Part 7: Marital Deduction
By David A. Handler and Alison E. Lothes
Originally written for WealthManagement.com
In PLR 201410011 (released March 7, 2014), the taxpayer and his spouse signed a prenuptial agreement that provided for certain outright distributions to the spouse and a distribution to a marital trust for the spouse’s benefit at the taxpayer’s death. The taxpayer also executed a revocable trust, the terms of which provided for distributions to the spouse and marital trust in accordance with the prenuptial agreement. In addition, the revocable trust provided that the spouse could make an election to forgo the distributions required under the prenuptial agreement. In that case, the spouse and marital trust would receive different amounts.
The first issue was whether the spouse’s ability to elect against the prenuptial agreement would interfere with the marital deduction. Under IRC Section 2056(b)(1), the marital deduction isn’t permitted when, on the lapse of time, occurrence of an event or contingency or failure of an event or contingency to occur, an interest in property passing to the surviving spouse will terminate or fail such that an interest in that property passes to another person.
Treas. Regs. Section 20.2056(c)-2(c) provides that a surviving spouse may elect between a property interest under a will or other instrument and a property interest to which she’s otherwise entitled (such as dower, a right in the decedent’s estate or her interest under community property laws). The regulations clarify that if such an election is made, the property interest relinquished by the spouse isn’t considered as having passed from the decedent to the spouse, so it isn’t considered an impermissible terminable interest.
The ruling applied the regulations, prior revenue rulings and a Tax Court case to hold that the spouse’s right to elect was a “mere procedural formality.” Even though the spouse was electing against the contractual rights under the prenuptial agreement, rather than electing against a will or a statutory right, as had been the case in most of the rulings, the IRS didn’t find the distinction meaningful. In fact, it cited to a prior Tax Court case and revenue ruling that approved the marital deduction for property transferred to a spouse pursuant to an election between a life estate in trust or an outright cash bequest. In that case and ruling, the election was simply between two alternatives under the will, not between the will and a “property interest to which [the spouse] is otherwise entitled” under Treas. Regs. Section 20.2056(c)-2(c). Similar to these prior rulings, PLR 201410011 held that the spouse’s right to choose wasn’t a “contingency” that interfered with the marital deduction.
The second issue was whether preferred units in an LLC distributed to the marital trust would be eligible for the marital deduction. The IRS held that they were eligible because the marital trust contained the required provisions, notably that the trust’s net income was paid to the spouse at least annually, and the spouse could request that unproductive assets be made productive. Furthermore, the structure of the LLC allowed the spouse to enjoy the LLC units in a similar manner as a life beneficiary of a trust: The marital trust would be entitled to an 8 percent return on the preferred units, payable annually; the LLC couldn’t redeem the preferred units for less than the greater of face or market value; and the operating agreement couldn’t be amended or restated without the affirmative vote or consent by all preferred members.