Less Taxing Matters

Avoiding estate tax pitfalls in marital deductions

Relying on the unlimited marital deduction to sidestep estate taxes is ultimately shortsighted Photo: google images

An old French proverb holds that providence watches over fools and drunkards.

In a similar manner, married San Francisco couples who never plan to avoid the estate tax are saved from their own folly by a tax provision known as the “unlimited marital deduction” – but providence’s protection is only temporary.

In a nutshell, the unlimited marital deduction allows any amount from the estate of the first spouse to pass to the surviving spouse without any estate tax. Unlike estate and gift tax exemptions, the marital deduction is unlimited in size. As a result, the surviving spouse is saved from his or her failure to plan ahead – but only temporarily, and at the cost of potentially paying significant estate taxes that could have been avoided.

As you may recall from last month’s column, the estates of those who die beginning Jan. 1, 2013 are subject to tax after an exclusion of just $1 million, versus the current $5.12 million. In a city like San Francisco, where a modest two-bedroom condominium can top $1 million and a small Marina District home can easily exceed $2 million in value, the new lower limits expose more individuals and couples to the estate tax.

This need to plan is seemingly at odds with our earlier discussion of the unlimited marital deduction. Recall, however, that the unlimited marital deduction offers only temporary – and therefore illusory – protection. Its two primary downsides are:

  • The deduction shields the first-passing spouse’s estate from the federal estate tax, but offers no protection for the estate of the second spouse.
  • The ability to shift unused tax exemptions from the estate of the first deceased to the estate of the second (known as portability) ends on Dec. 31, 2012.


An example will illuminate why relying on the unlimited marital deduction to sidestep taxes after the death of the first spouse is ultimately shortsighted.

Husband has an estate of $1 million, and Wife $2.5 million ($3.5 million total). The couple has done no estate planning beyond a joint will providing that the survivor receives all of the deceased’s property. Wife passes in 2013 and financial catastrophe ensues:

  • Some of Wife’s estate could be subject to probate fees of tens of thousands of dollars (when, as shown last month, maximum assets should have been placed into a living or other trust to side-step the cost and delay of probate).
  • Husband uses the unlimited marital deduction as a post-death maneuver to shield from estate tax the $2.5 million he receives from Wife.
  • However, if Husband should pass in 2014 or later (assuming no change to exemption rules and no restoration of portability), $2.5 million of his $3.5 million total estate will be exposed to the estate tax.
  • By comparison, proper planning via an “AB Disclaimer Trust” could have shielded all but $1.5 million of Husband and Wife’s combined estates from the estate tax.

Instead of delving into the details of the Disclaimer Trust, you need only know its results:

  • The survivor receives the income and (typically) limited rights to spend Trust A principal during the survivor’s life, with the property then shifting to final beneficiaries upon the second spouse’s passing. Importantly, Trust A is considered part of the first deceased spouse’s estate, eligible for the estate tax exemption applicable in that individual’s year of death.
  • Unlike a traditional AB Trust, an AB Disclaimer Trust does not require that the first deceased spouse’s property go into Trust A. The survivor is allowed to take or disclaim the first deceased’s assets. As a result, the document can be established decades in advance, with no foreknowledge of the estate tax exemption in effect when the first spouse passes, and with no need to predict future changes in the surviving spouse’s finances.

Most couples are comfortable with paying an attorney to prepare a complex document like an AB Disclaimer Trust. Choose a lawyer who will conduct a full review of your estate and create the plan that’s right for you, and consider one offering a free consultation and willing to work (when appropriate) on a fixed-fee basis.

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Attorney Andrew L. Jones concentrates his Pacific Heights practice in tax law, business law and estate planning. This article is intended to provide general information and should not be considered legal, tax or financial advice. Contact him at [email protected] or 415-745-1924.

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