Dear Clients and Friends:

When considering marital deduction in your estate plan, it is important to understand one danger this deduction poses: that of "overqualifying" for it.

There are no limits on how much of a marital deduction your estate can qualify for. Thus, if your entire estate goes to your surviving spouse, your estate will owe no federal estate tax. Many taxpayers take this simple approach. In the long run, however, it can cost your family hundreds of thousands of dollars in extra estate taxes. Here's what's involved.

Every individual is entitled to a "unified" credit entitling him to transfer $625,000 in cash or property free of federal estate or gift taxes ("transfer" taxes). (The $625,000 amount, which applies in 1998, will gradually rise to $1 million by 2006.) Property doesn't have to be transferred to the individual's spouse to qualify for this credit. A husband and wife, therefore, can transfer a total of $1,250,000 ($625,000 each) to their children (or other beneficiaries) in 1998, free of transfer taxes. If the first of them to die leaves everything to the surviving spouse, however, he will have failed to take advantage of his unified credit. At the later death of the spouse, assets with a value of from $625,000 to $1 million (depending on the year of her death) passing to the children will be "sheltered" by her credit, but the rest of the "parental" estate will be taxed.

Example (1). Harry dies in 1998 with an estate of $2 million, which he leaves in its entirety to his surviving spouse, Wilma. Harry's estate has no estate tax liability due to the marital deduction. Wilma dies in 1999 with the $2 million comprising her estate. After applying her unified credit, the estate tax bill will be roughly $570,000.

Example (2). The facts are the same as above except that Harry leaves only $1,375,000 to Wilma and $625,000 to their children. In this case, Harry's estate will still owe no estate tax due to the combined effect of the marital deduction and unified credit. At Wilma's later death, her estate is $1,375,000, instead of the $2 million in the first example. Now, after applying her unified credit, the estate tax bill will be roughly only $291,000. By having Harry keep $625,000 from qualifying for the marital deduction, roughly $279,000 in estate taxes are avoided.

Property passing to the spouse: One reason an estate may overqualify for the marital deduction is there are ways for property to go to the spouse automatically-that is, not via the taxpayer's Will or through his probate estate. Two common examples are jointly owned property and life insurance.

If a married couple owns property jointly with survivorship rights, the surviving spouse obtains complete ownership by operation of law outside the estate. Under the estate tax rules, half the value of the property is included in the gross estate but qualifies for the marital deduction since it goes to the surviving spouse. Similarly, if the surviving spouse is the beneficiary of life insurance, which is included in the estate, the marital deduction applies.

Accordingly, to avoid "overqualifying" for the marital deduction, it is important to know what property is already targeted to go to the surviving spouse. Then steps can be taken within your estate plan to make sure enough assets are set aside to take advantage of the unified credit.

If you are hesitant to remove $625,000 or more of your assets from your spousal bequest for fear of leaving your spouse with insufficient property to meet his/her needs after your death, special arrangements can be made to achieve your goals. One way is to place assets in trust with your spouse receiving the income interest for life and with your children receiving the assets at the spouse's death. The trust can be set up to avoid qualifying for the marital deduction at your death, thus avoiding inclusion in your surviving spouse's estate at her death.

If you wish to discuss the above, or to explore other estate planning techniques, please call us at (315) 363-0087.

Very truly yours,

G. William Hatfield
Certified Public Accountant
Certified Financial Planner