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									        Residuary v. Pecuniary
                     Marital Deduction
                                  Bequests Revisited

                                                    Don Llewellyn and Julia B. Fisher

                            Recent changes have made the choice between
                              residuary and pecuniary marital deduction
                                        bequests even more complicated.



THERE ARE THREE APPROACHES to draft-                           Each method produces the same marital deduc-
ing an estate plan that divides the estate into                tion amount for estate tax purposes, but the in-
credit shelter and deductible marital shares.                  come and generation-skipping transfer tax con-
Those three alternatives are:                                  sequences are markedly different.
• A pecuniary marital bequest followed by a                       Three recent developments have increased
residuary credit shelter;                                      the complexity of the decision to use a pecu-
• A pecuniary credit shelter followed by a                     niary or residuary marital deduction bequest.
residuary marital bequest; and                                 First, the 1998 legislation that changed retroac-
• A fractional share division of the residuary                 tively the section 2033A exclusion for a qualified
estate into marital and credit shelter fractional              family-owned business interest (“QFOBI”) to a
shares.                                                        section 2057 deduction will influence the choice


Don Llewellyn is Professor of Law at Villanova University School of Law, where he served as Director of the Graduate
Tax Program and as Dean of Graduate Legal Studies. Julia B. Fisher is a partner in the Philadelphia law firm of Erskine,
Wolfson, Gibbon & Fisher and currently serves as Vice Chair of the Fiduciary Income Tax Committee of the ABA Section
of Taxation. The authors have just published the 2000 supplement to Tax Planning for Lifetime and Testamentary
Dispositions—Prototype Plans, published by ALI-ABA. For more information on the book and supplement, call 1-800-
CLE-NEWS, or visit ALI-ABA’s web site at www.ali-aba.org.

                                                             25
26     The Practical Tax Lawyer                                                            Spring 2000



of a pecuniary marital bequest if the spouse is      planning purposes because of the double de-
the qualified heir. Also, two sets of recently fi-   duction prohibition of section 2056(b)(9), which
nalized regulations (the estate separate share       provides that “nothing in this section or any
and the Hubert regulations) will have a direct       other provisions of this chapter shall allow the
impact on structuring the marital bequest, al-       value of any interest in property to be deducted
though neither should be a deciding factor in        under this chapter more than once with respect
the choice of a pecuniary or residuary bequest.      to any decedent.”
This article examines these recent develop-             The original intent of section 2056(b)(9) ap-
ments and suggests responses to them.
                                                     parently was to prevent a charitable deduction
                                                     for a remainder interest in a section 2056(b)(7)
QUALIFIED FAMILY-OWNED BUSINESS
                                                     qualified terminable interest property (“QTIP”)
INTEREST DEDUCTION • The requirements
                                                     trust at the death of the first spouse to die.
under section 2057 for obtaining an estate tax
                                                     Nevertheless, Schedule T of Form 706 (revised
deduction for a qualified family-owned busi-
                                                     July 1999) applies section 2056(b)(9) to require
ness interest (limited to $675,000) are too com-
                                                     the elimination of a section 2057 deduction to the
plicated to summarize completely here. In gen-
                                                     extent that a marital deduction is allowed for the
eral, the QFOBI must pass from the decedent to
a qualified heir or be acquired from the dece-       same interest. If some portion of the QFOBI was
dent by a qualified heir. §2057(b)(1)(A), (2)(B).    used to fund a zero-tax marital deduction for-
(All section references are to the Internal Rev-     mula residuary bequest, the reduction in the
enue Code unless otherwise indicated.) The           QFOBI would lead to a concomitant increase in
terms “qualified heir” and “qualified family-        the marital formula bequest. Although there is
owned business” are defined, as are the other        no statutory authority for a partial QFOBI elec-
qualification requirements, by the statute, and      tion, if such a partial election could be made it
are beyond the scope of this article.                could be parlayed in tandem with the marital
                                                     deduction to obtain the maximum effect.
“Passing” by Post Mortem Purchase                       For example, if the QFOBI interest was val-
   One element of section 2057 must be noted,        ued at $1.675 million and $1 million of that in-
however, because it has a direct bearing on mar-     terest was needed to fund a marital deduction
ital deduction planning goals. That element is       residuary bequest, could a partial election be
the “passing” or “acquiring” requirement un-         made for an undivided fractional share of the
der section 2057, which interestingly can be sat-    whole QFOBI equal to $675,000 and the other $1
isfied by a post mortem purchase by a qualified      million interest be used to satisfy the marital be-
heir. This ability to meet the passing or acquir-    quest with no concomitant reduction in the sec-
ing requirement by a post mortem purchase has        tion 2057 deduction? If so, the result would be
very direct ramifications on the determination       that the entire value of that interest would be
of whether to use a pecuniary or residuary mar-      deductible, either as a marital deduction or a
ital deduction bequest.                              section 2057 deduction. There does not appear
  Being able to satisfy the passing requirement      to be any requirement that the election be with
by a sale is significant for marital deduction       respect to any specific portion of the business,
                                                                      Marital Deduction Bequests      27



such as specific shares of a corporation or spe-       property. Treas. Reg. §1.661(a)-2(f)(1). Out of an
cific acreage of a farm.                               abundance of caution, such a bequest should not
   The new Schedule T of Form 706 does permit          contain any funding instructions that would
a partial section 2057 election. The instructions      prevent funding the bequest at date-of-distribu-
to line 15 of Schedule T of the Form 706 provide,      tion values, so that the funding transfer would
inter alia: “For example, if a trade or business in-   be a true sale. The better result under a pecu-
terest that is a qualified family-owned business       niary marital bequest is another factor to consid-
interest passes to the surviving spouse and you        er in selecting a pecuniary or residuary marital
choose to deduct it on Schedule M, you may not         bequest when a QFOBI deduction is desired.
deduct on Schedule T the part of its value de-
ducted on Schedule M.” (Emphasis added.)               HUBERT REGULATIONS • Section 2056(b)(4)
                                                       requires a reduction in the value of marital
Partial Election and Reduction in the QFOBI            property to take account of the effect on the net
   It is not precisely clear how such a partial        value of property passing to the surviving
election will interface with the requirement for a     spouse of (1) tax imposed by section 2001, or
reduction in the QFOBI under section 2056-             any estate, succession, legacy or inheritance tax,
(b)(9). Obviously, section 2056(b)(9) will not be a    or (2) if such property is encumbered in any
problem when the QFOBI is used to fund a non-          manner or if the spouse incurs any obligation
charitable, nonmarital bequest. There also ap-         imposed by the decedent with respect to the
pears to be no reason why the surviving spouse         passing of such property. Treas. Reg. §20.2056-
or a marital trust (even a residuary trust) could      (b)-4(a), promulgated in 1958 in connection
not acquire the QFOBI property by purchase at          with that provision, provided for a reduction in
some later time, following satisfaction of the be-     the value of marital deduction property to the
quest. Section 2057(e)(3)(C) provides that an in-      extent there is a material limitation on the right
terest owned by an entity shall be considered as       to the income of such property. That rule was to
owned by the entity’s beneficiaries. The next          be applied, for example, when all estate admin-
sentence of section 2057(e)(3)(C) provides that a      istration expenses were charged to the income
person shall be treated as a beneficiary of a trust    from the marital property. Treas. Reg. §20.2056-
only if such person has a present interest in the      (b)-4(a) provided, inter alia:
trust. When that provision is read in its entirety     “In determining the value of the interest in
it is clear that a surviving spouse would be           property passing to the spouse account must be
treated as the only beneficiary of a section           taken of the effect of any material limitation
2056(b)(5), (7) or (8) marital trust and thus the      upon her right to income from the property. An
purchasing marital trust would be equated with         example of a case in which this rule may be ap-
the surviving spouse.                                  plied is a bequest of property in trust for the
   If the marital bequest is a pecuniary bequest       benefit of the decedent’s spouse but the income
rather than a residuary bequest, the bequest ap-       from the property from the date of the dece-
parently could be satisfied with the QFOBI ini-        dent’s death until distribution of the property to
tially, because funding a pecuniary bequest with       the trustee is to be used to pay expenses in-
a specific property is treated as a sale of that       curred in the administration of the estate.”
28     The Practical Tax Lawyer                                                             Spring 2000


Final Regulations                                    ment advisory fees, stock brokerage commis-
   The Supreme Court decision in Commissioner        sions, custodial fees, and interest. Estate trans-
v. Estate of Hubert, 520 U.S. 93 (1997), which ad-   mission expenses are defined as “expenses that
dressed the circumstances under which the use        would not have been incurred but for the dece-
of income to pay estate administration expens-       dent’s death and the consequent necessity of
es would constitute a material limitation on in-     collecting the decedent’s assets, paying the
come that instead should be available to a mar-      decedent’s debts and death taxes, and distribut-
ital bequest and thus cause a reduction in the       ing the decedent’s property to those who are en-
value of the bequest, led to the amendment of        titled to receive it.” Estate transmission expens-
this regulation. In response to the Hubert deci-     es include “any administration expense that is
sion, Proposed Regulations were published on         not a management expense” such as those in-
December 16, 1998 amending Treas. Reg.               curred in collection of the assets, payment of
§20.2056(b)-4(a) by substituting a different test    death taxes and the decedent’s debts, and dis-
in lieu of the material limitation of income re-     tribution expenses. Examples of transmission
quirement. The proposed regulations were fi-         expenses include executor’s commissions and
nalized on December 2, 1999. T.D. 8846. The          attorney fees (except to the extent specifically re-
final Hubert regulations provide a new standard      lated to investment, preservation, or mainte-
which is guided—but not controlled—by sound          nance of the assets), probate fees, appraisal fees,
fiduciary accounting principles. The amended         and will construction and contest costs.
regulations require a reduction in the value of
the marital deduction property interest to the       Application to a Typical Plan
extent the property is charged with estate trans-       The final regulations include the following
mission expenses, but not estate management ex-      examples of the application of the general rules
penses, incurred in connection with the marital      to a typical, zero-tax marital estate plan:
property interest during administration of the          “Example 5. The decedent dies after 2006 hav-
decedent’s estate. (Management expenses in-          ing made no lifetime gifts. The value of the
curred in connection with nonmarital property        decedent’s residuary estate on the decedent’s
interests require a reduction in the value of mar-   date of death is $3,000,000, before the payment
ital deduction property unless the expenses are      of administration expenses and Federal and
deducted on the estate tax return.) It no longer     State estate taxes. The decedent’s will provides
is relevant whether the expense is charged to        a formula for dividing the decedent’s residuary
principal or income.                                 estate between two trusts to reduce the estate’s
                                                     Federal estate taxes to zero. Under the formula,
Management and Transmission Expenses                 one trust, for the benefit of the decedent’s child,
   Estate management expenses are defined as         is to be funded with that amount of property
expenses incurred in connection with invest-         equal in value to so much of the applicable ex-
ment of estate assets and with the preservation      clusion amount under section 2010 that would
and maintenance of those assets during the pe-       reduce the estate’s Federal estate tax to zero.
riod of administration. Treas. Reg. §20.2056(b)-     The other trust, for the benefit of the surviving
4(d)(1)(i). Examples of such expenses are invest-    spouse, satisfies the requirements of section

								
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