Using QTIP Trusts

Planning With QTIP

With a QTIP trust, the surviving spouse can be given a testamentary power to appoint gifts to a limited class of beneficiaries, including the surviving spouse. No person other than the surviving spouse can appoint any part of the QTIP trust property to any beneficiary or person other than the surviving spouse.

Complex wills often use marital (A) and nonmarital (B) trusts. Some estate planners recommend three trusts rather than two, particularly for planning for larger estates: in addition to the A and B trusts, a QTIP or "C" trust is added to provide additional flexibility with respect to estate tax planning and control over estate assets. A QTIP trust might be used, for example, where the testator is reluctant to leave the bulk of the estate in the control of a surviving spouse, perhaps leaving the surviving spouse the income interest but vesting power in the executor or personal representative to elect marital deduction treatment for trust QTIP assets if circumstances indicate such an election is advisable.

QTIP Trust Defined

A QTIP trust is a testamentary trust (created under the decedent`s will and taking effect on the date of death) creating a life income interest in a surviving spouse with a direction that trust corpus may not be used for anyone other than the surviving spouse during the survivor`s lifetime [I.R.C. §2056(b)(7)].

Recall that qualified terminable interest property must:

1. pass from the decedent, creating a "qualifying income interest for life" in the surviving spouse (the surviving spouse must be entitled to all income from the property, payable at least annually);
2. be assets for which an election is made by the executor on the federal estate tax return (the election, once made, is irrevocable); and
3. comprise assets of the decedent`s estate with respect to which no other person has a power to appoint any part thereof to any person other than the surviving spouse.

The executor must affirmatively elect to have QTIP trust property qualify for the unlimited federal estate tax marital deduction. Where no estate has been opened or there is otherwise no executor or personal representative, a person in actual or constructive possession of QTIP trust assets can make the required election. Fractional or percentage elections are permitted [I.R.C. §§2044, 2519; Temp. Reg. §2.2056-1].

QTIP Trust Elections

Why would an executor or personal representative elect unlimited marital deduction treatment for QTIP assets? Where the election only defers the estate tax until the second death and may increase the aggregate estate tax, for example where the survivor has a larger estate than the first spouse to die, it can be advantageous not to make the QTIP trust election on the federal estate tax return.

The relative size of the two estates, age and other factors should be considered by the executor/personal representative.

Advantages of QTIP Trusts:

QTIP trusts add flexibility to the testator`s estate plans and should be explained to the client in detail by the estate and financial planner during the estate planning process.

The principal advantage lies in increased flexibility. Before 1982, the testator was required to make an outright bequest to a spouse in order for the gifted property to qualify for the marital deduction. The testator was often forced to make a difficult choice between preserving the marital deduction for estate assets and running the risk of those assets ending up in the hands of a surviving spouse`s new family in the event of remarriage.

A QTIP trust allows the testator to direct ultimate control over trust assets by creating lifetime income to a surviving spouse with directions as to disposition of the remainder, for example, to children or grandchildren. The best of both worlds is possible under a QTIP trust by: (a) permitting elective marital deduction treatment for trust assets after the testator`s death at a time when the personal representative can take into consideration changing circumstances of the surviving spouse and other beneficiaries; and (b) by retaining control and flexibility with respect to ultimate disposition of QTIP trust assets to a beneficiary other than the surviving spouse while providing the surviving spouse with lifetime income from the QTIP trust assets. Alternatively, it can be advisable to empower the surviving spouse to assess changing circumstances among ultimate beneficiaries under a special power of appointment to distribute QTIP trust corpus among children or grandchildren according to needs at or near the time of final distribution, i.e. the second death.

Suppose the surviving spouse assigns "qualifying income interest for life." Can the estate tax be avoided? Yes, but Code §2519 provides that the spouse makes a gift of the property that produces the income, rather than just a gift of the remaining income interest. This applies to "qualifying income interests for life" acquired under either the gift tax marital deduction or the estate tax marital deduction.

Code §2207A provides that the ultimate recipient of the property in which the spouse has a terminable interest is liable for any gift tax or estate tax attributable to such property. In the case of the estate tax, the decedent can direct otherwise by will.

Excerpted from onlineAUS Library Section 2, Sub Heading G