Spousal Transfers

Wealth transfer of one's separate property or share of community property to a spouse is a common and efficient method of preserving a family's lifestyle after the death of one of the partners. Spousal transfers may be made during lifetime of the spouses, or upon the death of the first of them to die. Basis "step-up" considerations make testamentary spousal transfers particularly attractive, especially in community property states where both shares of their community property receive the step-up. Spousal transfers are federal transfer tax-free under current law and are likely to remain so.

All of these benefits, however, do not suggest that an outright transfer of one spouse's property to a surviving spouse is in the best interest of the family. From a federal estate tax perspective, such an outright transfer serves to create or increase the taxable estate of the second spouse to die, resulting in estate tax payable where none would be required with simple planning. Current transfer tax law provides each individual with a transfer tax credit. This credit translates into a lifetime amount that every individual can transfer without out-of-pocket payment of estate taxes. The tax credit of the first spouse to die is wasted if all of that spouse's assets pass outright to the surviving spouse. While this may become a "non-issue" in the unlikely event the federal estate tax is completely eliminated, it remains a significant issue even in the event of a substantial increase in the estate tax credit for each individual. A "credit shelter trust" in a decedent's will can provide income to the decedent's surviving spouse for life, plus give the trustee the right to invade trust corpus for the surviving spouse's benefit, yet keep the value of the trust corpus out of the federal gross estate of the surviving spouse. Properly structured, the surviving spouse has nearly unlimited rights to the decedent's property (as with an outright transfer), but with potentially significant reduced taxes in transfers to children at the second death.

Transfer tax considerations aside, the use of trusts in spousal transfers can provide income and asset protection for the surviving spouse, and at the same time ensure that the remaining trust assets pass to the first decedent's intended beneficiaries upon the death of the second spouse. An outright transfer of one's assets to a surviving spouse raises the possibility that subsequent events (remarriage followed by premature death or divorce, for example) may result in one's intended beneficiaries receiving nothing or significantly less than intended.

Testamentary trusts for the benefit of a surviving spouse may also provide for professional management of trust assets and protection from creditors not provided by an outright transfer. Typically, a combination of a tax credit shelter trust and a trust providing lifetime benefits for the surviving spouse provide an excellent combination to ensure income and asset availability to the surviving spouse as well as asset protection for the benefit of intended remainder beneficiaries.

©2008 Ronnie C. McClure, PhD, CPA