Deferring, minimizing, or avoiding estate taxes altogether is often an important estate planning goal for married couples. However, uncertainty surrounding what the estate tax laws and the value of their accounts and property will be at the first spouse’s death can leave a couple feeling that they need a crystal ball to make the right decisions. Using either a disclaimer or the so-called Clayton election as part of their estate plan can allow at least some hindsight and, consequently, peace of mind.
Marital Deduction Planning and Marital Share Funding Formulas
Before diving into some of the particulars of using a disclaimer and the Clayton election, let us first lay some conceptual groundwork. The main objective of using a marital funding formula in estate tax planning is to take advantage of both (1) the estate tax marital deduction and (2) the estate tax exemption to eliminate the federal estate tax due at the first spouse’s death and to reduce or eliminate federal or Minnesota estate tax due at the surviving spouse’s death.
What is the marital deduction? In general, as long as they meet the requirements under federal estate tax law, transfers from a decedent spouse to a surviving spouse (provided the surviving spouse is a US citizen) are excluded from the decedent spouse’s estate and are not subject to estate taxes at the first spouse’s death. This is the “unlimited estate tax marital deduction”. The unlimited estate tax marital deduction essentially postpones the payment of any estate taxes until after the second spouse’s death.
The general concept of the estate tax exemption is that, if the value of your estate is less than the exemption amount, no federal estate tax is due. The 2024 exemption amount for an individual is $13.61 million. Under current law, the exemption amount will be reduced to $5 million (adjusted for inflation) on January 1, 2026. Currently, a 40 percent tax is imposed on the estate to the extent that its value exceeds the exemption amount. The current exemption amount for Minnesota residents is $3 million. Minnesota estate tax rates vary from 13 percent to 16 percent.
Marital share funding formulas use both concepts to eliminate federal and Minnesota estate tax to the greatest extent possible. In essence, because the unlimited estate tax marital deduction allows estate tax liability to be postponed until the second spouse’s death, the first decedent spouse’s estate plan should use a formula to divide the their estate into two shares: (1) the marital share, which is the part of the decedent spouse’s estate that passes to the surviving spouse in a form that qualifies for the unlimited estate tax marital deduction, and (2) the nonmarital share, which is the part of the decedent spouse’s estate that does not qualify for the unlimited marital deduction but is instead sheltered by the decedent spouse’s remaining estate tax exemption amount.
Disclaimer
There are numerous different ways to divide a couple’s trust property into marital and nonmarital shares upon the first spouse’s death, but the disclaimer option gives the surviving spouse the most flexibility. Using the disclaimer option, the trustee or executor distributes all the decedent spouse’s trust property to the marital share. The surviving spouse may then exercise a qualified disclaimer (refusal to take ownership of money or property left to them by their deceased spouse) under Internal Revenue Code section 2518, and the trustee distributes any property disclaimed by the surviving spouse to the nonmarital share, which can be either held in trust for the benefit of the surviving spouse (and other beneficiaries if desired) or otherwise administered under the trust agreement’s residuary provisions.
With the disclaimer option, the surviving spouse can choose to give any amount or property they wish to the nonmarital share, depending on the estate tax law in effect at the time of the first spouse’s death, the value of the decedent spouse’s estate, and the surviving spouse’s financial needs. This can add even more flexibility for Minnesota residents who are facing estate tax at the federal level and the state level.
Clayton Election
The Clayton election, named after the court case Estate of Clayton, Jr. v. Commissioner,[1] is another formula used to divide a couple’s trust property into marital and nonmarital shares. It also provides maximum flexibility to engage in marital deduction planning after the first spouse’s death. The way the Clayton election works is almost the opposite of the disclaimer option. Instead of distributing all the decedent spouse’s trust property to the marital share, the trustee distributes it to the nonmarital share. The trustee may then list any property on Schedule M—Bequests, etc., to Surviving Spouse (Marital Deduction) of the decedent spouse’s IRS Form 706 (the federal estate tax return) to allocate it to the marital share instead.
An potential advantage of the Clayton election, in contrast to the disclaimer option, is that its technical requirements and timelines are less rigid. While a disclaimer must be made within nine months after the first spouse’s death, a Form 706 is not due until up to fifteen months (or possibly twenty-four months if the executor is not required to file an estate tax return but files to elect portability) after the first spouse’s death, allowing more time to grieve and for making a less emotion-driven decision. Another potential advantage of the Clayton election is that it allows someone other than the surviving spouse to objectively decide what property should be apportioned to the marital and nonmarital shares. In addition, because a Form 706 must be filed when using the Clayton election option, there is the opportunity to claim for future use any unused amount of the decedent spouse’s estate tax exemption. Finally, because the Clayton election sends the decedent spouse’s property into a nonmarital share trust by default, the surviving spouse automatically receives those accounts and property in a form that offers a degree of creditor protection.
Whether to use a marital formula in your estate plan, and which marital formula to use, requires considerable analysis of your estate, your goals, and the law. Contact us to put in place or review your plan to ensure that it will meet all your goals, including deferring, minimizing, or eliminating the estate tax that your heirs will pay.
[1] Estate of Clayton, Jr. v. Comm’r, 976 F.2d 1486 (1992).
