Understanding the Marital Deduction

Creating a successful estate plan requires you to do more than just decide how you want your estate assets to be distributed. You also need to protect those assets while you are alive as well as protect your estate after you are gone. For example, understanding how federal gift and estate taxes will impact your estate is crucial. To do that, you need to understand the marital deduction. To help you, an Oklahoma City estate planning attorney at Parman & Easterday explains how the marital deduction works.

Federal Gift and Estate Taxes

All estates are potentially subject to federal gift and estate taxes. The tax is levied on the combined total of the value of all qualifying gifts made during a decedent’s lifetime and the value of all estate assets owned at the time of death. Although the federal gift and estate tax rate was once subject to change on a yearly basis, the American Taxpayer Relief Act of 2012 (ATRA) permanently set the tax rate at 40 percent. Without any additional deductions or considerations, that means a taxpayer could lose almost half of his/her estate to taxes!

Fortunately, every taxpayer is also entitled to make use of the lifetime exemption which is essentially a deduction taken prior to calculating the tax. Like the tax rate, the lifetime exemption limit was also subject to change – and did change – on a regular basis prior to the passage of ATRA. In 2012, ATRA set the lifetime exemption limit at $5 million, to be adjusted annually for inflation. President Trump, however, signed tax legislation into law that changed the lifetime exemption amount for 2018 and for several years thereafter. Under the new law, the exemption amounts increased to $11.58 million for individuals and $23.16 million for married couples for 2020. These exemption amounts are scheduled to increase with inflation each year until 2025. On January 1, 2026, the exemption amounts are scheduled to revert to the 2017 levels, adjusted for inflation, or somewhat more than $5 million.

What Is the Marital Deduction?

Certain gifts are always exempt from the gift and estate tax, including gifts to a spouse. Consequently, if you are married at the time of your death, any assets gifted to your spouse at that time are tax-exempt as far as the gift and estate tax is concerned. Moreover, there is no limit to the marital deduction. While this sounds like the solution to all your tax problems, relying heavily on the marital deduction often results in over-funding a surviving spouse’s estate. 

In reality, using the marital deduction may only delay the payment of federal gift and estate taxes instead of actually avoiding them. If your spouse passed away and left an estate valued at $15 million, even with the increased lifetime exemption amount for 2020, over $3 million would be subject to estate taxes. Those assets could be gifted to you tax-free, but would in turn increase your taxable estate by over $3 million. If the assets you already own were of equal value to those owned by your spouse, your $15 million estate is now worth over $18 million. While you are also entitled to make use of the lifetime exemption, your estate would still owe federal gift and estate taxes on over $6 million. At a tax rate of 40 percent, your estate would hand over $2.4 million to Uncle Sam that could have been handed down to loved ones.

While the marital deduction is a useful tool when proper estate planning was not done prior to the decedent’s death, it usually is not the best way to avoid taxes. Instead, incorporating tax avoidance strategies into your estate plan long before your death can result in handing down a much larger and more valuable estate to your loved ones.

Contact an Oklahoma City Estate Planning Attorney

For additional information, please join us for an upcoming FREE seminar. If you have additional questions or concerns about the marital deduction, contact an experienced Oklahoma City estate planning attorney at Parman & Easterday by calling 405-843-6100 to schedule your appointment today.