Pay Early, Pay Less: Maximizing TPT Credit Availability for Married Couples

The federal estate tax credit allows married couples to save on taxes when one spouse dies within 10 years of the other. This happens because some of the property transferred from the first spouse to the second spouse is not subject to tax in the second spouse’s estate. As a result, the combined estate tax paid by the spouses is lower. When figuring out the TPT credit, the first step is to see if the person who gave the property (transferor) actually gave something to the person who received it (transferee) that was included in the transferor’s estate. “Transfers” can include things like getting property through marriage, as the surviving owner of joint property, as a life insurance beneficiary, under a will with a power of appointment, or as the person who gets property after someone else with a power of appointment gives it up or doesn’t use it. “Property” is defined as any interest in property, including a power of appointment. These broad definitions allow for big tax savings for the person who receives the property when they die. The TPT credit has two limits: 1) the amount of FET owed by the transferor spouse’s estate, and 2) the amount owed by the transferee spouse’s estate. The first limit is calculated by multiplying the transferor’s FET liability by the value of the transferred property and dividing by the transferor’s taxable estate. The second limit is a bit more complicated, as it involves subtracting the greater FET liability on the transferee’s estate from the lesser FET liability. This calculation can be tricky, especially when dealing with charitable and marital deductions in the transferee’s estate. If the spouse who received the property from the deceased spouse dies within two years, they get 100% of the tax credit. If they die within 2-10 years, the credit decreases based on when they died. If they survive more than 10 years, they don’t get any tax credit. Married couples often create a plan to benefit each other after one spouse passes away. This plan involves setting up a trust for the first spouse’s assets, with the remaining assets going into one or two income trusts for the surviving spouse. This helps limit the federal estate tax (FET) liability. The decision to use the trust credit or not needs to be made before the FET is due. If the surviving spouse is older, it becomes a gamble on their life. The trust credit is only better than a full trust deduction when certain conditions are met. When one spouse passes away, the surviving spouse will have certain rights to the trust income from the marital trust. The value of these rights is determined based on the fair market value of the trust assets and the age of the surviving spouse. This value can help reduce the amount of tax the couple has to pay. The younger the surviving spouse, the more tax savings the couple may receive. When a spouse transfers their rights to income from a trust to their partner, the value of this transfer is usually determined using mortality tables. However, there are some exceptions to this rule. If both spouses die at the same time, the value of the trust income will be zero. If the receiving spouse is terminally ill when the transferor spouse dies, the value of the trust income may also not be determined using mortality tables, unless certain conditions are met. Additionally, if it is uncertain whether the receiving spouse will actually receive the trust income, the value of the transfer may not be determined using mortality tables. Courts and the IRS have disagreed on when the transfer of trust income will qualify for certain tax credits, and there are rules about how a trustee can use trust funds to support the receiving spouse. Simply put, if one spouse gives the other spouse the power to control certain property, it can help reduce taxes when the first spouse passes away. This power must be given up by the second spouse before they pass away in order to get the tax benefit. If the second spouse doesn’t use this power, it will be treated as a gift for tax purposes, but there are limits to how much can be considered a gift. The IRS has said that these powers can qualify for the tax benefit, even if they are only used for a short time. The IRS looks at whether a power of appointment (GPOA) can be valued on the date of the transferor spouse’s death to determine if it qualifies for a tax credit. It’s important for the power to be immediately exercisable and not tied to a specific day of the year. To maximize the tax credit, the transferee spouse can be given all trust income annually for life, but this may not be what the clients want. Also, giving the transferee spouse too much control over the trust could expose the assets to creditors. So, it’s important to consider non-tax factors when planning an estate. In estate planning, it can be difficult to convince clients to prioritize tax benefits over other benefits. Even if a tax benefit is well-established, some clients may be hesitant to pay taxes sooner than necessary. In these cases, lawyers may want to consider alternative options, such as a disclaimer trust, to give the surviving spouse more control over trust assets. However, even with these alternatives, it’s important to consider the potential advantages of the tax benefit and run the numbers to see if it’s worth paying taxes early. This section discusses the rules for transferring property between married couples to minimize estate taxes. It explains how to calculate the estate tax and the limitations on the amount of tax owed. It also mentions the use of QTIP trusts to maximize the GST tax exemption. In simple terms, it’s about how to transfer property between spouses to avoid paying a lot of taxes. In a typical estate plan, the assets of the first spouse to die go into a trust, with some going to the surviving spouse and some to other beneficiaries. The surviving spouse may also have a say in how the trust assets are distributed. If the surviving spouse is in poor health, special rules apply. These rules are supported by many court cases. If the surviving spouse lives for at least 18 months after the first spouse dies, they are presumed to not be terminally ill unless there is strong evidence to the contrary. In a nutshell, when a person transfers property with a life estate to someone else, the value of the life estate may need to be calculated for tax purposes. There have been cases where the tax credit for this type of transfer was denied because the trustees had too much control over how the income from the property was used. This happened in cases where the trustees could invest in unproductive property, had unlimited discretion to distribute income, or could give the income to the spouse and children. In one case, the lifetime income interest couldn’t even be valued because the trustee could distribute income based on the spouse’s standard of living and other sources of income. In another case, the spouse’s lifetime income interest was only guaranteed if her other income fell below a certain amount and if the trust had enough income left. In a court case, the Eastern District Court of Virginia allowed a credit for a spouse’s income interest in a trust, even though the trust allowed the trustee to add income to the trust’s principal. Other courts have also allowed credits for similar trusts. The IRS has issued rulings on when a trust qualifies for the credit. It’s important that the surviving spouse doesn’t have too much power over the trust at their death. If the spouse dies at the same time as the person who set up the trust, the credit will be disallowed. David Pratt is a lawyer who specializes in personal planning and managing a law office in Boca Raton. He has a lot of experience and is recognized for his expertise in tax and estate law. Michael Rosenblum is a lawyer who also works in the personal planning department. He studied English and law at different universities and is licensed to practice law in several states. This information comes from a column submitted by the Tax Law Section of The Florida Bar.

Source: https://www.floridabar.org/the-florida-bar-journal/pay-early-pay-less-maximizing-tpt-credit-availability-for-married-couples/