How Married Couples Can Use the Clayton Election and Disclaimer Options to Reduce Federal Estate Taxes

Married couples with larger estates face uncertainty about the federal estate tax exemption when the second spouse dies. Currently, the 2024 federal estate tax exemption amount for an individual is $13.61 million. For married couples, the combined exemption amount is $27.22 million. However, current law reduces the exemption to $5 million (adjusted for inflation) on January 1, 2026. Married couples who use either a disclaimer option or the Clayton Election can help remove some uncertainty in estate planning and reduce their federal estate taxes.

What are Marital Deduction Funding Formulas?

The primary purpose of using a marital deduction funding formula is to maximize the advantages of:

1. The estate tax marital deduction
2. The estate tax exemption, with the goal of eliminating federal estate tax due when the first spouse dies and minimizing the federal estate tax due when the second spouse dies.

In addition to the strategies outlined, it’s essential to consider the annual gift tax exclusion for 2024, which is $18,000 per person or $36,000 for married couples who elect to split gifts. This exclusion provides an effective way to reduce a taxable estate incrementally over time, especially for high-net-worth couples seeking to maximize their estate planning options.

The Estate Tax Marital Deduction

Married couples who are both U.S. citizens and meet federal estate tax law requirements can transfer property and accounts from the spouse who has died to the surviving spouse. This transfer of property and accounts is excluded from the decedent spouse’s estate and is not subject to estate taxes upon their death. This marital estate tax deduction is unlimited. All estate taxes due on the decedent spouse’s estate are essentially postponed until the surviving spouse dies.

The Estate Tax Exemption

If the estate value is less than the current estate tax exemption threshold, no taxes are due. However, if the estate tax exemption is lowered and the estate value exceeds that amount, then a 40% tax (current value) is imposed on the estate’s value that exceeds the estate tax exemption cap.

Marital Share Funding Formulas

Marital share funding formulas utilize both the estate tax marital deduction and the estate tax exemption to reduce federal estate taxes to the lowest amount possible. Typically, these formulas divide the decedent spouse’s estate into two portions:

1. Marital share: this is part of the estate that passes from one spouse to the other in a form that allows it to qualify for the unlimited estate tax marital deduction
2. Nonmarital share: This is part of the estate that does not qualify under the unlimited estate tax marital deduction and is sheltered by the decedent spouse’s remaining estate tax exemption amount

Scenario 1 Without A Marital Share Funding Formula

Elliot and Jean are married U.S. citizens who own a combined $30 million estate. Elliot dies in 2024, and Jean dies in 2026.

• Upon Elliot’s death in 2024, his $15 million estate passes to Jean tax-free under the unlimited marital deduction.
• When Jean dies in 2026, her total estate is $30 million. However, the 2026 exemption amount is reduced to $5 million (adjusted for inflation).
• Jean’s estate is taxed at 40% on the amount exceeding the exemption: $30 million – $5 million = $25 million taxable estate. Jean’s estate owes $10 million in federal estate taxes.

Scenario 2 With a Marital Share Funding Formula

Elliot and Jean are married U.S. citizens who own a combined $30 million estate. Elliot dies in 2024, and Jean dies in 2026.

• Upon Elliot’s death in 2024, his $15 million estate passes to Jean tax-free under the unlimited marital deduction.
• When Jean dies in 2026, her total estate is $30 million. However, the 2026 exemption amount is reduced to $5 million (adjusted for inflation).
• Jean’s estate is taxed at 40% on the amount exceeding the exemption: $30 million – $5 million = $25 million taxable estate. Jean’s estate owes $10 million in federal estate taxes.

These scenarios assume static asset values, but in reality, asset growth between 2024 and 2026 could substantially affect the final estate value and tax liability. Including an assumption for potential appreciation, particularly for high-growth investments or real estate, would offer a more comprehensive picture of the potential tax burden.

Disclaimer Option

The disclaimer formula gives the surviving spouse the most flexibility. However, it is important to note that there are many ways to divide a couple’s trust property into marital and nonmarital shares. Using the disclaimer option, the trustee or executor will distribute all the decedent spouse’s trust property to their marital share. The surviving spouse then has the option of exercising a qualified disclaimer (refusing to accept ownership of money or property left to them by their deceased spouse) under Internal Revenue Code section 2518, and the trustee distributes any property that the surviving spouse does not claim to the nonmarital share.

The property that the surviving spouse does not claim can be held in a trust for their benefit or the benefit of other beneficiaries. The surviving spouse can choose to give any amount of property they want to the nonmarital share using the disclaimer option. They will make this decision based on the estate tax law in effect at the time, the value of the decedent spouse’s estate, and the surviving spouse’s financial needs.

Clayton Election

Based on the court case Estate of Clayton, Jr. v. Commissioner, the Clayton election is another way to divide property between the marital and nonmarital share. However, the Clayton election does so by making the opposite division of the disclaimer option. The decedent spouse’s trust property is distributed to the marital share instead of the nonmarital share by listing any property on Schedule M-Bequests, etc., to the Surviving Spouse (Marital Deduction) of the surviving spouse’s IRS Form 706 (the federal estate tax return).

Key Considerations for the Clayton Election

1. The disclaimer must be made within nine months after the decedent’s spouse’s death.
2. A Form 706 is not due until 15 months and sometimes 24 months after the first spouse’s death.
3. The Clayton election allows someone other than the surviving spouse to decide how the property should be divided into marital and nonmarital shares.
4. Because Form 706 is filed when using the Clayton election, there is the potential to use any unused amount of the decedent spouse’s estate tax exemption in the future.
5. The Clayton election defaults to putting the decedent spouse’s property into a nonmarital share trust, which can offer a greater degree of creditor protection.

How Portability Helps Couples Reduce Estate Taxes

Building upon the advantages of the unlimited marital deduction, portability serves as a crucial mechanism for minimizing estate taxes. While the marital deduction permits tax-free asset transfers between spouses, it may result in the surviving spouse possessing a substantial taxable estate, potentially subject to a 40% estate tax on amounts exceeding their lifetime exemption.

Portability mitigates this issue by allowing the surviving spouse to inherit the deceased spouse’s unused exemption, known as the Deceased Spousal Unused Exclusion (DSUE). By combining these exemptions, couples can enhance their estate tax protection, effectively shielding up to $27.22 million from estate taxes in 2024. This approach ensures the full utilization of both exemptions, offering significant tax savings for high-net-worth couples.

For instance, if a spouse had utilized $5 million of their exemption prior to passing, the surviving spouse could add the remaining $8.61 million to their own exemption, resulting in a total exemption of $22.22 million. This strategy underscores the importance of timely estate planning to maximize available tax benefits.

it is important to consider potential changes to tax laws before 2026, as these could significantly impact the projected reduction in the estate tax exemption. Individuals who utilize the federal estate and gift tax exemption between January 1, 2018, and December 31, 2025, can do so with confidence, as there will be no “clawback” of the increased exemption amount used. This stability allows taxpayers to maximize the higher exemption limits during this period without fear of retroactive tax implications, ensuring greater predictability in long-term planning.

Contact an Estate Planning Lawyer Near You

How best to use these formulas requires analyzing your estate, your estate planning goals, and the law. Contact us to discuss your estate planning options. You can schedule a call with us or reach us directly at 855.631.3457 to learn more about how best to plan today to protect those most important to you.