2006 Supplement
8
1
Brief History Of The Estate Tax And The Marital Deduction
§1.1 HISTORICAL BACKGROUND OF THE FEDERAL ESTATE TAX AND THE MARITAL
DEDUCTION 1
Before the adoption of the Federal Estate Tax in 1916, federal death taxes in the United States were
imposed and repealed three times, primarily due to wars or the threat of war. The first federal death tax
was imposed from 1797 until 1802 as a stamp tax on inventories of deceased persons, receipts of
legacies, shares of personal estates, probates of wills, and letters of administration. It was designed to
pay for the development of strong naval forces felt necessary because of strained trade relations with
France. Act of July 6, 1797, 1 Stat. 527. After repeal of the Stamp Tax (Act of Apr. 6, 1802, 2 Stat.
148), there were no death taxes imposed by the United States until the Civil War, when the government
imposed an inheritance tax between 1862 and 1870. Act of July 1, 1862, 12 Stat. 432, 483; Act of July
14, 1870, 16 Stat. 256. To finance the Spanish-American War, the United States imposed its first estate
tax in 1898, which remained in effect until its repeal in 1902. War Revenue Act of 1898, 30 Stat. 448,
464 (June 13, 1898).
The commencement of World War I caused revenues from tariffs to fall. In 1916 the United States
adopted a progressive estate tax on all property owned by a decedent at his or her death, certain lifetime
transfers that were made for less than full and adequate consideration (this rule is contained in IRC
section 2043), transfers not intended to take effect until death (this rule is contained in IRC section
2037), and transfers made in contemplation of death. Act of September 8, 1916, 39 Stat. 756. The 1916
estate tax provided an exemption (in the form of a deduction) of $50,000, with estate tax rates ranging
from one percent on the first $50,000 of transferred assets to 10 percent on transferred assets in excess
of $5 million. In 1917, the revenue needs from World War I resulted in increases in estate tax rates, with
a top rate of 25 percent on transferred assets in excess of $10 million. Act of March 3, 1917, 39 Stat.
1000. In 2001 the estate tax was repealed once again (along with the GST tax), but this time only for a
period of one year (January 1 – December 31, 2010) due to budget constraints and political factors. The
repeal was subject to a sunset provision and an automatic reinstatement of the estate tax and GST tax
beginning January 1, 2011. The Economic Growth and Tax Relief Reconciliation Act of 2001, Pub. L.
No. 107-16, 115 Stat. 38 (the “2001 Tax Act”).
From 1916 until 1942, the federal estate tax burden imposed on residents of common law
jurisdictions was more onerous than that imposed on residents of community property jurisdictions. The
community property system operated to give income, gift, and estate tax advantages to couples residing
in community property states. If, for example, a spouse living in a common law state died leaving a $1
million estate accumulated from his or her earnings, the entire $1 million was includable in that
decedent’s estate. If a counterpart in a community property state died leaving a $1 million estate
accumulated from community property earnings, only the decedent’s half of the community estate, or
$500,000, was includable in his or her gross estate. The decedent’s surviving spouse ultimately was
taxable on his or her one-half share of the community property at his or her death, but taxation was
deferred as to that one-half during the surviving spouse’s lifetime.
1
See, Martin Fried, “Wartime Necessities,”143 Trusts & Estates 20 (January 2004) for more background on the history of
the federal estate tax. See also, Debra Rahmin Silberstain, “A History of the Death Tax - A Source of Revenue, or a Vehicle
for Wealth Redistribution?,” 17 Probate & Property, 58 (May/June 2003); and Barbara R. Hauser, “Death Duties and
Immortality: Why Civilization Needs Inheritances,” 34 Real Property, probate and Trust Journal 363 (Summer 1999).
1
9
Drafting Marital Deduction Trusts
§1.2 SIX COMMON LAW STATES ADOPT COMMUNITY PROPERTY LAW
To provide parity with the community property states, six common law states adopted community law
provisions between 1945 and 1947. But these laws were brief in duration due to the passing of The
Revenue Act of 1948, discussed in section 1.4, below. After the 1948 Act, the six states reverted to their
prior common law systems.
§1.2(a) Uniform Disposition Of Community Property Rights At Death Act
Fourteen states have adopted the Uniform Disposition of Community Property Rights at Death Act,
which was promulgated in 1971. (These states are Alaska, Arkansas, Colorado, Connecticut, Florida,
Hawaii, Kentucky, Michigan, Montana, New York, North Carolina, Oregon, Virginia, and Wyoming.)
Property acquired during marriage while domiciled in a community property state retains its character as
community property. §3 of the Act. Upon the death of a married person, one-half of the decedent’s
community property is subject to the testamentary disposition laws of the applicable state. Id. of the Act.
The decedent’s community property is not subject to the surviving spouse’s right to elect against the
will. Id. The executor does not have a fiduciary duty to discover the community property, unless written
demand is made by an heir, devisee, or creditor of the decedent. §5 of the Act.
§1.3 1942 ESTATE TAX AMENDMENT TREATS COMMUNITY PROPERTY SIMILAR TO
COMMON LAW PROPERTY
In 1942 Congress attempted to bring the community property states in line with the estate tax burden
imposed on the residents of non-community property states. The estate tax law was amended so that it
required all of the community property to be included in the gross estate of the first spouse to die, except
to the extent the property was attributable to the services or property of the surviving spouse. This
legislation proved to be unpopular with community property states.
§1.4 1948 LEGISLATION EQUALIZES THE EFFECTS OF COMMUNITY PROPERTY AND
NON-COMMUNITY PROPERTY JURISDICTIONS BY ESTABLISHING THE MARITAL
DEDUCTION
The Revenue Act of 1948 finally brought parity between the community property and non-community
property states by extending the principal tax benefits enjoyed by the community property states to
residents of non-community property states. The 1948 Act equalized income tax consequences among
the states by introducing the joint income tax return, in effect permitting couples residing in noncommunity property states to split their earnings and cause their collective income to be taxed in the
same manner as community income.
§1.4(a) Gift Splitting And 50 Percent Marital Deduction Introduced
Under the 1948 Act, transfer tax parity was achieved by creating the IRC section 2513 split gift
provisions and the IRC sections 2056 and 2523 estate and gift tax marital deductions, which permitted
residents of non-community property states the opportunity to split their gifts and their estates for wealth
transfer tax purposes. After 1948, a decedent in a non-community property state could devise up to half
of his or her property to his or her surviving spouse and (because of the marital deduction) pay no estate
tax on that devise. Thus, a pseudo-community property result was achieved.
In permitting a marital deduction when the first spouse died, the 1948 Act also disqualified
terminable interests for the marital deduction because of concern that the estate tax deferred due to the
marital deduction might not be collected on the death of the surviving spouse. The Act also spelled out
specific requirements that had to be met to avoid disqualification: the surviving spouse had to receive
(1) income for life and (2) a general power of appointment that met specified standards.
2
2006 Supplement
10
§1.5 1976 LEGISLATION INCREASES MARITALDEDUCTION AMOUNT
Until 1977, the maximum marital deduction available under IRC section 2056 to any estate was 50
percent of the decedent’s “adjusted gross estate.” No marital deduction was available for transfers of
community property since this property already was “split” for transfer tax purposes. The Tax Reform
Act of 1976 amended IRC section 2056(c), and increased the maximum allowable marital deduction to
the greater of $250,000 or 50 percent of the decedent’s adjusted gross estate.
§1.6 1981 LEGISLATION PROVIDES UNLIMITED MARITAL DEDUCTION AND QTIP
The Economic Recovery Tax Act of 1981 (“ERTA”) made two major changes to the marital deduction.
First, ERTA removed all prior limits on the maximum allowable deduction and adopted an unlimited
estate and gift tax marital deduction applicable equally for separate and community property. Second, a
new form of distribution to a surviving spouse that qualifies for the marital deduction came into
existence—the qualified terminable interest property (“QTIP”) trusts under IRC sections 2056(b)(7) and
2523(f). The unique feature about QTIP is that it gives the grantor ultimate control over who receives
the remaining QTIP property upon the death of the surviving spouse. Such an arrangement is
particularly attractive in second-marriage situations where the decedent has children from the first
marriage and wants to ensure that they receive the balance of the QTIP trust property upon the death of
their step-parent.
Practice Point: Estate planning instruments executed before September 12, 1981, should be reviewed to
determine the need to revise the marital deduction formula so as to take advantage of the unlimited
marital deduction brought about by ERTA. ERTA section 403(e)(3) contains a special transition rule
designed to not disturb the effects of pre-September 12, 1981, estate plans that contain marital deduction
pecuniary formula clauses that were designed to devise an amount equal to the maximum federal estate
tax marital deduction available to the grantor’s estate. In the absence of an amendment to the governing
instrument or state law overriding the effect of the transition rule, these marital deduction plans are
limited to the pre-1982 marital deduction amount of 50 percent of the decedent’s adjusted gross estate or
$250,000, whichever amount is greater. Post-mortem disclaimers may help to remedy such plans, but
reliance on these techniques is uncertain and may not produce the optimum or desired result (from the
surviving spouse’s perspective). Note that the transition rule may not apply if the formula refers to the
maximum marital deduction in effect at the time of the decedent’s death or available to his or her estate
at the time of death, or words of similar import. Pvt. Letter Rul. 8349050.
§1.7 SEVEN TYPES OF FEDERAL ESTATE TAX MARITAL DEDUCTION CURRENTLY
AVAILABLE
As a result of ERTA, seven forms of bequest to a surviving spouse are currently available that qualify
for the federal estate tax marital deduction. They are:
(1) Outright Bequest. An outright bequest to the surviving spouse.
(2) General Power of Appointment Trust. An IRC section 2056(b)(5) marital deduction general power of
appointment trust (or, a legal life estate with a general power of appointment). 2
(3) Insurance and Annuity Payments. An IRC section 2056(b)(6) life insurance settlement and annuity
payment.
(4) Estate Trust. A marital deduction estate trust permitted by Treas. Reg. §20.2056(c)-2(b)(1) (Treas.
Reg. §20.2056(e)-2(b)(1) before re-designation by T.D. 8522 (Mar. 1, 1994)).
2
Throughout this book, a general power of appointment marital deduction trust is also referred to as a “GPOA trust.”
3
11
Drafting Marital Deduction Trusts
(5) QTIP Trust. IRC sections 2056(b)(7) and 2523(f) marital deduction QTIP trusts.
(6) Survivor Annuities. IRC section 2056(b)(7)(C) survivor annuities included in the decedent’s gross
estate pursuant to IRC section 2039.
(7) Charitable Remainder Trust. An IRC section 2056(b)(8) charitable remainder marital deduction
trust.
This book will only discuss those bequests referred to in items (2), (4), and (5).
§1.8 CHECKLIST OF ADVANTAGES AND DISADVANTAGES OF THE DIFFERENT TYPES
OF FEDERAL ESTATE TAX MARITAL DEDUCTION
The advantages and disadvantages of each of the different types of federal estate tax marital deduction
(other than life insurance settlements and annuity payments) are outlined below.
§1.8(a) Advantages And Disadvantages Of An Outright Bequest To The Surviving Spouse
§1.8(a)(1) Advantages
• This method is preferred by most clients and all surviving spouses.
• An outright bequest provides the surviving spouse with the greatest flexibility to gift marital property
to heirs, thereby reducing the estate tax due at the surviving spouse’s death.
• The surviving spouse may receive and hold unproductive assets.
• A separate income tax return is not required for the surviving spouse’s share (i.e., no fiduciary income
tax return).
• No accountings are required during the surviving spouse’s lifetime.
• The bequest can be easily disclaimed.
§1.8(a)(2) Disadvantages
• There is no ability to fully use the grantor’s GST tax exemption.
• A non-U.S. citizen surviving spouse is treated as the transferor of any property he or she transfers to an
IRC section 2056A qualified domestic trust (“QDOT”) created by the surviving spouse. 3
• The surviving spouse (and not the grantor) determines who receives the property upon the death of the
surviving spouse.
• No investment, creditor, or administrative protection is available to the elderly, inexperienced, or
spendthrift surviving spouse.
• Any property disclaimed by the surviving spouse does not benefit the surviving spouse.
§1.8(b) Advantages And Disadvantages Of The Marital Deduction General Power Of
Appointment Trust
§1.8(b)(1) Advantages
• The surviving spouse can be provided with financial and investment protection.
3
See, Chapter 5, below, for discussion of QDOT requirements, and in particular sections 5.4(c) and (d) (regarding the
surviving spouse’s ability to create a QDOT and transfer property to that QDOT).
4