MARITAL DEDUCTION PLANNING

Transcription

1 MARITAL DEDUCTION PLANNING DAVID L. HEFFLINGER* MARITAL DEDUCTION-AN OVERVIEW The marital deduction became law in 1948 as a response to unequal benefits accruing to residents of estate tax community property states. There was a benefit of dying in a community property state because the laws of those states automatically served to equalize the estates of the husband and the wife. This provided an advantage over common law states where the property all passed through the husband's estate. The marital deduction was enacted to equalize the burden of estate taxation. I have generally found that most practitioners do not have any trouble in determining the amount of the marital deduction or the language which sets up the marital deduction. For purposes of the deduction, the decedent must be a citizen or resident survived by a spouse to whom property included in the decedent's gross estate passes in such a manner that it will be included in the spouse's subsequent estate. That determination is fairly simple. The amount under the Tax Reform Act is fairly simple to determine; it is $250,000 or one-half of the adjusted gross estate. I have also found that most practitioners are familiar with two possible problem areas under the Tax Reform Act. The first concerns the situation where an individual may have made gifts to a spouse during lifetime. Under the Tax Reform Act, the first $100,000 of gifts to a spouse are completely gift tax free. However, to the extent the individual falls within the parameters of that $100,000 gift tax exclusion, a portion of the marital deduction equal to one-half of that amount gifted will be lost. There is an additional problem in that if the husband dies within three years after the gift, he may lose part of the benefit and not get to recoup that portion of the marital deduction lost. The Technical Amendments Act eliminates this problem, but the Technical Amendments Act has not been passed at this point. The second problem which is caused by the Tax Reform Act concerns the use of formula clauses. Many of you have drafted

2 CREIGHTON LAW REVIEW [Vol. 11 documents, I am sure, which contain a marital deduction in the terms of a maximum marital deduction. For example, if I left my wife an amount equal to the maximum marital deduction, that used to be fine; you knew what it meant; it meant fifty per cent of the adjusted gross estate. This is no longer true. Now the maximum marital deduction may be $250,000 in an estate of under $500,000. This can be a problem because a husband may leave to the wife an amount in excess of that which is the maximum desirable for tax purposes in qualifying the marital deduction. The individual is safe until January 1, 1979, because under the Tax Reform Act of 1976 a will which states that I will leave my wife the maximum marital deduction, will be read as if it said an amount equal to fifty per cent of the adjusted gross estate until January 1, Beginning on January 1, 1979, regardless of when the particular testamentary document was drafted, that clause will then be read as the current maximum marital deduction, i.e., $250,000 or one-half of the adjusted gross estate. If you have used in the past documents referring to the maximum marital deduction, you have to get back to those clients, determine their current situation, the current amount of their assets, and whether or not any revision in their marital deduction is required. Most practitioners, I found, are familiar with the above areas. But I have also found that the familiarity with those basic areas is insufficient to do the marital deduction planning and drafting which is necessary to insure a competent and effective job of estate planning. I would like to go over some of those planning and drafting techniques with which you should be familiar in order to do that competent job. MARITAL DEDUCTION-PLANNING AND DRAFTING The first thing to consider is whether or not a marital deduction is desirable at all. Subject to the spouse's right to elect against the will, most spouses want to have a marital deduction if for no other reason than love and affection, and to pass property to the spouse in such a way that she can take care of the children and herself during the remainder of her life. Assuming it is desirable, there are both nontax aspects and tax aspects of the marital deduction. Considering some of those tax aspects, it is easy to see that if the husband has, for example, a $400,000 estate, it is desirable to use the marital deduction to save taxes in the first estate, assuming that the husband dies first. Yet, it is not so easy to see that if

3 1978] MARITAL DEDUCTIONS the estates of the husband and the wife are fairly equal, taxes can be saved by not using the marital deduction. The reason is the progressive rates that apply for estate tax purposes. In other words, two taxes on $400,000 are less than one tax on $800,000. If you follow the matrices in the appendix you can see that if the husband has a $400,000 estate and the wife has a $400,000 estate and if the husband does not use a marital deduction, the total taxes on both estates are $149,600. On the other hand, if the husband uses the maximum marital deduction allowable under the 1976 Tax Reform Act, which in this case is equal to 62.5% of the estate, the total taxes will be $164,300. Looking at the figures as they appear in the appendix, from a tax aspect it would appear that it would be undesirable to use the marital deduction. However, you have to be certain that you also consider the ages and respective situations of the spouses. It is likely that there may be an advantage to using the marital deduction to save the taxes in the first estate on the assumption that the spouse will consume or otherwise utilize the property that passes to her, and in that way reduce the tax on the subsequent estate. Given this rationale, the question that arises is: How do I leave my spouse an amount which is sufficient to qualify for the marital deduction but doesn't pyramid my wife's subsequent estate in such a way that she pays excess taxes? When the individual comes in you may be able to ascertain that he has an estate of $500,000 and decide that it would probably work to draft a document stating that I will leave my wife $250,000 because such amount at that time is equal to the maximum marital deduction. It is extremely unlikely, considering consumption of assets and inflation of assets, that this amount will always be correct and it is for this reason that most of the estate planning documents you see in larger estates utilize a marital deduction formula. Whether they be pecuniary bequests or fractional bequests the theory behind using the formula is to make sure that an individual is certain to leave his wife an amount exactly equal to the maximum marital deduction: no more, no less. He receives the maximum marital deduction but does not pass to his spouse more than is necessary to get that deduction and thereby eliminates any possibility of pyramiding her subsequent estate. PECUNIARY BEQUEST FORMULA Beginning on page 699 of the appendix, you will find language for the pecuniary bequest formula. A pecuniary bequest

4 CREIGHTON LAW REVIEW [Vol. 11 should be thought of as a bequest of an amount, a dollar amount, even though the assets of the estate may be entirely unliquidated. If a pecuniary bequest is utilized, the individual in theory is leaving the spouse a dollar amount. If the maximum marital deduction determined under the pecuniary amount is $300,000, that amount theoretically would be satisfied by transferring to the spouse $300,000 in cash. The language which is utilized in establishing this type of clause is set forth in the appendix. If you look at the language you can see that it begins with the maximum estate tax marital deduction. You eliminate from this figure any amounts which pass to the spouse otherwise pursuant to the terms of this marital bequest. In other words, if there is joint property, or if there is life insurance directly paid to the spouse, or if there have been any gifts in contemplation of death, although those properties may be included in the gross estate, you want to reduce the marital deduction by the value of these items. You want to look at the gross estate and give the wife half of that. If she has already received half of the adjusted gross estate by a transfer separate and apart from the testamentary document, then the spouse would not receive anything pursuant to the clause. Note that the last sentence of the lead-in which you would utilize indicates that the personal representative is empowered to satisfy the bequest in cash or in kind. This gets around the problem in uniforn Probate Code states such as Nebraska which favor in kind distribution in satisfaction of pecuniary bequests. Once you have defined a pecuniary amount, there are a number of ways in which you can direct the personal representative or trustee to satisfy that particular bequest. Three basic methods are used by estate planners. The True Worth Provision The first method is provided by the true worth provision. Personally this is the type that I favor. The true worth provision attempts to avoid inflation in the spouse's subsequent estate. Thus, in determining the amount of the gift, federal estate tax values are applied, but in satisfying the bequest, fair market values determined at the date or dates of distribution to the marital deduction trust are utilized. You are then limiting the assets distributed to the wife to the exact amount you determine under the pecuniary formula. Consider the example in the appendix. The adjusted gross estate is $700,000 and there is a

5 1978] MARITAL DEDUCTIONS pecuniary bequest for $350,000. If the husband owned 1000 shares of X stock at $350,000 value which had appreciated to $700,000, when the personal representative makes the distribution to the spouse you would only want to transfer 500 shares in order to satisfy the true worth bequest. This should be done since you want to give to the wife, when you distribute the assets, an amount exactly equal to the marital deduction which you have taken on the estate tax return. However, if you were to give her the entire 1000 shares, you would still only get the marital deduction which you took on the return but you would have pyramided the wife's subsequent estate by the inflation between the federal estate tax value and the date of distribution value. Normally, that is not desirable. In addition, the true worth provision is not subject to Revenue Procedure which only applies to distributions which are required to be valued at federal estate tax values. I might just mention the rationale behind if you are not familiar with it. Prior to 1964, the personal representative had a great planning device available to him. Suppose the pecuniary amount required under this formula was $100,000 but at the date of death a particular asset of the estate had depreciated to $50,000. While it was worth $100,000 when he died, it was worth only $50,000 when the personal representative got around to distributing it. The personal representative could then take that asset valued at $50,000 and give it to the spouse. The full marital deduction was obtained because it was valued at federal estate tax values although $50,000 was eliminated from the wife's subsequent estate since at the date of distribution the asset was only worth $50,000. The Internal Revenue Service noted that this was a great planning technique and eliminated it. Now it says that you either have to use assets which are fairly representative of the appreciation or depreciation since the date of death, or you have to leave the spouse an amount exactly equal to the marital deduction or not less than the amount determined to be the marital deduction. I might also mention that under the Nebraska Probate Code unless there is a contrary expression of intent in the will, the fair market value at the date of distribution is required to be used for satisfaction of pecuniary bequests. With these limitations in mind, why would you use the true worth method of the pecuniary bequest? One reason is that you freeze the value of the assets for the purposes of the wife's subsequent estate. In addition, if any animosity or potential animosity exists between the beneficiaries, this method al-

6 CREIGHTON LAW REVIEW [Vol. 11 leviates some pressure on the fiduciary with respect to distribution. This is because you have pegged in the exact amount that the spouse is going to receive. However, one possible drawback "s the fact that satisfaction of this type of clause with appreciated property may result in a gain taxable to the estate. The Minimum Worth Provision The second method which may be utilized, is the minimum worth provision. This is a provision that gives a great deal of flexibility to the fiduciary. It says in effect that you use federal estate tax values to determine the amount, but in satisfying the bequest you use assets which have a fair market value on the date of distribution amounting to no less than the amount of the pecuniary gift. In other words, the personal representative can distribute any amount he wants to the spouse as long as he gives her some assets having a value on the distribution dates equal to the marital bequest. Obviously under this type of formula the spouse could receive the entire amount left in the estate. For this reason, and for the reason that it gives such great flexibility to the fiduciary, it probably is not a method that you would want to use where there is any friction or potential animosity among the beneficiaries. Indeed, you might consider whether or not the mere fact that you have such a clause in the will may foster animosity among the beneficiaries. Moreover, it is a clause that generally would not be favored by the fiduciary because it places the fiduciary in a rather undesirable position. The Fairly Representative Provision The third type of pecuniary clause which is used quite often is the fairly representative provision. The reason this clause is used so often is that its terminology is derived directly from Revenue Procedure Under this clause you again use federal estate tax values to determine the amount of the gift, but in satisfying the bequest the personal representative is required to transfer assets which fairly represent the appreciation or depreciation occurring from the date of death to the date of distribution. The advantage of this type of clause is that it is fair and it is easy for the fiduciary to administer. Every individual is going to share and share ratably in the appreciation or depreciation since the date of death. Furthermore, there is no problem with this clause under Revenue Procedure because it specifically complies with this ruling. Although the amount received by the spouse may be less than the exact amount deter-

7 1978] MARITAL DEDUCTIONS mined on the date of death, since the personal representative is required to distribute pro rata that depreciation among all of the beneficiaries, the Internal Revenue Service has determined that it is not objectionable. When would you use a fairly representative type of clause? At the outset it should be recognized that this clause removes the flexibility in the personal representative to vary the amount of the bequest, so if you want that flexibility you may not want the fairly representative provision. Yet for this very reason it may be useful in an estate with a number of potentially hostile beneficiaries. In larger estates if you want to freeze the marital share, the true worth provision may be more desirable. However, if you have an estate where it is possible that there could be a substantial depreciation in the assets, this type of clause may be better to use. This would assure that the nonmarital beneficiaries will at least receive something. If you use the true worth method and the assets depreciate in value, the spouse is liable to receive the entire amount of assets in the estate with the nonmarital beneficiaries receiving nothing. Generally this would not be desirable from a testator's point of view. FRACTIONAL BEQUEST FORMULA The above discussion considered the use of pecuniary clauses, which should be distinguished from fractional share clauses. A pecuniary clause is in theory a gift or bequest of a specific dollar amount to the spouse. A fractional share clause, in theory and in practice, is a clause under which the spouse is entitled to an undivided one-half interest in all of the assets in the estate. In other words if there are three assets in the estate, 100 shares of A.T.&T., a quarter section of farmland, and an individual checking account, under the fractional share bequest the spouse would be entitled to half of the shares of A.T.&T., an undivided one-half interest of the real estate, and half of the amount of the checking account. There are a couple of problems associated with the use of the fractional share. The first problem is to determine against what fund you are going to apply this fraction. Is it going to be the amount of the estate after the payment of taxes and after the payment of debts, or is it going to be the amount of the estate only after the payment of debts but before the payment of taxes? The determination is going to effect the amount of the fraction; therefore it should be noted that there are some planning techniques which the personal representative can utilize

8 CREIGHTON LAW REVIEW [Vol. 11 after the death to affect the amount which would go to the spouse. For example, the personal representative may be able to pay administration expenses as an estate or an income tax deduction or to sell certain assets prior to distribution. This would affect the type of assets which would eventually pass to the spouse. However, the fund normally is determined after payment of taxes, assuming the taxes are going to come out of the nonmarital share. Thus, while it may vary the type of asset going to the spouse, it will not vary the fractional figures. The reason a fractional figure is important initially is that it is the fraction utilized in determining the proportion of each interim distribution which goes to the spouse or to the nonmarital beneficiaries. This is indicated in the appendix which also gives an example of whether you might use a pretax residuary clause or a true residuary clause. Once you take out the losses and administration expenses and give consideration to the taxes, you then have the fractional share marital deduction. In the example you will find that the marital deduction bequest represents 55.74% of the entire residuary estate. This fraction will be determinative of the interim distribution to the spouse. Why would you use a fractional share bequest? Well, as you probably can imagine, it is a very fair way of making distribution to the spouse and to the nonmarital beneficiary. Since the personal representative has no right to give a particular asset to the spouse and a separate asset to the beneficiaries, this type of fractional share may be desirable under the carryover basis provision. In this type of marital formula the personal representative would not have the authority to transfer low basis assets or high basis assets to the marital share and consequently shift the income tax burdens between the respective beneficiaries. Now as I have said, there may be a reason to use this method if you want to be fair; however, from a planning standpoint, assuming that you can still be fair, it is usually considered more desirable to give the personal representative the maximum amount of flexibility. Thus, if you want to do some planning to enable the personal representative to transfer some high basis assets or low basis assets into the marital share, flexibility will be necessary. This cannot be done under the fractional share. However, you can do this under the pecuniary bequest. These are considerations you might want to keep in mind. A consideration which is very relevant in large estates is the step-up in basis for federal estate taxes paid if the assets actually bear a portion of the federal estate taxes. However, if your

9 1978] MARITAL DEDUCTIONS document requires the taxes to be paid from the nonmarital share, the one-half of the assets under a fractional share bequest which go into the marital share will not be subject to any taxes. In effect you would lose one-half of the potential step-up in basis or adjustment in basis on account of the federal estate taxes. In a large estate, that may be reason not to use the fractional share type of formula. The fractional share type of formula is not subject to Revenue Procedure for the obvious reason that the personal representative does not have discretion in distributing assets to the respective individuals. These are the drafting considerations in determining your marital bequest. Do I use a pecuniary or a fractional bequest formula? Those considerations apply both before and after the Tax Reform Act. TAX REFORM ACT CONSIDERATIONS Now I would like to discuss two items which have to be given some thought in drafting documents under the Tax Reform Act. The first concerns generation skipping transfers. If the generation skipping transfer occurs at the same time or within nine months after the death of a deemed transferor, for purposes of computing the marital deduction, the gross estate is increased by the amount of such transfer. Let me give you an example. Suppose the estate is $600,000 and the maximum marital deduction is $300,000, but this decedent was the deemed transferor to the extent of $200,000. Under the law as written, if you don't put anything to the contrary in your testamentary document, the gross estate is artificially increased from $600,000 to $800,000. Consequently the marital deduction is increased from $300,000 to $400,000. Now, depending on the size of generation skipping transfer, there may be required an increase of the marital deduction to such an extent that the marital devisee receives all of the available assets and the nonmarital devisee receives none of the available assets. Remember, however, by the very nature of the generation skipping transfer, that transfer presumably went to the nonmarital beneficiaries. It is hard to think of how you would have a generation skipping transfer to the spouse,so maybe there is no problem in allowing that artificial increase in the marital deduction on the theory that the testator wanted his wife to have one-half of the assets available at the time of his death. If you consider the generation skipping transfers as part of the assets available at the time of his death, then the "artificial" increase in the marital deduction may be entirely justified.

10 CREIGHTON LA W REVIEW [Vol. 11 Assuming that you are in a planning situation where you don't want to increase the marital deduction on account of the generation skipping transfer, you might want to consider using the type of language which can be found on page 905 of the appendix. In defining the gross estate for purposes of that marital deduction, it excludes any generation skipping transfers. Fairly simple drafting accomplishes this result. However, my own opinion is, in the absence of any countervailing considerations, you would not want to use this clause in your documents. Instead you would assume that the testator desires onehalf of his "increased" estate to pass to his surviving spouse. The second item which I touched on earlier, is the increased marital deduction. I mentioned that you may want to get back to your clients for whom you have drafted wills containing a max:- imum marital deduction and consider whether or not they should change it. Example: Suppose the individual has an estate of $350,000. That may have worked out fairly well under a maximum marital deduction with the old law because you had a $175,000 marital deduction; assuming your nonmarital section was properly drafted, there was $175,000 taxed to the husband's estate and $175,000 taxed in the wife's estate. If you still have that same document and it is now 1979, all of a sudden there is $250,000 which qualifies for the marital deduction. So the husband's estate is $100,000 with no tax. However, you have pyramided the wife's subsequent estate to $250,000, the amount of the marital deduction. Even with the $175,000 exemption equivalent available in 1981, there still is going to be a $20,000 tax in the spouse's estate. This result can be avoided. In most of the documents which you draft for an individual with an estate between $300,000 to $500,000, you want some type of language which would cover that situation. What you do is tie the marital deduction into the husband's unified credit. There is language which accomplishes that result on page 706 of the appendix. The language is used in the same clause that I discussed earlier. Whether it be a pecuniary clause or fractional clause, you would provide that the marital deduction shall be further reduced by an amount, if any, necessary to increase the taxable estate sufficiently to fully utilize all available credits for federal estate tax purposes. With this in mind let's return to the example. Assuming death in 1981, the unified credit amounts to an exemption of $175,000; you will just back in to the marital deduction. You know you want an estate of $175,000 because that results in no tax. You know you have an adjusted gross estate at $350,000.

11 1978] MARITAL DEDUCTIONS Thus you plug in the middle figure of $175,000 and if you use the type of language discussed above, the marital deduction becomes $175,000. That is desirable because then only $175,000 is included in the spouse's subsequent estate; and again assuming a death after 1981, that is the exact amount of the exemption equivalent-there should be no tax in either estate. I hope you can also see the problems created for wills prepared using a maximum marital deduction formula in an estate having between $350,000 and $500,000, because with a little drafting revision you can eliminate all the tax. Without any drafting revisions, as the example indicates, you can have, even in a $350,000 estate, a tax of up to $23,800. RELATED PROVISIONS IN MARITAL DEDUCTION FORMULAS There are a number of provisions which usually follow the marital language. I would like to discuss those briefly so we can understand why they are there. Distribution to the Spouse First, there is usually a determination of how the amount so determined will be distributed to the surviving spouse. Once you determine the pecuniary amount or the fractional share, you could just give that outright to the surviving spouse. It is hers to use and that clearly qualifies it for the marital deduction. On the other hand, the testator may desire some restrictions on the availability of those assets to the surviving spouse. Many interesting cases concerning the marital deduction concern validity or invalidity of the various restrictions which testators have attempted to put on the subsequent disposition of the marital assets by the spouse. As a rule of thumb you can usually consider the maximum restriction to be that contained in section 2056(b)(5)-the Life Estate Power of Appointment Trust. Under this provision you are required to leave to the spouse, or the personal representative or trustee is required to distribute to the spouse, all of the income of the trust, at least annually. The spouse is also required to have a general power of appointment exerciseable during her life or by her will. Section 2056(b)(5) allows you to limit the assets available to the spouse and still qualify for the marital deduction. Practically speaking, the spouse may only receive the income. Under the probate code rules in most states and in Nebraska, a general residuary clause is not effective to exercise a

12 CREIGHTON LAW REVIEW [Vol. 11 power of appointment and it is unlikely that the spouse would exercise the power of appointment in her testamentary document. Accordingly, assuming that he desired to do so, the husband could qualify for the marital deduction by leaving the wife only the annual income with this power of appointment, bearing in mind that it is unlikely the spouse would exercise the power of appointment. I pointed this out to illustrate the maximum restrictions that can be put on the marital share. On page 707 of the appendix there is some drafting language which can be used to increase or decrease the availability of assets to the surviving spouse. For example it may be desirable to allow the spouse to withdraw whatever she wants from the trust at any time, if the husband has confidence in the wife's investment ability. On the other hand, he may want to limit that discretion and give it to the fiduciary. The fiduciary can then give the spouse so much as the fiduciary determines to be in her best interest from time to time. Generally the availability of assets to the wife can be as varied as the imagination of the individual drafting the document. For example, it is not uncommon for the husband to say that he does not want the wife to have anything if she remarries. You may find the form books state this cannot be done. As a practical matter, however, you can do this as long as you leave the wife all the income during her life and give her the general power. Thus, you can have a provision in the document that the wife shall have the right to withdraw $10,000 a year from principal, provided, however, that this power shall terminate upon her remarriage. Moreover you can give the trustee the power to distribute to her whatever amount the trustee deems to be in her best interest, provided, however, that no such distribution shall be made after the remarriage of the spouse. As long as you have no qualifications on the income distribution and on the power to appoint, you can put just about anything you want in the provision applicable to the surviving spouse. Four Problem Areas There are some other problems in the normal marital drafting which I would now like to discuss. First, there is the problem of unidentified assets. The Code states that if there are two assets available for marital distribution, one which would qualify for the marital deduction, and one which would not because it is a term of years or something in that nature, if the personal representative has the authority to distribute either of those

13 1978] MARITAL DEDUCTIONS assets in satisfaction of the marital bequest, the marital bequest does not qualify for the marital deduction. This occurs even though the personal representative may in fact distribute the qualifying assets in satisfaction of the bequest. In addition, there are certain items requiring special treatment, for example, items which pass outside the probate estate. In dealing with these items, you want to make certain that your marital drafting defines the marital bequest by excluding those items in the gross estate which pass to the surviving spouse separate and apart from the bequest. The language found on page 708 of the appendix may be appropriate in solving these problems. A second problem area that is normally covered in the marital drafting relates to unproductive assets. Remember that you may limit the surviving spouse's share as long as you give her all the income during her life and the general power to appoint. However, there has been substantial litigation in determining whether or not the spouse has the right to all the income from the assets during her life. The Internal Revenue Service takes the position that if the assets in the marital trust are nonincome producing, for example, farm land which is not rented, or investment real estate, or closely held business corporation stock, then in the absence of some right in the spouse to require the fiduciary to make those assets productive, the spouse does not have the requisite right to the income and the marital bequest fails. Generally you cannot be certain these assets will not be required to fund the marital bequest. In that situation you probably should consider the language on page 709 of the appendix. You give the wife the power by written request to require the trustee to convert or make productive any unproductive property. The third problem area relates to fiduciary powers. It may be important to have a catch-all savings clause at the end of the document. If I go through the marital drafting but there is a sentence in the document which disqualifies the deduction, I would want to have a sentence which overrides the disqualifying sentence. This is a catch-all savings clause. Revenue Ruling 75:440 states that as long as you are expressing the testator's intent, the courts can interpret that intent and apply it. The language found on page 709 of the appendix is an attempt to follow the holding of the revenue ruling and is not intended to be considered a savings clause, but merely as an expression of the particular testator's intent.

14 CREIGHTON LA W REVIEW [Vol. 11 Finally, there is the problem area of survivorship. You should note that those states which have a probate code generally did not repeal their Uniform Simultaneous Death Acts. The Uniform Simultaneous Death Act provides that if the deaths occur in such a way that you cannot determine who died first, it shall be presumed that each individual survived. If each individual survived, in a husband/wife situation, there is no marital deduction. I mentioned earlier in my example regarding the $400,000 estates that if you ran through the numbers, the taxes are less if you don't use any marital deduction; but you may want to use a marital deduction if the spouses are young enough, on the theory that the surviving spouse would have consumed the assets. You saved the taxes and there is no pyramiding of the second spouse's estate since she consumed the assets. However, that benefit is not present if there is death from a common disaster or if the second spouse doesn't survive by six months. The consumption of the assets is unlikely to take place. The marital deduction provisions allow you to condition the marital deduction upon the spouse surviving for a period of at least six months. You can't provide for more than six months. If you want to cover the problem created by the Uniform Simultaneous Death Act to assure that you get the marital deduction but also want to draft around the problem of having the six month survival period, you should consider the language on page 710 of the appendix. This language also includes a provision which Casner has suggested equalizing the two estates. Allocation of Taxes The document may direct the payment of taxes from the nonmarital share. To the extent that the marital bequest is required to contribute to the payment of taxes, the marital bequest will be reduced by that amount. That is the reason why you see all taxes applied against the nonmarital share. Two other considerations are present: (1) you want to make certain there is no language which may be interpreted as imposing on the residuary beneficiary any liabilities for the generation skipping transfer tax, since that tax should fall on the trust assets which compose the generation skipping trust; and (2) you want to consider whether language of this type is necessary in a state which has an apportionment statute. Nebraska has an apportionment statute; so does South Dakota. Iowa has a type of judicial apportionment which usually does not accomplish the

15 1978] MARITAL DEDUCTIONS desired result. In Nebraska you have built into the statute allowance for the marital deduction, which means the marital deduction would not share in the federal estate taxes. An individual may come in and say: I like the idea of the marital deduction; I like the idea of not pyramiding my spouse's estate but I want to make sure that my wife has some powers over these assets; I have a lot of confidence in her and I think that she can handle it; I would like to leave her everything, but for all of these tax problems that you are talking about, what can I do? What you can do is draft the nonmarital share to give the spouse maximum powers and still keep the nonmarital share out of her estate. Generally speaking, as long as the surviving spouse does not have a general power to appoint, those assets will be removed from her estate. On page 711 of the appendix I have given you an idea of the broad power a surviving spouse may possess in the nonmarital share. You can give her all the income, or the trustee can have the discretion to distribute to her such amounts as may be necessary for her welfare. She can also have a five per cent or $5,000 power and the only thing that would be in her estate in that case would be the amount withdrawn or available for withdrawal in the year of her death. However, one caveat I would like to mention is that in drafting the nonmarital share you want to be careful for those individuals who don't want to use a corporate fiduciary. If you give a "sensitive" fiduciary (son, wife) any discretion at all, you can have a real problem. For example, let's say the nonmarital share gives my fiduciary the power to distribute such amounts of income and principal as my fiduciary deems advisable for the welfare of my wife and children during their lifetimes. If the son is the trustee, the son will be taxed on the income from that nonmarital share under section 678 of the Code. Moreover, the son will be deemed to have a general power of appointment over those assets under the estate tax power of appointment rules. Therefore, if you want to give the trustee flexibility, which is very desirable from an income tax planning standpoint, it is usually advisable to give serious consideration to using a corporate trustee. You can give the corporate trustee that type of flexibility without having the adverse income and estate tax consequences. Of course you can draft around those consequences, but you have to make the distribution subject to an ascertainable standard. You have to say these distributions can only be made for health, education, support, and maintenance; to the extent that standard is not

16 CREIGHTON LAW REVIEW [Vol. ii sufficient discretion in your particular estate problem, you have to go with a nonsensitive trustee. Thus, it usually makes good sense to use a corporate trustee. MARITAL DEDUCTION-FUNDING Now that you've drafted the document, you have to consider what type of assets are going to flow into the trust once the testator dies. You will have some funding considerations. I want to emphasize that funding considerations can exist during the lifetime of the individual. I call it pre-mortem funding. PRE-MORTEM FUNDING You have seen documents that contain a properly drafted maximum marital deduction bequest. You ask the individuals what assets they have. They pull out the deeds and they are all in joint tenancy. For example, they have a thousand acres of Hall County farm land at $2,000 an acre, all in joint tenancy. Their marital deduction document is going to be worthless because nothing will pass under that document. Instead, everything that is in joint tenancy is going to pass to the surviving spouse. Therefore you have to make certain that at least onehalf of the assets of each spouse is not held in joint tenancy or will not be disposed of in such a fashion that it goes to the spouse outside the operation of a particular testamentary vehicle. In addition, you want to avoid underfunding the wife's share. While there is a problem of overfunding it because you pyramid the second estate, there is also a problem with underfunding the share. This occurs if the surviving spouse, the wife in many cases who has the smaller estate, dies first. The husband on his subsequent death has the big estate. He doesn't get the marital deduction unless he remarries. As a practical matter, it is desirable under the new law, assuming you have an estate of $350,000 or more, to see that each spouse has at least $175,000 in their respective estates. In this way if the spouse of the smaller estate dies first, nothing will be taxed from that estate. Yet, you want to make certain that when you do this you don't put a marital deduction in that smaller estate; otherwise you pyramid the larger estate. Thus, in a smaller estate you probably just want to use a life estate with remainder to the children.

17 1978] MARITAL DEDUCTIONS POST-MORTEM FUNDING There are a number of post-mortem funding aspects which should be considered. In post-mortem funding the personal representative can affect the size of the formula bequest. In the appendix there are some ideas to remember in deciding what type of assets go into the marital and what type of assets go into the nonmarital share. It may be that you want to give the surviving spouse high basis assets under the theory that the low basis assets will then bear the tax and get the step-up for estate tax payments. On the other hand you may want to throw the low basis assets into the marital share on the theory that those are the assets the spouse is going to sell and she reduces her estate by the amount of the capital gains tax which is attributable to them. In this regard you can't forget the distribution tax. You can have tax results flowing from the distribution of principal if the estate has a distributable net income. In the appendix I mention section 1040A which is the new clause under the Tax Reform Act which is really a savings clause. In the absence of that clause, the difference between the cost basis and the fair market value on the date of distribution of a pecuniary bequest is subject to capital gains tax. Section 1040A is intended to make the result the same as it was under prior law. Thus, only the difference between the date of death value and the date of distribution value of a pecuniary bequest is subject to capital gains tax. This is one benefit of a fractional share bequest, since the fractional share will not be subject to capital gains tax on its distribution; the fractional share is not a specific dollar bequest subject to capital gains taxation when satisfied with appreciated assets. Casner seems to feel that al: though the true worth provision is clearly subject to capital gains taxation, perhaps the fairly representative and the minimum worth provision may not be subject to that tax. The Internal Revenue Service doesn't take this position but if you have a fairly representative clause or a minimum worth clause in a pecuniary bequest and you get into litigation, you have Casner to support you. Finally, I should mention improper funding. What if you go through all these formulas and determinations and do it wrong? For example, instead of putting $275,000 into the marital share, you only put $250,000. There are cases which indicate that the Internal Revenue Service can include that difference in the spouse's subsequent estate under the theory that it is either a retained life estate or a claim against that property, which is an

18 CREIGHTON LAW REVIEW [Vol. 11 interest under section 2033 of the Code. Consequently, you want to make sure that you not only initially draft the document properly, but if you are the fiduciary or the attorney or the accountant who is directing the funding of that bequest, that you also do that properly; otherwise some adverse tax consequences can result. CONCLUSION I hate to end by discussing improper funding. When I have done that in the past I have a feeling that the people I have talked to did not understand that they should go back and draft, but rather that they should go back and check the exclusions on their malpractice policies. I hope I did not give you that impression. The marital deduction is very simple and it is very simple to draft. I hope I have given you some planning considerations and forms which you can use when you go back and draft your documents. Hopefully the ideas and forms will help both you and your clients.

19 1978] MARITAL DEDUCTIONS APPENDIX I. THE MARITAL DEDUCTION-AN OVERVIEW A. Introduction. Prior to 1948, married residents of community property states received, as the result of state property law, federal tax advantages not available to married persons residing in common law states. The Revenue Act of 1948 was adopted for the purpose of providing "geographical equalization of the burden of the income, estate and gift taxes". The equalization was accomplished through the split income provisions of the income tax law, the split gift and marital deduction. The rationale underlying the estate tax marital deduction provisions is to permit one spouse to pass noncommunity property to the other and enjoy tax advantages substantially comparable to those received by a spouse in a community property state. Section 2056 of the Internal Revenue Code accomplishes the desired result by permitting a deduction in the decedent's estate equal to the value of the property interests which are included in his gross estate, and which are transferred or "passed" to his surviving spouse. B. Section 2056 sets forth the requirements for the marital deduction. (1) The decedent must be a citizen or resident of the United States, survived by a spouse, to whom property included in the decedent's gross estate "passes" in such a manner that it will be included in spouse's gross estate if not consumed. (2) The interest may not be a nondeductible terminable interest (e.g., a life estate), except for (a) an interest conditioned on survival for a limited period and (b) a life estate with general power of appointment in surviving spouse. C. Section 2056(c) limits the maximum marital deduction. (1) The maximum marital deduction was increased by the Tax Reform Act of 1976 (TRA) to the greater of: (a) $250,000.00, or (b) one-half of the adjusted gross estate. (2) The maximum marital deduction is reduced by any gift tax marital deduction in excess of fifty percent of the ifts. Reduction applies if post-1976 gifts are less than 200, Example: Decedent made gifts to his spouse of $103, in 1978, fully utilizing the first $100, of

20 CREIGHTON LAW REVIEW [Vol. 11 the gift tax marital deduction and the annual exclusion. No other taxable gifts were made prior to decedent's death in If decedent left all of his adjusted gross estate of $450, to his spouse, the marital deduction would be $200, This is equal to the maximum limitation of $250, less the difference between the post-1976 gift tax marital deduction used ($100,000.00) and the fifty percent of post-1976 gifts ($50,000.00). (3) Formula clauses. (a) The increased marital deduction will not be available for a pre-1977 will or trust containing a formula clause designed to give the spouse the maximum amount qualifying for the marital deduction if the clause is not amended and the decedent dies in 1977 or In such cases the "maximum marital deduction" shall be fifty percent of the adjusted gross estate. (b) Example: Decedent died in 1978 with an adjusted gross estate of $400, and 1970 estate plan containing a formula marital deduction clause. The amount of the marital deduction would be $200, and not $250, II. MARITAL DEDUCTION-PLANNING AND DRAFTING A. Desirability. (1) Nontax considerations. Love and affection, confidence in spouse's management abilities, other assets of spouse, age and health of spouse, possibility of spouse's remarriage, age and needs of children. (2) Tax considerations. Balance tax savings on first death and value of tax deferral, against possible additional taxes at spouse's subsequent death. H's Estate $400,000 Percent of H's Estate to W 0% 50% 621/2% 100% Taxes "saved" by Marital Deduction 0 67,000 74,800 74,800 Taxes-both estateswith W's separate assets of: 0 74,800 15,600 23,800 49, ,000 82,600 82,600 91, , , , , , ,124

21 1978] MARITAL DEDUCTIONS B. Rationale for Formula Clauses. There are numerous ways in which an interest in property passing from the decedent to the surviving spouse can qualify for the marital deduction. In the absence of careful planning, the likelihood that the interests passing to the spouse will exactly equal the maximum marital deduction is extremely remote. However, in many cases, it is desirable to transfer to the surviving spouse only the maximum marital deduction and to provide collaterally, if it is desired, for her to participate in the balance of the decedent's estate in such ways as do not result in such balance being includible in the spouse's gross estate. Most estate planners attempt to take into consideration the various contingencies and possibilities by defining the maximum marital gift with a formula which is in turn tied to the statutory definition of the maximum marital deduction. C. Pecuniary Bequests Formula. The pecuniary bequest is a devise of a fixed dollar amount or an amount which may be so fixed by reference to the adjusted gross estate. There are generally three types of formula pecuniary bequests: the true worth pecuniary bequest, the minimum worth pecuniary bequest, and the fairly representative pecuniary bequest. The three formulae differ in valuation of the amount passing to the surviving spouse. The following description of the desired amount applies to all three pecuniary bequest formulae: If my wife survives me, I hereby devise absolutely to the Trustee hereinafter named, in trust as a part of a separate trust to be known as THE MARITAL DEDUC- TION TRUST, an amount equal to the maximum estate tax marital deduction (allowable in determining federal estate tax payable by reason of my death) minus the value for federal estate tax purposes of all items in my gross estate which qualify for said marital deduction and which pass or have passed to my wife from me under other provisions of this will, by right of survivorship with respect to jointly owned property, or otherwise. My personal representative is specifically em-. powered, in setting aside this bequest, to distribute assets in cash or in kind, or partly in cash and partly in kind. (1) The "true worth" provision. The following sentences, when added to the preface, require that assets distributed pursuant to a pecuniary bequest be valued at the date or dates of distribution: In determining the amount of this gift, federal estate tax values shall control. In satisfying this bequest, my personal representative shall use fair market values determined at the date or dates of