Gabriel Katzner - August 1, 2022 - Asset Protection
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Married couples with larger estates face uncertainty about the federal estate tax exemption when the second spouse dies.

Currently, the 2022 exemption amount for an individual is $12.06 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 a goal of eliminating the federal estate tax due when the first spouse dies and minimizing the federal estate tax due when the second spouse dies

The Estate Tax Marital Deduction

Married couples who are both US citizens and who meet the federal estates’ taxes 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 the 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 the 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 and both US citizens. They each own half of their $25 million estate. Elliot died in 2022 and Jean in 2026.

Elliot’s estate tax exemption cap is $12.06 million, and Jean’s is only $5 million. According to their estate plan, everything they owned was passed to Jean upon Elliot’s death. After Jean’s death, their estate passes to their four children.

When Elliot died, his $12.5 million estate passed to Jean tax-free under the unlimited estate tax marital deduction.

When Jean dies, she only has a $5 million exemption amount to cover the couple’s $25 million estate.

Applying the 40% estate tax rate to the other $20 million, $8 million is due in estate taxes.

Scenario 2 With a Marital Share Funding Formula

What if Elliot’s share of the couple’s estate was divided into marital and nonmarital shares?

Upon Elliot’s death

  1. $12.06 million is put in the nonmarital share
  2. $440,000 is put in the marital share

When Jean dies in 2026, her estate is valued at $12,940,000, of which $5 million will be protected under her estate tax exemption. Applying the 40% estate tax to the other $7,940,000, her estate will owe $3,176,000 in estate taxes, saving her children from paying $4,824,000 in estate taxes.

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 for 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 Surviving Spouse (Marital Deduction) of the surviving spouse’s IRS Form 705 (the federal estate tax return).

The technical requirements and timeline are less rigid for the Clayton election than for the disclaimer option.

  1. The disclaimer must be made within nine months after the decedent 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 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.


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