Why You Should Not Depend Entirely on the Marital Deduction
When you create an estate plan, that plan should accomplish several inter-related goals. One of those goals should focus on tax avoidance. After all, no one wants to lose a significant portion of their estate to Uncle Sam. One common mistake you should avoid, however, is to rely too heavily on the marital deduction. An Indianapolis estate planning attorney at Frank & Kraft explains the marital deduction is often not enough to protect your estate from federal gift and estate taxes.
Federal Gift and Estate Taxes
At the time of your death, your estate will be subject to federal gift and estate taxes. The tax is levied on the combined total of the value of all qualifying gifts made during a decedent’s lifetime and the value of all estate assets owned at the time of death. Although the federal gift and estate tax rate was once subject to change on a yearly basis, the American Taxpayer Relief Act of 2012 (ATRA) permanently set the tax rate at 40 percent. Without any additional deductions or considerations, that means you could lose almost half your estate to Uncle Sam. Fortunately, you are also entitled to make use of the lifetime exemption which acts as a deduction taken prior to calculating the tax. Like the tax rate, the lifetime exemption limit was also subject to change on a regular basis prior to the passage of ATRA. In 2012, ATRA set the lifetime exemption limit at $5 million, to be adjusted annually for inflation. President Trump, however, signed tax legislation into law that changed the lifetime exemption amount for 2018 and for several years thereafter. Under the new law, the exemption amounts are $12.92 million for individuals and $25.84 million for married couples in 2023; however, the exemption amounts are scheduled to increase with inflation each year until 2025. On January 1, 2026, the exemption amounts are scheduled to revert to the 2017 levels, adjusted for inflation.
The Unlimited Marital Deduction
The “unlimited marital deduction” refers to the fact that gifts to a spouse, made during your lifetime or after death, are always exempt from the gift and estate tax. Moreover, there is no limit to the marital deduction. Although the marital deduction can be a helpful tax avoidance tool, relying too heavily on the marital deduction often results in over-funding a surviving spouse’s estate. Using the marital deduction may only delay the payment of federal gift and estate taxes instead of avoiding them. For example, if your spouse passed away and left an estate valued at $15 million. Even with the increased lifetime exemption amount for 2023, over $2 million would be subject to estate taxes. Those assets could be gifted to you tax-free using the unlimited marital deduction; however, the value of your taxable estate would also be increased by the value of the assets gifted to you. Ultimately, using the marital deduction only delays the payment of estate taxes, in many cases, to after the death of the surviving spouse. Assume, for example, that you also owned assets valued at $5 million. If your spouse gifts you all of his/her assets using the marital deduction you gain over $2 million in taxable assets after applying your spouse’s lifetime exemption. Your estate is now valued at over $17 million, meaning that over $4 million would be subject to federal gift and estate taxes.
The good news is that there are tax avoidance strategies that could potentially shelter your assets without relying on the marital deduction. Talk to your estate planning attorney to determine which tools and strategies are right for your estate plan.
Contact an Indianapolis Estate Planning Attorney
For more information, please download our FREE estate planning worksheet. If you have additional questions or concerns about the unlimited marital deduction, or tax avoidance in general, contact an experienced Indianapolis estate planning attorney at Frank & Kraft by calling (317) 684-1100 to schedule an appointment.
Paul Kraft is Co-Founder and the senior Principal of Frank & Kraft, one of the leading law firms in Indiana in the area of estate planning as well as business and tax planning.
Mr. Kraft assists clients primarily in the areas of estate planning and administration, Medicaid planning, federal and state taxation, real estate and corporate law, bringing the added perspective of an accounting background to his work.
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