Lifetime gifts between a husband and wife, and spouse to spouse bequests upon death, will pass to the spouse without liability for estate tax or gift tax. This unlimited deduction on gifts between spouses is known as the marital deduction. 26 USC §2056.

There are exceptions to the marital deduction that you should discuss with your financial planner and estate planning counsel. For example, a life estate does not qualify for the marital deduction. 26 USC §2523. The same section of the Internal Revenue Code also says that there is no marital deduction "where, on the lapse of time, on the occurrence of an event or contingency, or on the failure of an event or contingency to occur, an interest passing to the surviving spouse will terminate or fail."

Estate and gift taxes are not the only issues. Income taxes must also be considered when you are thinking about transferring assets between spouse. Half the value of qualified spousal property held as "joint tenants" or "tenants by the entirety" gets a step up in basis, when the interest passes to a surviving spouse upon death, and the deceased spouse was the only other joint owner. This rule, giving a step up in basis to 50% of the qualified jointly owned property, applies to spousal joint interests created after 1976. 26 USC §2040(b).

Old rules apply to jointly owned spousal property acquired before 1977. Under those pre-1977 rules, if a husband provided all consideration for jointly owned real property, the entire value of the property would be included in the husband's estate if he was the first to die. So, 100% of the property would receive a step up in basis from the husband's estate under Section 1014.

Be careful with deathbed conveyances. §1014(e) says that property that is transferred by a donor to a decedent within 1 year before the decedent's death, and then passes back to the donor will end up with the "the adjusted basis of such property in the hands of the decedent immediately before the death of the decedent." This is one of four exceptions the the step up in basis under Section 1014, which otherwise "steps-up" the basis of property in the hands of a person acquiring the property from a decedent to the fair market value of the property at the date of the decedent’s death. The other three exceptions are:

1. §1014(c): Property representing income in respect of a decedent- Section 691 - amounts of gross income that the decedent was entitled to prior to death. Section (c) preserves the income element of amounts received after death, rather than giving them the status of property with a fair market value at death basis. The survivors who are taxed on this IRD are allowed a deduction for the federal estate tax attributable to the IRD.
2. §1014(b)(9): Joint tenancy property to the extent the surviving joint tenant was not a contributor.
3. §1014(9): Depreciation that was taken by a surviving joint tenant to the extent he was not a contributor.

We can help protect your marital deduction with a comprehensive estate plan that includes a marital trust.