C Trust Structure

The A-B-C structure adds a QTIP trust for additional flexibility:

Advantages of A-B-C Structure:

• QTIP election provides postmortem flexibility
• Executor can determine optimal split based on values at death
• Useful when first spouse cannot predict estate tax law at second death

Qualified Domestic Trust (QDOT)

When the surviving spouse is not a U.S. citizen, the unlimited marital deduction is NOT available unless property passes to a Qualified Domestic Trust (QDOT).

QDOT Requirements (IRC Section 2056A)

1. U.S. Trustee Required: At least one trustee must be a U.S. citizen or domestic corporation
2. Bank Trustee for Large Estates: If QDOT assets exceed $2 million, a U.S. bank must serve as trustee (or bond/letter of credit required)
3. Estate Tax on Distributions: Principal distributions are subject to estate tax as if included in the first spouse's estate
4. Income Exception: Income distributions are not subject to estate tax (but are subject to income tax)
5. Hardship Exception: Limited hardship distributions may be allowed without immediate tax
6. Election Required: QDOT election must be made on Form 706

QDOT Tax Treatment

Non-Citizen Spouse Annual Gift Exclusion

For lifetime transfers, there is a special annual gift tax exclusion for gifts to non-citizen spouses: $190,000 in 2025 (indexed for inflation).

Planning Considerations

When to Use Maximum Marital Deduction

• Surviving spouse's estate will be below the exemption amount
• Portability election will be made
• Step-up in basis on all assets is desired at second death

When to Limit Marital Deduction (Use Credit Shelter Trust)

• Combined estates exceed exemption amounts
• State estate tax does not recognize portability
• Blended family requires asset protection for children
• GST planning is desired (GST exemption not portable)
• Concern about surviving spouse's creditors or future marriages