The Problem with Relying on the Unlimited 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 unlimited marital deduction. An Indianapolis estate planning attorney at Frank & Kraft explains the problem with relying on the unlimited marital deduction.
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 is $12.06 million for individuals and $24.12 million for married couples for 2022. These 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. Because of these recent changes in the estate tax lifetime exemption, it is even more important than ever to consult with an experienced estate planning attorney now to take advantage of the changes.
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 $20 million. Even with the increased lifetime exemption amount for 2022, over $7 million would be subject to estate taxes. Those assets could be gifted to you tax-free; however, your taxable estate would be increased by over $7 million. If the assets you already own were of equal value to those your spouse owned, your $20 million estate is now worth over $27 million. While you are also entitled to make use of the lifetime exemption, your estate would still owe federal gift and estate taxes on over $14 million. At a tax rate of 40 percent, your estate would lose more than $5 million to federal gift and estate taxes. Moreover, when the lifetime exemption limit decreases in a few years, even more of your estate assets will be at risk of being lost to Uncle Sam. Finally, if your spouse is not a U.S. citizen, you may not take advantage of the unlimited marital deduction, creating yet another potential threat to your assets.
Fortunately, there are several estate planning tools and strategies that can help protect your assets without relying entirely on the unlimited marital deduction. Consult with your estate planning attorney about how to implement those tools and strategies into 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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