The federal estate marital deduction provides for a deduction from a decedent’s gross estate for property passing to a surviving spouse by will or trust, or by a qualified terminable interest property (“QTIP”) marital trust. The marital deduction is unlimited in amount.

A QTIP marital trust properly drafted in compliance with the Internal Revenue Code has become an extremely popular device to avoid payment of federal estate taxes upon the death of the first spouse. A QTIP trust is particularly desirable for spouses in second marriages where each spouse desires to leave as much of his or her estate to his or her children and/or heirs.

Where property is left outright by a decedent spouse to a surviving spouse by trust without a separate marital trust that qualifies under I.R.C.§ 2056(b)(7), that spouse then owns such property and would have the right to leave such property to his or her children and/or heirs, instead of the decedent’s (first spouse to die) children and/or heirs. The decedent’s children and/or heirs would not have any legal right to such property left to a surviving spouse under the terms of such a trust. In second marriages, this is usually not the desired or intended result.

I.R.C. § 2056(b)(7) is the Internal Revenue Code provision which allows the QTIP marital trust marital deduction. It provides:

(7) Election with respect to life estate for surviving spouse.–

(A) In general.–In the case of qualified terminable interest property–

(i) for purposes of subsection (a), such property shall be treated as passing to the surviving spouse, and

(ii) for purposes of paragraph (1)(A), no part of such property shall be treated as passing to any person other than the surviving spouse.

(B) Qualified terminable interest property defined.–For purposes of this paragraph–

(i) In general.–The term “qualified terminable interest property” means property–

(I) which passes from the decedent,

(II) in which the surviving spouse has a qualifying income interest for life, and

(III) to which an election under this paragraph applies.

(ii) Qualifying income interest for life.–The surviving spouse has a qualifying income interest for life if–

(I) the surviving spouse is entitled to all the income from the property, payable annually or at more frequent intervals, or has a usufruct interest for life in the property, and

(II) no person has a power to appoint any part of the property to any person other than the surviving spouse.

Subclause (II) shall not apply to a power exercisable only at or after the death of the surviving spouse. To the extent provided in regulations, an annuity shall be treated in a manner similar to an income interest in property (regardless of whether the property from which the annuity is payable can be separately identified).

(iii) Property includes interest therein.–The term “property” includes an interest in property.

(iv) Specific portion treated as separate property.–A specific portion of property shall be treated as separate property.

(v) Election.–An election under this paragraph with respect to any property shall be made by the executor on the return of tax imposed by section 2001. Such an election, once made, shall be irrevocable.

Thus, to qualify as a separate QTIP marital trust, the surviving spouse must be entitled to all income for life, payable annually, or at more frequent intervals, and no one including the spouse may appoint the property to any other person during the spouse’s life. The decedent’s executor must make an irrevocable election on the estate tax return. The decedent may therefore leave the principal of property held in a QTIP marital trust to his children and/or heirs under the terms of such marital trust, upon the death of the surviving spouse, while providing income from the marital trust to his surviving spouse during her lifetime. The decedent, and not the surviving spouse, then controls the ultimate distribution of property held in a QTIP marital trust. The decedent’s QTIP marital deduction trust”qualifies” for the federal estate tax deduction because it is not deemed to be a”terminable” interest, and such property is therefore treated under the Internal Revenue Code as passing to the surviving spouse, and constitutes a marital deduction for the decedent’s estate.

It is not advisable to leave all of one’s property to a surviving spouse for federal estate tax reasons, if in doing so, the value of the surviving spouse’s estate will then exceed the applicable exclusion amount for federal estate taxes, currently $2,000,000. Instead, it is then advisable for the decedent (first spouse to die) to take advantage of the full applicable exclusion amount (now $2,000,000) by leaving the maximum amount of property (now $2,000,000) in a decedent’s trust (also known as a bypass or credit shelter trust), so that there is no federal estate tax owed by decedent’s estate. Otherwise, when the surviving spouse dies, the federal estate tax then owed by the surviving spouse’s estate will include property which has passed to such spouse, but which could have been”sheltered” in decedent’s estate. The result is that federal estate taxes owed by the surviving spouse’s estate will be much higher than they otherwise would have been. It is possible depending on the size of both spouse’s estates to completely avoid the payment of any federal estate taxes for both spouse’s estates with a QTIP marital deduction trust. There still may be federal estate taxes owed by the surviving spouse’s estate on property held in the marital trust, but at least this will not include the value of property in the decedent’s credit shelter trust which escaped federal estate taxation under the applicable exclusion amount, and is not subject to federal estate tax.

In estates that exceed a single applicable exclusion (now $2,00,000), it will generally therefore be advisable to make maximum use of the applicable exclusion amount, and use a separate QTIP marital trust to transfer the excess of property to a QTIP marital trust that cannot be sheltered by such exclusion amount, in order to eliminate all federal estate tax upon the death of the first spouse. This will also minimize federal estate taxes upon the surviving spouse’s death because the value of his or her estate will be less. QTIP trusts contain various different formulas that maximize the applicable exclusion amount by leaving property in the decedent’s trust which has a value equal to the applicable exclusion amount, often incorporating a formula known as a”fractional share marital formula.”

Married couples with unequal assets may want to consider transferring property between them to take maximum advantage of the applicable exclusion amount and avoid or lessen federal estate taxes owed. For example, if a wife dies with a much smaller estate than her husband, which estate has a value below the applicable exclusion amount, then her estate will not be able to take advantage of the full exclusion amount, and the consequence is that her husband’s estate (assuming over $2,00,000) will have to pay much higher federal estate taxes than otherwise. In community property states like Arizona, this can be accomplished for certain property with an agreement known as a declaration of community property, or changing title to real estate to be held as community property, and where a QTIP trust is used, deeding title to real estate to the trust as community property, with each spouse retaining a ½ community property interest in such real estate. If the spouse with the larger estate has doubts about giving the spouse control over the transferred property, the property can be placed in a lifetime QTIP trust.

A QTIP marital trust may permit discretionary distributions of principal to the surviving spouse, but usually such distributions are subject to an ascertainable standard, such as, the maintenance or health of the surviving spouse, with invasion of principle for such purposes required to be distributed from the survivor’s trust first, in order to leave as much property to decedent’s children and/or heirs upon the surviving spouse’s death.

The estates of married couples today can take advantage of the marital deduction and save federal estate taxes, through the use of a QTIP marital trust, while at the same time, a spouse may retain control over the ultimate disposition of assets held in a QTIP marital trust upon the surviving spouse’s death, a result which is particularly desirable or even essential in cases of second marriages.

***
This article is not, nor is it intended to be, legal advice. You should consult an attorney or outside competent professionals for individual legal or tax advice regarding your own situation. Use or publication of this article does not create an attorney-client relationship with John H. Ryley. All statements or opinions contained herein are the sole opinion of the writer and are subject to change without notice. Receipt of this information constitutes your acceptance of these terms and conditions.

After graduating from Cornell University and the University of Arizona’s Law School, John has actively practiced law in Arizona since 1967. Visit John’s website to consult with him about your estate planning, probate and trust needs, or learn more about a variety of legal topics at John’s website and blog, http://www.johnryley.com

Tags: , , , , , , ,

Related Posts