Section 2056 of the Internal Revenue Code ("IRC") provides for what is commonly known as the "marital deduction." The idea of the deduction is simple: a spouse should be able to pass his or estate- the property and assets that he or she has at the time of his or her death - to the surviving spouse without the property being taxed.
In keeping with that idea, the federal tax laws allow spouses to take advantage of the estate tax break by creating a "marital deduction trust" ("marital trust") during their lifetimes. When properly drafted, such a trust will shield the assets of both spouse's from federal estate taxes when they die, as opposed to protecting only the deceased spouse's estate through the § 2056 deduction.
There are several requirements that must be met in order for a marital trust to be valid. If you're considering a marital deduction trust, be certain to read the federal tax laws carefully, or seek the advice of attorney who is experienced tax or estate planning.
Making a Valid Marital Trust
For a trust to qualify for the marital deduction, the surviving spouse:
- Must be the only beneficiary of the trust during her lifetime, that is, he or she is the only person who receives any money or property from the trust for as long as he or she lives, and
- Must be given either the unrestricted power to give away the trust assets when he or she dies, or
- All of income that trust makes must be given to the survivor spouse at least annually during her lifetime, with the trust specifying who gets the trust assets when the surviving spouse dies. This called a "QTIP" or qualified terminable interest property trust. This is the most commonly used marital trust.
As with other types of trusts, a marital deduction trust is not valid unless:
- It names one or more "trustees," who are responsible for giving the surviving spouse (the "beneficiary" of the trust) the property or assets being held by the trust, and
- Specifies what property or assets are to be held by the trust, for example, a certain amount of money, stocks and bonds, or the settlor's spouse's "entire estate"
Effect of the Trust
Essentially, the trust shields both spouse's assets and estates from federal estate taxes. How? When the first spouse dies, the assets specified by the settlor-spouse pass to the marital trust pass free and clear of all federal estate taxes -- neither the settlor-spouse nor the surviving spouse pay estate taxes on that property. When the surviving spouse dies, the assets in the trust are not included as part of her estate, and so his or her federal estate taxes are not as high as they would have been if there had been no trust.
During the surviving spouse's lifetime, the property or assets in the trust "trust principal" (or "trust res") are intended to generate income. That income is then distributed to the trust's beneficiaries, with the principal remaining intact and continually generating income.
The QTIP Trust
The QTIP trust is frequently used in the case of second marriages where one or both spouses have children from a previous marriage and the settlor-spouse wants to provide for the new spouse but also wants to be certain that his or her children will receive the trust assets on the surviving spouse's death. Here, the trust will usually provide that when the surviving spouse dies, whatever is left over in the marital trust is to pass to settlor-spouse's children, or to anyone else the settlor-spouse wants to name, like his or grandchildren, for example.
Important: QTIP trust can't authorize distributions to anyone other than the surviving spouse during his her lifetime. So, the trustee can't pay money from the trust to the spouses' children, for example.
Special Marital Trust Provisions
Often, neither spouse has been married before and the settlor-spouse wants the surviving spouse to have easy access to trust principal, rather than just the income that the trust generates, during his or her lifetime. There are a number of ways to accomplish this. One would be to give the trustee the power to make distributions of principal to the surviving spouse. That is, the trustee might be given the power to make an extra distribution of money to the surviving spouse if some special need or circumstance arises, such as unexpected medical costs that the surviving spouse cannot afford to pay immediately.
Another way to provide access to principal of the marital trust would be to give the spouse the power to simply direct the trustee to make a principal distribution to her. This is called a "general power of appointment," and the power could be limited to a certain annual amount (e.g., $5,000 or 5 percent of the total, whichever is greater) or it could be unlimited.
The surviving spouse's interest or benefits under the marital trust must be unconditional. That is, you cannot provide that benefits will cease if she remarries, or moves out of state, or fails to take care of the children or your elderly parent. You can, however, limit the time in which the surviving spouse can qualify for benefits under the trust, which can't exceed 6 months.
For example, the trust can contain language such as: "If my wife survives me for at least 6 months, the marital deduction trust will be valid and effective."
Get Help From an Attorney
Marital deduction trusts must be precise, and the law is complicated. See an experienced lawyer to get a well-drafted trust that meets the needs of your individual circumstances.
Questions for Your Attorney
- How much money or property should I leave in a marital deduction trust?
- Can my children challenge a marital trust that I make in favor of my second wife?
- Can my spouse and I make a joint marital deduction trust that includes our separate property?