Protecting Your Marital Deduction

Lifetime gifts between a husband and wife, as well as spouse to spouse bequests upon death, will pass to the spouse without liability for estate tax or gift tax. This unlimited deduction on gifts between spouses is known as the marital deduction. 26 USC §2056. But there are exceptions to the marital deduction that you must discuss with your financial planner and estate planning counsel.

For example, a life estate does not qualify for the marital deduction. 26 USC §2523. The same section of the Internal Revenue Code also says that there is no marital deduction "where, on the lapse of time, on the occurrence of an event or contingency, or on the failure of an event or contingency to occur, an interest passing to the surviving spouse will terminate or fail."

Estate and gift taxes are not the only issues. Income taxes must also be considered when you are thinking about transferring assets between spouses. Only one-half the value of qualified spousal property held as "joint tenants" or "tenants by the entirety" gets a step up in basis, when the interest passes to a surviving spouse upon death, and the deceased spouse was the only other joint owner. This rule, giving a step up in basis to 50% of the qualified jointly owned property, applies to spousal joint interests created after 1976. 26 USC §2040(b).

We can help protect your marital deduction, and protect your spouse from unexpected tax liability, with a comprehensive estate plan that includes a marital trust.