Lack of entitlement to current income doomed marital deduction.

• Author: Puckett, Mark D.

Generally speaking, Congress permits a free flow of assets between spouses, unencumbered by transfer taxes, via the estate tax marital deduction. A transfer to or for the benefit of a surviving spouse may qualify for the marital deduction if such interest, when retained until death, would be taxed in the surviving spouse's estate. However, two recent developments demonstrate that unless the statutory requirements for a marital deduction are satisfied, the deduction will be denied. In Davis, 394 F3d 1294 (9th Cir. 2005), aff'g TC Memo 2003-55, the marital deduction was disallowed for a trust that restricted a surviving spouse's right to receive all of the trust income currently. Under similar circumstances, the marital deduction was denied in IRS Letter Ruling (TAM) 200505022.

Background

Generally, under the so-called "terminable interest rule" terminable interests do not qualify for the marital deduction; see Sec. 2056(b)(1). An exception is provided for both power of appointment trusts under Sec. 2056 (b)(5) and for qualified terminable interest property (QTIP) trusts under Sec. 2056(b)(7).

Power of appointment: Under Sec. 2056(b)(5), the marital deduction is available when a surviving spouse is given both a fife estate and a general power of appointment over a property interest. The surviving spouse must be entitled to all of the income from the property for life, payable at least annually, and must have the power to appoint the entire interest, or a specific portion thereof, free of trust to himself or herself or his or her estate. The surviving spouse's power must be exercisable by him or her alone and, in all events, either during life or via a will. Lastly, no person other than the surviving spouse can have the power to appoint the property to any other person except the surviving spouse.

QTIP: A marital deduction is available for QTIP property if an election is made under Sec. 2056(b)(7), and the surviving spouse is entitled for life to all of the income from the property, payable at least annually. No person, including the surviving spouse, can have a power to appoint any part of the property to any person other than the surviving spouse.

Whiting

Qualifying for the marital deduction can be frustrated by drafting errors and inconsistencies in the operative documents. Further, local law must be interpreted to determine the nature of the interest that passes to a surviving spouse. Amply illustrating these points is Est. of Merle Allen...