Guarding Marital Deductions

P roperty passing from a decedent to the surviving spouse generally qualifies for the marital deduction under IRC section 2056. But a terminable interest, such as a life estate in a trust created by someone other than the person receiving it, generally does not qualify. IRC sections 2056(b)(5) and (b)(7) allow the marital deduction for a terminable interest only if the surviving spouse is entitled for life to all the income from the interest and has power over the principal of the trust, and if no other person has power to direct any part of the interest to a person other than the spouse. Treasury regulations section 20.2056(b)-5(f)(6) indicates that to meet these standards, a surviving spouse must show that he or she “is entitled to the income until the trust terminates or has the right, exercisable in all events, to have the principal distributed to her at any time during her life.”

In the Davis case, Mr. Davis’s trust agreement required that all income of the trust be distributed to his widow and said she could invade the trust principal if the income was insufficient to maintain her health, support and maintenance. Although Mrs. Davis was the trustee and the one who could determine whether the trust income was insufficient, the IRS concluded she did not have the necessary right to have the principal distributed to her. Therefore, the life interest did not qualify for the marital deduction.

Result. For the IRS. The Ninth Circuit determined the terms of the trust were unambiguous: Mr. Davis had left to his widow “an interest limited to the amount of income proper for her health, education, or support, maintenance, comfort and welfare in accordance with her accustomed manner of living;” she, therefore, did not have complete control of the trust income. Consequently, the life estate left to Mrs. Davis did not qualify for the marital deduction.

Estate planners should take care that qualified terminable interests designed to qualify for the marital deduction carefully duplicate the requirements of IRC section 2056(b)(5) and (7) and regulations section 2056(b)-5. Departures from the very specific requirements of these provisions may result in the loss of the marital deduction.

Davis v. Commissioner, 95 AFTR 2d 2005-667, 01/24/2005 (CA-9).

Prepared by Do-Jin Jung, PhD, CMA, CFM, assistant professor of accounting, and Darlene Pulliam, CPA, PhD, professor of accounting, both of West Texas A&M University, Canyon.