Exemption and Marital Deduction Planning

In order to properly understand and comprehend a client’s estate plans, professional advisors need to review or create a balance sheet demonstrating the titling, composition by asset type and value of the client’s gross estate along with copies of their current estate planning documents. These documents should inform the advisor as to how the client’s assets are to be disposed of and distributed at death, the formation of any entities to hold those assets, who is responsible for administering the plans and entities

and where taxes are to be paid from. This purpose of this paper is to assist professional advisors in  reviewing and interpreting estate planning documents in states that impose a state estate tax; specifically  how to identify the exemption and marital deduction planning that is so crucial to understanding the structure of any trusts money may be left to and how much will go into those entities given that state and federal exemptions differ.

Reviewing Documents Drafted between (2005 to 2010)

Prior to 2005 the Federal Estate tax gave a portion of the estate tax the IRS would have collected to the individual states through a limited credit under IRC. Sec. 2011. Essentially, any state that didn’t have a state estate tax was missing out on a free a free lunch because it cost the taxpayer no additional tax dollars for the state to collect what the federal government was offering. In 2005 it became necessary to consider the implications of the state estate tax and not just federal estate taxes because the federal government no longer gave a credit to the states for state estate taxes, which meant that any state estate tax now would be in addition to and not inclusive of the federal estate tax. This paper will assist professional advisors to identify and interpret estate exemption and marital deduction planning in existing estate planning documents as well as plan for the creation of new ones.

Most estate planning documents prior to 2005 planned for the use of the federal estate tax credit or exemption. Many documents after 2005 planned for the use of Federal and/or State exemptions by allocating assets between credit shelter trusts and marital trusts, otherwise known as A(Credit shelter)/B (marital) trust arrangements.


1. Avoid Federal estate tax, but pay state estate tax– if a document fully funded the federal exemption in a credit shelter trust in the state of MN the estate would have to pay the state  estate rate on the difference between the federal exemption funding a credit shelter trust ($5,120,000 in 2012) and the maximum state estate exemption ($1,000,000 in MN) causing approximately $405,200 in state estate taxes at the first spouses death depending on the state the client resides in because the $4,120,000 difference would not have been allowed the marital deduction.

2. Avoid Federal and state estate tax, but waste some federal exemption amount- simply fund an A trust (credit shelter) to the state estate tax exemption level and the rest to the B (marital).

3.    Avoid Federal and state estate tax, and fully use the exemption amounts, using an A/B/C trust design

In this design the A trust would hold the state exemption amount, the executor would make a state, but not federal QTIP election for the C trust, which would hold the difference between the

state and federal exemption amounts and the B trust would hold whatever remained. State Qtip elections are allowed in the following states Illinois, Maine, Maryland, Massachusetts, New York, Ohio, Oregon, Rhode Island, Tennessee, and Washington. Minnesota does not allow a state QTIP election.

The significance of a state QTIP election is that it qualifies for the marital deduction thereby deferring any state estate taxes until the death of the surviving spouse while allowing the full use of the federal exemption by use of the combined assets of the A and C trusts. QTIP trust assets must benefit only the surviving spouse during their lifetime.

4. Avoid Federal and estate tax, and fully use the exemption amounts, using the typical A/B trust design, except that the A Marital trust will use a QTIP Election for federal and state purpose- The personal representative can decide to make the QTIP election for all or a portion of the assets for state or federal purposes. The separate portions that are QTIP and non-QTIP can be segregated into separate shares. The advantage if this type of plan vs. the A/B/C trust is that the decision can be deferred as to how much of the assets must be used for the spouse (all QTIP trusts must only benefit the spouse during their lifetime) vs. how much can benefit other family members in the non-QTIP

Reviewing Documents Created after 2011

The enactment in 2011 of new federal estate tax laws that allowed for portability of the federal unused lifetime exemption between spouses created a new and relatively simple way for spouses to transfer and maintain their lifetime exemption at their death without the need for a credit shelter trust simply by election on an estate tax return at the first persons death. This makes the use of a credit shelter trust unnecessary solely as a way to capture the first spouse to die’s lifetime exemption. Still, portability may not solve all planning issues for the following reasons:

  1. Remarriage may eliminate some or all of its benefits.
  2. Some may prefer to put the higher amount in a credit shelter trust anyway in order to increase the value during the surviving spouse’s life and shield it from federal estate taxes.

The factors above make the use of disclaiming provisions that much more attractive and useful as a means of providing for planning flexibility. The disclaiming provisions don’t give a surviving spouse or heir any power they don’t already possess by state law, but they are helpful as a means of providing instructions and guidance as to how funds or assets should be managed if they are disclaimed.

Additional Planning Considerations

Tax payment directions in living trusts – Most practitioners believe it’s best to pay taxes from the marital trust in order to preserve as much of the nonestate taxable assets in the credit shelter trust as possible.

Gifting- Often times it may make sense to gift assets in during lifetime as there are no state gift taxes though, there may be state GST tax implications.

Domicile- Clients who already own property and spend significant time in states that don’t impose estate taxes may be able to preserve significant wealth by changing domicile.

Converting Real Tangible Property into Intangible Personal Property- Even if a client lives in a state that does not impose state estate taxes they may own significant real interests in states that do. In most instances states that impose estate taxes, do so on all real property located within their borders. It may be possible to transfer interest in real property to an entity like an LLC or partnership and save on state estate taxes if the state in question does not tax intangible property. However, some states tax both real and intangible property. Also, some states impose other types of taxes on intangible property that may for one reason or another make this an unsuitable option.

In closing, there are several different designs that you are likely to see if you review documents from a client in a state that imposes state estate taxes and may or may not have taken into account features that may or may not exist into future years like exemption portability.  Depending on the size and asset makeup of the estate, a credit shelter trust may still make sense, nevertheless, the purpose of this paper is to help advisors to at least better understand the existing designs in comparison to what is possible.


Hope this helps…

Jeremy P. Green CFP, CTFA, CLU, CEBS, MSFS, AEP, EA 
Wealth Strategist & Expert Witness Consultant
Wealth Strategist Designs
Cell: 612-405-0799

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