Creative Estate Planning Strategies for Using Lifetime QTIPs
Tuesday, April 7, 2015
SPEAKERS
Richard S. Franklin
McArthur Franklin
Washington, DC
Lester B. Law
Abbot Downing
Naples, FL
Barry A. Nelson
Nelson & Nelson, P.A.
North Miami Beach, FL
American Bar Association
Section of Real Property, Trust and Estate Law
321 North Clark Street
Chicago, IL 60654-7598
http://www.americanbar.org/groups/real_property_trust_estate/events_cle.html
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© 2015 American Bar Association. All rights reserved.
This publication accompanies the audio program entitled “Creative Estate Planning Strategies for
Using Lifetime QTIPs” broadcast on April 7, 2015 (Event code: RP5TQT).
To register for this and additional programs, visit the Section at:
http://www.americanbar.org/groups/real_property_trust_estate/events_cle.html
PLEASE CONSIDER THE ENVIRONMENT WHEN PRINTING
MATERIAL
American Bar Association
Creative Estate Planning Strategies
for using Lifetime QTIPs
Presented to:
ABA SECTION OF REAL PROPERTY, TRUST AND ESTATE LAW WEBINAR
APRIL 7, 2015
Richard S. Franklin
McArthur Franklin PLLC
1101 Seventeenth Street NW
Suite 820
Washington, DC 20036
rfranklin@mcarthurlaw.com
Richard Franklin is a member of McArthur Franklin PLLC in Washington, D.C. He focuses on
estate planning, trusts and estate administration, and beneficiary and fiduciary representation.
He is a member of the District of Columbia and Florida Bars, is a Fellow of the American College
of Trust and Estate Counsel, and is a Group Co-Vice-Chair of the ABA RPTE Section’s Income and
Transfer Tax Planning Group. He serves on the ACTEC Transfer Tax Study Committee. He has
spoken at numerous estate planning programs and written on estate planning topics for the
ACTEC Law Journal, Actionline, BNA Insights, Estate Planning, Journal of Multistate Taxation and
Incentives, Probate & Property, Steve Leimberg’s Newsletters, Tax Notes, The Florida Bar
Journal, The Washington Lawyer, Trusts & Estates and the BNA Estates, Gifts & Trust Journal.
Richard is a DC Super Lawyer and is ranked in the 2009 - 2014 editions of The Best Lawyers in
America as a leading lawyer in the Trusts and Estates category.
These materials are for education purposes and are not designed or intended to provide
financial, tax, legal, accounting, or other professional advice. The reader is cautioned that
changes in law may be applicable, that these materials only provide a general discussion, that
critical information may be omitted, and that these strategies may not be suitable for any
particular individual.
Copyright 2015 Richard S. Franklin. All Rights Reserved.
1
Table of Contents
I.
Background on Lifetime QTIPs. ...............................................................................................................1
A.
Qualifying Income Interest for Life. ................................................................................................... 1
Income Requirement. ................................................................................................................... 2
No Power to Appoint .................................................................................................................... 3
Optional Provisions ....................................................................................................................... 3
a) Principal Distributions............................................................................................................... 3
b) Special Testamentary Power of Appointment. ......................................................................... 3
c) Assignment. .............................................................................................................................. 4
d) Spendthrift Trust Protection. .................................................................................................... 4
e) Remainder Structure. ............................................................................................................... 4
4.
Divorce. ......................................................................................................................................... 4
1.
2.
3.
B.
Gift Tax .............................................................................................................................................. 4
QTIP Election. ............................................................................................................................... 4
a) No Late Filed Gift Tax QTIP Elections. ....................................................................................... 5
b) Rev. Proc. 2001-38 Does Not Apply to Gift Tax QTIP Elections. ............................................... 6
2.
Section 2519 Dispositions. ............................................................................................................ 6
1.
C.
Estate Tax. ......................................................................................................................................... 7
Section 2044 Inclusion. ................................................................................................................. 7
a) Passing From Donee Spouse. .................................................................................................... 7
b) Who is Responsible for Valuing the QTIP property? ................................................................ 7
2.
Section 2207A Right of Recovery. ................................................................................................. 8
1.
D.
1.
2.
3.
4.
E.
1.
2.
3.
II.
GST Tax. ............................................................................................................................................. 8
Allocation of GST Exemption by Donor Spouse and Reverse QTIP Election. ................................ 8
Allocation of GST Exemption by Donee Spouse. .......................................................................... 8
Waiver of 2207A Right of Reimbursement. .................................................................................. 9
Application of Move-up Rule to Lifetime QTIP. ............................................................................ 9
Income Tax. ..................................................................................................................................... 10
Grantor Trust During Donor Spouse’s Lifetime. ......................................................................... 10
After Divorce. .............................................................................................................................. 10
Section 1014 Basis Adjustment. ................................................................................................. 10
a) Automatic Basis Adjustment under Section 1014(a). ............................................................. 10
b) Exception of 1014(e). .............................................................................................................. 11
Specific Uses of Lifetime QTIPs .............................................................................................................11
A.
Funding Testamentary use of Donee Spouse’s Applicable Exclusion Amount. ............................... 11
B.
Funding Lifetime use of Donee Spouse’s Applicable Exclusion Amount. ........................................ 12
C.
Funding use of Donee Spouse’s GST Exemption. ............................................................................ 12
D.
1.
2.
3.
E.
Funding Lifetime use of Donor Spouse’s Applicable Exclusion Amount. ........................................ 13
Formula QTIP Election. ............................................................................................................... 13
Simulated FAC Gift. ..................................................................................................................... 14
Formula Disclaimer. .................................................................................................................... 14
a) Decedent’s Surviving Spouse v. Transferor’s Spouse ............................................................. 16
1.
“Grantor” By-Pass Trust. ................................................................................................................. 16
The Plan Described. .................................................................................................................... 16
1.
Minority Interest Planning. ............................................................................................................. 18
Estate of Mellinger. .................................................................................................................... 18
F.
i
2
2.
Action on Decision 1999-006. ..................................................................................................... 19
3.
Same Result for Continuing QTIP for Donor Spouse’s Estate after Section 2044 Inclusion in
Donee Spouse’s Estate? ....................................................................................................................... 19
4.
Planning Concerns. ..................................................................................................................... 20
a) Trustee. ................................................................................................................................... 20
b) Special Powers of Appointment. ............................................................................................ 20
c) LLCs and LPs. ........................................................................................................................... 21
d) Fractional Interests in Real Property. ..................................................................................... 21
e) Important Difference Between Estate and Gift Taxes. ........................................................... 21
G.
Donee of Excess Value under Formula Allocation Gift or Sale (a la Petter). ................................... 22
No Procter Reversion. ................................................................................................................. 23
Analogy to Estate Tax Credit Shelter/Marital Trust Formula...................................................... 23
Gift Tax........................................................................................................................................ 23
a) Not a Contingent or Protective QTIP Election. ....................................................................... 24
b) QTIP Election on Form 709. .................................................................................................... 26
4.
Comparison to Using a Charity under FAC.................................................................................. 27
5.
Comparison to using a GRAT under FAC. .................................................................................... 27
1.
2.
3.
H.
Income Tax Basis Adjustment.......................................................................................................... 28
I.
Creditor Protection Planning. .......................................................................................................... 28
J.
1.
2.
K.
III.
Elective Share Planning. .................................................................................................................. 30
UPC. ............................................................................................................................................ 30
Florida Illustrates a Twist. ........................................................................................................... 34
Pre-Separation/Divorce Planning. ................................................................................................... 34
Practical Planning Implications .............................................................................................................35
A.
Planning for Donor Spouse to be a Beneficiary after Donee Spouse’s Death ................................. 35
1.
Estate Tax Pursuant to Sections 2036 and 2038. ........................................................................ 35
2.
Estate Tax Pursuant to Section 2041 and the Rule Against Self-Settled Spendthrift Trusts. ...... 36
3.
Avoid Concerns by Establishing Lifetime QTIP in a DAPT State or Inter Vivos QTIP Trust
Jurisdiction. .......................................................................................................................................... 39
4.
Avoid Concerns by Subsequent Transfer of Interests by Donor Spouse During Donee Spouse’s
Lifetime. ............................................................................................................................................... 40
5.
Avoid Concerns with Donor Spouse Retaining a Special Power of Appointment. ..................... 41
6.
When Section 2041 is Not a Concern with Retained Backend Interest. ..................................... 41
7.
GST Tax and Backend Interests. .................................................................................................. 43
B.
1.
2.
3.
C.
Planning to Reduce Estate Tax on Donee Spouse’s Death. ............................................................. 43
Distribution of QTIP Assets to Donee Spouse to Make Gifts or Sales......................................... 45
Funding Family LLC/FLPs. ............................................................................................................ 45
Sales of Discounted Assets for Promissory Notes. ..................................................................... 45
Section 2519 Concerns. ................................................................................................................... 45
Risk of Transactions with Lifetime QTIP. .................................................................................... 46
a) Deemed Gift............................................................................................................................ 48
b) Disclose Lifetime Marital Trust Sale........................................................................................ 49
2.
Section 2702. .............................................................................................................................. 49
1.
D.
Spendthrift Clauses. ........................................................................................................................ 50
E.
QDOTs ............................................................................................................................................. 52
F.
Divorce Issues .................................................................................................................................. 52
ii
3
1.
2.
Divorce and Income Taxation of the QTIP Trust ......................................................................... 52
Funded with Separate or Marital Property. ............................................................................... 54
a) Separate Property. .................................................................................................................. 54
b) Marital Property. .................................................................................................................... 54
c) Marital Agreement. ................................................................................................................ 55
3.
State Death Taxes. ...................................................................................................................... 55
Appendix A – QTIP Trust State Statutes
1.
2.
3.
4.
5.
6.
7.
8.
9.
10.
11.
12.
ARIZ. REV. STAT. § 14-10505(E) ................................................................................................. A-1
DEL. COD ANN. TIT. 12 § 3536(c)(2) .......................................................................................... A-1
FLA. STAT. § 736.0505(3) ........................................................................................................... A-2
KY. REV. STAT. § 386B.5-020(8)(a) ............................................................................................. A-2
MD. EST. & TR. CODE ANN. § 14-116(a)(1)-(2) .......................................................................... A-3
MICH. COMP. LAWS § 700.7506(4) ........................................................................................... A-4
N.C. GEN. STAT. § 36C-5-505(c) ................................................................................................. A-5
S.C. CODE ANN. § 62-7-505(b)(2) .............................................................................................. A-5
TENN. CODE ANN. § 35-15-505(d) ............................................................................................. A-5
TEX. PROP. CODE § 112.035(g) .................................................................................................. A-6
VA. CODE ANN. § 64.2-747(B)(3) ............................................................................................... A-6
WYO. STAT. ANN. § 4-10-506(f) ................................................................................................. A-7
Appendix B
1.
2.
3.
Illustration of Funding Testamentary Use of Donee Spouse’s Applicable Exclusion Amount .. B-1
Illustration of Lifetime Use of Donor Spouse’s Applicable Exclusion Amount .......................... B-2
Illustration of “Grantor” By-Pass Trust ...................................................................................... B-3
iii
4
Lifetime QTIPs*
Testamentary QTIP trusts are used extensively in estate planning.1 Lifetime QTIP trusts (aka
inter vivos QTIP trusts) are not used as often. This is unfortunate, because clients could be
missing out on the tremendous benefits of using lifetime QTIPs. The good news is that there’s
still time to change this situation!
Recent changes to the income and transfer tax laws contribute to the utility of lifetime QTIPs.
The Tax Relief, Unemployment Insurance Reauthorization, and Job Creation Act of 2010 (PL
111–312, enacted December 17, 2010) (hereinafter, the “2010 Act”) and the American Taxpayer
Relief Act (PL 112-240, enacted January 2, 2013) (hereinafter, “ATRA 2012”) significantly
increased the lifetime exclusion amount to $5.34 million, introduced portability and generally
increased the income tax rates relative to the estate tax rates. Lifetime QTIPs can be used to
ensure that the higher exclusions of both spouses are used notwithstanding the order of the
spouses’ deaths and to achieve better income tax results. But that is just the tip of the iceberg.
The possible uses of a lifetime QTIP are so extensive that they should be ubiquitous in estate
planning. This outline provides background on lifetime QTIPs, ideas for specific uses of lifetime
QTIPs, and practical implementation information.
I.
Background on Lifetime QTIPs
For gift tax purposes, qualified terminable interest property is property in which the donee
spouse has a qualifying income interest for life and to which a gift tax QTIP election has been
made.2 Both testamentary and lifetime QTIPs must provide the surviving spouse or donee
spouse with a qualifying income interest for life – the requirements are identical – and both
require a QTIP election to obtain the marital deduction.
A.
Qualifying Income Interest for Life
Section 2523(f)(3)3 applies the testamentary definition of a qualifying income interest for life to
a lifetime QTIP by reference to section 2056(b)(7)(B)(ii). The donee spouse has a qualifying
income interest for life if (i) the donee spouse is entitled to all the income4 from the property
and (ii) no person has a power to appoint any part of the property to any person other than the
surviving spouse. The donee spouse’s right to income must begin immediately upon
establishing the lifetime QTIP and must continue for the donee spouse’s life.5 A term of years or
a life estate subject to termination upon the occurrence of a specified event (e.g., divorce) will
not satisfy the qualifying income interest for life requirement.6
*For taking the time to provide their comments and suggestions, I gratefully acknowledge and thank Steve R. Akers,
Managing Director, Bessemer Trust, Dallas, Texas, Lester B. Law, Director, Abbot Downing, Naples, Florida, Barry A.
Nelson, Nelson & Nelson, P.A., North Miami Beach, Florida, Linda J. Ravdin, Pasternak & Fidis, Bethesda, Maryland,
and Molly B.F. Walls of McArthur Franklin PLLC.
1
th
For an overview of QTIP Trusts, see Moore, Estate Planning for QTIP Trust Assets, 44 Heckerling Inst., 12 (2010);
Grassi, Estate Planning with QTIP Trusts after the 2001 Tax Act, 30 ACTEC J. 111 (2004).
2
IRC § 2523(f)(2).
3
References to a “section” are to a section of the Internal Revenue Code of 1986, as amended (the “IRC”), unless
otherwise indicated, and references to Regs. or Regulations are to the Treasury Regulations promulgated thereunder.
4
The term “income” means fiduciary accounting income or “trust income,” and not taxable income. Regs. §
25.2523(f)-1(c)(2).
5
Regs. §25.2523(f)-1(c)(2).
6
Regs. §§ 25.2523(f)-1(c), 25.2523(e)-1(f).
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Copyright 2015 Richard S. Franklin. All Rights Reserved.
5
1.
Income Requirement
In a lifetime QTIP, all of the trust income (i.e., trust accounting income7) must be paid to the
donee spouse at least annually. Regs. § 25.2523(f)-1(c)(1)(i) applies the Regulations under
25.2523(e)-1(f) (i.e., applicable to general power of appointment marital trusts) that define the
“all income” requirement for QTIP trusts. The “all income” requirement is not satisfied if the
income is required to be accumulated in whole or in part or may be accumulated in the
discretion of any person other than the donee spouse. Neither permitting non-income
producing assets to be retained8 nor investing in non-income producing assets automatically
results in disqualification. For example, a power to retain a residence for the spouse or other
property for the personal use of the spouse will not disqualify the interest transferred in trust.
To be cautious, however, the donee spouse should have the power to require the trust to
produce a reasonable amount of income. An extensive discussion of the “all income”
requirement is beyond the scope of this paper, but it is critical to understand these principles.
The core standard is in Regs. § 25.2523(e)-1(f)(1), which provides:
If an interest is transferred in trust, the donee spouse is “entitled for
life to all of the income from the entire interest or a specific portion of
the entire interest,” for the purpose of the condition set forth in
paragraph (a)(1) of this section, if the effect of the trust is to give her
substantially that degree of beneficial enjoyment of the trust property
during her life which the principles of the law of trust accord to a
person who is unqualifiedly designated as the life beneficiary of a
trust. Such degree of enjoyment is given only if it was the donor's
intention, as manifested by the terms of the trust instrument and the
surrounding circumstances, that the trust should produce for the
donee spouse during her life such an income, or that the spouse should
have such use of the trust property as is consistent with the value of
the trust corpus and with its preservation. The designation of the
spouse as sole income beneficiary for life of the entire interest or a
specific portion of the entire interest will be sufficient to qualify the
trust unless the terms of the trust and the surrounding circumstances
considered as a whole evidence an intention to deprive the spouse of
the requisite degree of enjoyment. In determining whether a trust
evidences that intention, the treatment required or permitted with
respect to individual items must be considered in relation to the entire
system provided for the administration of the trust. In addition, the
spouse’s interest shall meet the condition set forth in paragraph (a)(1)
of this section if the spouse is entitled to income as defined or
determined by applicable local law that provides for a reasonable
apportionment between the income and remainder beneficiaries of
7
IRC § 643.
See Regs. §§ 25.2523(f)-1(f), Ex. 2 (“D transfers assets having a fair market value of $500,000 to a trust pursuant to
which S is given the right exercisable annually to require distribution of all the trust income to S. No trust property
may be distributed during S's lifetime to any person other than S. The assets used to fund the trust include both
income producing assets and nonproductive assets. Applicable local law permits S to require that the trustee either
make the trust property productive or sell the property and reinvest the proceeds in productive property within a
reasonable time after the transfer. If D elects to treat the entire trust as qualified terminable interest property, the
deductible interest is $500,000. If D elects to treat only 20 percent of the trust as qualified terminable interest
property, the deductible interest is $100,000; i.e., 20 percent of $500,000.”)(emphasis supplied).
8
2
Copyright 2015 Richard S. Franklin. All Rights Reserved.
6
the total return of the trust and that meets the requirements of
1.643(b)-1 of this chapter.
Planning Pointer: Consider incorporating parts of the language of the Regulation in your lifetime
QTIP provision requiring the payment income to the donee spouse. For example, the following
sample provision is designed to ensure that the “all income” requirement is satisfied:
The Trustee shall distribute to my husband all of the net income of the
trust at least quarter-annually. I intend that my husband shall have
substantially that degree of beneficial enjoyment of the trust property
during his life which the principles of the law of trusts accord to a
person who is unqualifiedly designated as the life beneficiary of a trust
as contemplated by Treasury Regulations § 25.2523(e)-1(f). I intend
that the trust should produce for my husband an income consistent
with the value of the trust corpus and with its preservation. If the
trust consists of nonproductive or underproductive property, the
Trustee shall take such steps as are necessary to provide my husband
with the requisite degree of beneficial enjoyment in the trust, which
steps could include, but are not limited to, converting such property to
property which is productive of a reasonable amount of income,
providing payments to my husband out of other assets of the trust or,
if permitted, borrowing against such property for the purpose of
providing payments to my husband. My husband may require the
Trustee to provide the required beneficial enjoyment.
2.
No Power to Appoint
To qualify as QTIP property, no person may have a power to appoint any part of the property to
any person other than the surviving spouse.9 This means, for example, that neither the trustee
nor the donee spouse may possess a power to appoint assets from the QTIP trust during the
spouse’s lifetime to the children.10
3.
Optional Provisions
Optional provisions that may be included in a lifetime QTIP include: distributions of principal,
special testamentary powers of appointment, assignment of the life interest, spendthrift
provisions, and varying dispositive options after the donee spouse’s lifetime.
a)
Principal Distributions
The QTIP trust could provide for principal distributions to be made to the donee spouse,11 which
provision could be subject to an ascertainable standard12 or, if an independent trustee is used, a
best interests or other non-ascertainable standard.
b)
Special Testamentary Power of Appointment
The QTIP trust could grant the donee spouse a special testamentary power of appointment.13
An inter vivos special power of appointment is not permitted.14
9
IRC § 2056(b)(7)(B)(ii)(II) made applicable to lifetime QTIPs by IRC § 2523(f)(3).
Regs. 25.2523(f)-1(f), Ex. 4 (trustee’s power to distribute $5,000 per year to child disqualifies QTIP).
11
Regs. § 25.2523(f)-1(c)(1)(iv).
12
IRC § 2041(b)(1)(A).
13
See Section II.F.4(b).
14
IRC § 2056(b)(7)(B)(ii)(II) made applicable to lifetime QTIPs by IRC § 2523(f)(3). See also Lischer, 845-3rd T.M.,
Gifts, X.A.5.c.(2)(a)(iv), footnote 1308 (even the donee spouse may not have a power to appoint to someone else
during the donee spouse’s lifetime).
10
3
Copyright 2015 Richard S. Franklin. All Rights Reserved.
7
c)
Assignment
The QTIP trust could, by not imposing spendthrift trust protection on the donee spouse,
essentially permit the donee spouse to assign his or her interest in the trust. Consider whether
doing so will expose the trust assets to possible claims by the donee spouse’s creditors.15
d)
Spendthrift Trust Protection
Alternatively, the QTIP trust could provide spendthrift trust protection to the donee spouse’s
interests. Creditors are, however, likely able to reach the income of the lifetime QTIP once
distributed to the donee spouse.
e)
Remainder Structure
Assuming the QTIP election is made, the balance of the lifetime QTIP will be included in the
donee spouse’s estate for estate tax purposes.16 There are many options for the lifetime QTIP
following the donee spouse’s death. If the donor spouse is then living, the lifetime QTIP could
continue for the donor spouse in a format that again qualifies for QTIP treatment. Another
option is to use a formula dividing the balance in the QTIP at the donee spouse’s death between
a by-pass trust and a continuing QTIP trust for the donor spouse.
4.
Divorce
Suppose the donor spouse desires to plan for the possibility of divorce. Is it possible to use a
generic definition of “spouse” so that if a divorce occurs with spouse #1, the lifetime QTIP could
continue for spouse #2? No, it is not possible. The donee spouse’s right to income must
continue for the donee spouse’s life. The possibility of spouse #1’s interest ending on the
couple’s divorce would not satisfy the qualifying income interest for life requirement.17
A lifetime QTIP is necessarily established with the knowledge that even if divorce subsequently
occurs, the income payments must continue to the former spouse for life. The lifetime QTIP
could provide that any authority to make discretionary principal distributions terminates upon
divorce, as well as eliminating or curtailing other rights given to the donee spouse, but the
income interest must continue uninterrupted. See the discussion below in Section III.F.1
regarding marital rights.
B.
Gift Tax
1.
QTIP Election
The gift tax QTIP election must be made by the time for filing a gift tax return, plus extensions.18
Section 6075(b) provides that gift tax returns must be filed by April 15th after the calendar year
of the gift. If the donor spouse timely extends the time for filing the gift tax return, the election
must be made by the extended due date of October 15th (after the calendar year of the gift).19 If
15
See e.g., VA Code § 64.2-742 (“To the extent a beneficiary's interest is not subject to a spendthrift provision, the
court may authorize a creditor or assignee of the beneficiary to reach the beneficiary's interest by attachment of
present or future distributions to or for the benefit of the beneficiary or other means. The court may limit the award
to such relief as is appropriate under the circumstances.”).
16
IRC § 2044.
17
Regs. §§ 25.2523(f)-1(c), 25.2523(e)-1(f). See also Regs. 25.2523(f)-1(f), Ex. 5 (QTIP not qualified because donee
spouse’s interest passes to child upon divorce); TAM 9127005 (March 22, 1991)(QTIP not qualified because Tenn. law
terminated donee spouse’s interest upon divorce).
18
Section 2523(f)(4)(A) provides that the gift tax QTIP election must be made “on or before the date prescribed by
section 6075(b) for filing a gift tax return with respect to the transfer (determined without regard to section 6019(2))
and shall be made in such manner as the Secretary shall by regulations prescribe.” Regs. § 25.2523(f)-1(b)(4) repeats
this requirement.
19
An extension of the donor spouse’s income tax return also extends the time for filing the gift tax return.
4
Copyright 2015 Richard S. Franklin. All Rights Reserved.
8
the donor spouse dies during the calendar year of the gift, the gift tax return must be filed by
the time for filing the estate tax return, if sooner.20
a)
No Late Filed Gift Tax QTIP Elections
A great deal of caution is warranted in ensuring that a gift tax return is timely filed and the QTIP
election is made, because the IRS has privately ruled that it does not have discretion to grant a
request for an extension of time to file the QTIP election beyond the 6-month period allowed
automatically by Regs. § 301.9100-2. The IRS reasoned that the time for filing an inter vivos
QTIP election is expressly prescribed by the statute in section 2523(f)(4), and the IRS's authority
to grant discretionary extensions applies only to requests for extensions of time fixed by
regulations or other published guidance (and not statutory prescription).21
In PLR 201025021 (February 19, 2010), the IRS mistakenly granted a 60-day extension of time to
make a Federal gift tax QTIP election pursuant to section 2523(f)(2)(C) on a supplemental Form
709 pursuant to Regs. § 301.9100-3. The IRS revoked that ruling in PLR 201109012 because “it
did not have the discretion to grant an extension of time under Treas. Reg. §301.9100-3 to make
that election.” There is, however, no logical reason for 9100 relief to be available for estate tax
QTIP elections and not available for gift tax QTIP elections.22
Gift tax QTIP elections are scary because the failure to make the election means that there will
be no marital deduction. In the best case, the use of the donor spouse’s lifetime exclusion
amount would occur, and in the worst case, gift tax liability, perhaps accompanied by penalties
and interest, would occur. This situation is illustrated in Estate of Nielsen,23 where Ms. Nielsen
made a gift of $550,000 to a lifetime QTIP but the gift tax QTIP election was not made. The
estate paid the resulting gift tax and sought a refund by claiming that there was an absence of
donative intent by Ms. Nielsen pursuant to state law. The Tenth Circuit, however, found that
the applicable standard for determining the imposition of the Federal gift tax is not donative
intent, but rather whether the donor parted with dominion and control as to leave her no power
to change its disposition.24 In this case, the court found that Ms. Nielsen clearly parted with
dominion and control, amusingly noting “the architect of the trust employed virtually every
word in a legal scrivener’s lexicon to denote the complete abandonment by Ms. Nielsen of any
interest in the transferred property.”
Because this lifetime QTIP election is so critical, and must be timely made, the planning attorney
should consider insisting that he or she take responsibility for preparing and filing the gift tax
return just to be sure that the QTIP election is made. Alternatively, write to the client and
accountant and confirm that they are responsible for the return and election, being sure to
explain the critical nature of the election. Even in this case, since the client may have to pay
large sums of gift tax, interest and penalties if the election is not actually made, do not rest easy
until you obtain a copy of the signed and filed return. A client who must unexpectedly pay
hundreds of thousands or millions of dollars in gift taxes (and/or penalties and/or interest) will
20
IRC § 6075(b)(3).
PLRs 200314012 and 9641023.
22
For the reasons why the IRS should adopt PLR 2010025021 as being the correct result, see the letter from Beth
Shapiro Kaufman, Douglas Siegler, Howard M. Zaritsky, and Richard Franklin to the IRS (July 23, 2010), published by
Tax Notes on July 27, 2010. See also the letter from the ABA RPTE Section to Congress dated April 25, 2013 asking for
the statute to be changed to specifically allow relief for late gift tax QTIP elections similar to IRC § 2642(g)(1)(B)
enacted to allow relief for failed allocations of GST exemption.
23
th
319 F.3d 1222 (10 Cir. 2003).
24
Regs. § 25.2511-2(b).
21
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be dissatisfied even if you have a letter in your files confirming that the accountant is
responsible for the filing.
b)
Rev. Proc. 2001-38 Does Not Apply to Gift Tax QTIP
Elections
The Service issued Revenue Procedure 2001-3825 in response to numerous requests for relief in
situations in which an executor made an unnecessary QTIP election. For example, the
procedure is designed to provide relief if a QTIP election is made for an estate having a value
less than the applicable exclusion amount under section 2010. In such a case, the election is
unnecessary because no estate tax would be imposed without the election. The procedure
notes that in some cases QTIP elections were mistakenly made for by-pass trusts.26 Importantly,
the procedure only applies to estate tax QTIP elections. Gift tax QTIP elections are beyond its
scope. This means, for example, that a lifetime QTIP trust could be used, rather than a
testamentary QTIP trust, to enable the estate tax portability election, without any concerns with
Rev. Proc. 2001-38.27
2.
Section 2519 Dispositions
Section 2519 creates a complicated system to impose gift tax upon a lifetime transfer by the
donee spouse of his or her interest in the lifetime QTIP. The theory is explained as follows:
The transfer that created the QTIP interest was exempt from the transfer taxes (the
gift and estate taxes) on the theory that interspousal transfers should not be
subject to tax, but that an eventual transfer of the property to another person
would be subject to either the gift tax (if the donee spouse makes a subsequent
inter vivos gift of the property) or the estate tax (if the donee spouse dies owning
the property). A QTIP transfer requires special rules to accomplish this tax on the
donee spouse's subsequent disposition or death because the donee spouse's
interest is only an income interest. Even though the donee spouse had only an
income interest, the donee spouse's disposition of the property should and will
generate a tax on the entire value of the property to maintain the integrity of the
28
interspousal transfer tax theory of deferral of tax, not forgiveness of tax.
Essentially, if the donee spouse makes a lifetime transfer of all or any portion of his or her
qualifying income interest, that will result in a taxable gift pursuant to section 2519. The
amount of the gift will be 100% of the fair market value of the entire trust property minus the
value of the income interest retained, if any. In other words, the gift will be the value of the
entire remainder interest, even if only a portion of the income interest is transferred.29 The gift
of the remainder interest will not be eligible for the annual gift tax exclusion.30 The spouse is
entitled to recover any gift taxes imposed as a result of section 2519 from the person receiving
the property pursuant to section 2207A, in effect resulting in a net gift structure.31
25
Rev. Proc. 2001-38, 2001-1 C.B. 1335 (06/11/2001).
See PLR 2011120001 (3/25/2011)(erroneous QTIP election for by-pass trust ruled void).
27
See ABA RPTE Section, Est. & Gift Committee’s Comments on Rev. Proc. 2001-38 (June 11, 2013).
28
Lischer, 845-3rd T.M., Gifts, X.A.5.c.(2)(b).
29
The spouse is entitled to recover any additional gift taxes imposed as a result of section 2519 from the person
receiving the property pursuant to section 2207A.
30
Reg. §25.2519-1(c).
31
IRC §§ 2207A(b), 2519(c); Regs. § 25.2519-1(c)(4)(“The amount treated as a transfer under paragraph (c)(1) of this
section is further reduced by the amount the donee spouse is entitled to recover under section 2207A(b) (relating to
the right to recover gift tax attributable to the remainder interest). If the donee spouse is entitled to recover gift tax
under section 2207A(b), the amount of gift tax recoverable and the value of the remainder interest treated as
transferred under section 2519 are determined by using the same interrelated computation applicable for other
26
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The gift tax consequences of the disposition of the life income interest are determined under
the ordinary gift tax rules of section 2511 and will be eligible for the annual gift tax exclusion.
See Section III.C below for section 2519 concerns.
C.
Estate Tax
1.
Section 2044 Inclusion
Upon the donee spouse’s death, section 2044 requires the inclusion in the donee spouse’s
estate for estate tax purposes of the value of any property in which the donee spouse had a
qualifying income interest for life.32 Inclusion is applicable to any property for which a
deduction was allowed under section 2523(f) and for which a section 2519 transfer did not
occur.33
a)
Passing From Donee Spouse
Section 2044 inclusion also means that for estate and GST tax purposes, the QTIP property is
treated as property passing from the donee spouse.34 For example, this means that the
property is treated as passing from the donee spouse for purposes of determining the
availability of the charitable deduction, the marital deduction, special use valuation, and
qualification for installment payment of estate tax under section 6166.35 Even if the donor
spouse through the creation of a lifetime QTIP is the one who specifies that an amount shall
pass to charity upon the donee spouse’s death, the donee spouse’s estate is entitled to the
charitable deduction. Example 6 of Regs. § 20.2044-1(e) provides:
D transferred $800,000 to a trust providing that trust income is to be
paid annually to S, for S's life. The trust provides that upon S's death,
$100,000 of principal is to be paid to X charity and the remaining
principal distributed to D's children. D elected to treat all of the
property transferred to the trust as qualified terminable interest
property under section 2523 (f). At the time of S's death, the fair
market value of the trust is $1,000,000. S's executor does not elect the
alternate valuation date. The amount included in S's gross estate is
$1,000,000; i.e., the fair market value at S's death of the entire trust
property. The $100,000 that passes to X charity on S's death is treated
as a transfer by S to X charity for purposes of section 2055. Therefore,
S's estate is allowed a charitable deduction for the $100,000
transferred from the trust to the charity to the same extent that a
deduction would be allowed by section 2055 for a bequest by S to X
charity.
b)
Who is Responsible for Valuing the QTIP property?
Section 6018(a)(1) provides that the executor is responsible for the estate tax filing, including
reporting the value of assets held by a QTIP trust. Hopefully, the executor and trustee of the
QTIP trust will cooperate to resolve issues of responsibility and cost. It behooves them to do so,
given that the executor is responsible for the estate tax filings, but the QTIP trustee, in most
transfers in which the transferee assumes the gift tax liability. The gift tax consequences of failing to exercise the
right of recovery are determined separately under Section 25.2207A-1(b).”).
32
IRC § 2044(a).
33
IRC § 2044(b).
34
IRC § 2044(c). The exception to this rule for GST tax purposes is if the donor spouse made the reverse QTIP
election. See Section I.D.1 below.
35
Regs. § 20.2044-1(b).
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cases, is responsible for estate tax payments relating to the QTIP inclusion (see next Section).
The executor would typically pay for whatever appraisals the executor obtains, and the QTIP
trustee would typically pay for whatever appraisals the trustee obtains. In some cases, the
estate and QTIP trust might own interests in the same investment and might agree to share the
costs.
2.
Section 2207A Right of Recovery
Section 2207A(a) creates a right of recovery for the estate of the donee spouse against the
person receiving the QTIP trust property to obtain the additional amount of federal estate tax
that is caused by having the QTIP trust included in the donee spouse’s estate under section
2044. Importantly, section 2207A is not a right of recovery for a ratable amount or pro rata
share of the total estate tax;36 rather, it is a recovery of the marginal federal estate tax that is
imposed by adding the value of the QTIP trust (under section 2044) to the donee spouse’s gross
estate.37 Section 2207A does not provide a right of recovery for state death taxes caused by the
section 2044 inclusion.
Failure to enforce the right of recovery is a transfer subject to gift tax (i.e., from the persons
who would benefit from the recovery to the persons from whom the recovery could have been
obtained).38 However, the donee spouse may waive the section 2207A right of recovery by
specifically indicating such intent in his Will or revocable trust.39 If the right of recovery is waived
by the spouse, no gift tax transfer occurs.40
If there is more than one person receiving the QTIP property, the right of recovery is against
each person.41 The liability for penalties and interest follow the tax liability.42
As mentioned above in Section I.B.2, section 2207A(b) creates a similar right of recovery for gift
taxes paid with respect to a transfer occurring pursuant to section 2519.
D.
GST Tax
1.
Allocation of GST Exemption by Donor Spouse and Reverse QTIP
Election
Pursuant to section 2652(a)(3), the donor spouse may elect the so called “reverse QTIP
election.” In the case of QTIP property under section 2523(f), the election under section
2652(a)(3) has the effect of treating the gift tax QTIP election as having not been made, thereby
making the donor spouse the transferor of the QTIP property for GST tax purposes.43 In the case
of a lifetime QTIP, the reverse QTIP election is made on the gift tax return making the gift tax
QTIP election, and it is irrevocable.44 The donor spouse can then allocate his or her GST
exemption to the lifetime QTIP trust.
2.
Allocation of GST Exemption by Donee Spouse
If the reverse QTIP election is not made, the donee spouse will be the transferor of the QTIP
property for GST tax purposes as a result of inclusion of the QTIP property in the donee spouse’s
36
Cf. IRC § 2207 (ratable sharing right of recovery for section 2041 general power of appointment property).
IRC § 2207A(a).
38
Regs. § 20.2207A-1(a)(2).
39
IRC § 2207A(b).
40
Regs. § 20.2207A-1(a)(3).
41
IRC § 2207A(c).
42
IRC § 2207A(d).
43
The same reverse QTIP election is available for QTIP election made pursuant to section 2056(b)(7).
44
Regs. §§ 26.2652-2(a), (b).
37
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estate pursuant to section 2044 upon the donee spouse’s death45 or as a result of a transfer
pursuant to section 2519 during the donee spouse’s lifetime. In either case, the donee spouse’s
GST exemption may be allocated to the QTIP trust.
3.
Waiver of 2207A Right of Reimbursement
Pursuant to Regs. § 26.2652-1(a)(3), the waiver of the section 2207A right of reimbursement for
estate taxes on a GST exempt QTIP trust is not treated as a constructive addition. This is the
case whether (i) the spouse in whose estate the QTIP property will is included waives the right
of reimbursement46 or (ii) the beneficiaries of such spouse’s residuary estate (i.e., those persons
who would benefit from the recovery) refuse to enforce the right of reimbursement.47
4.
Application of Move-up Rule to Lifetime QTIP
How does the move-up rule of section 2651(e)(1) apply in the context of a lifetime QTIP trust?
Section 2651(e)(1) provides that “if (A) an individual is a descendant of a parent of the transferor
(or the transferor’s spouse or former spouse), and (B) such individual’s parent who is a lineal
descendant of the parent of the transferor (or the transferor’s spouse or former spouse) is dead
at the time of the transfer (from which an interest of such individual is established or derived) is
subject to a tax imposed by chapter 11 or 12 upon the transferor (and if there shall be more
than 1 such time, then at the earliest such time),” then such individual moves up to the
generation which is 1 generation below the transferor.
Example 1: Wife establishes a lifetime QTIP for Husband and
makes the gift tax QTIP election on a timely filed gift tax return.
Wife does not make the reverse QTIP election for GST tax
purposes. Upon Husband’s death, the QTIP distributes to Wife’s
descendants, in per stirpes shares. Wife has one son and two
daughters, each of whom has children. Wife’s son is alive when
the lifetime QTIP is established, but predeceases Husband.
In the case of a QTIP trust, Regs. § 25.2651-1(a)(3) provides:
For purposes of section 2651(e) and paragraph (a)(1) of this section,
the interest of a remainder beneficiary of a trust for which an election
under section 2523(f) or section 2056(b)(7) (QTIP election) has been
made will be deemed to have been established or derived, to the
extent of the QTIP election, on the date as of which the value of the
trust corpus is first subject to tax under section 2519 or section 2044.
The preceding sentence does not apply to a trust, however, to the
extent that an election under section 2652(a)(3) (reverse QTIP
election) has been made for the trust because, to the extent of a
reverse QTIP election, the spouse who established the trust will remain
the transferor of the trust for generation-skipping transfer tax
purposes.”
45
Regs. § 26.2652-2(d), Ex. 3.
Regs. § 26.2652-1(a)(5), Example 8.
47
Regs. § 26.2652-1(a)(5), Example 7. Note that the failure to enforce the right of reimbursement may still be a gift
subject to gift taxes from those persons who would benefit from the recovery to those persons from whom the
recovery could have been obtained. See Section I.C.2 above.
46
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Therefore, in Example 1 above, the son’s children will move-up in the generation assignment
upon Husband’s death as a result of the section 2044 inclusion in Husband’s estate.48 The moveup rule would not apply had Wife made the reverse QTIP election.49 It also does not matter that
son is not a child of Husband, as the move-up rule applies because he is the son of Husband’s
spouse.
E.
Income Tax
1.
Grantor Trust During Donor Spouse’s Lifetime
During the donor spouse’s lifetime, the lifetime QTIP would typically be a wholly “grantor” trust
for income tax purposes under section 677.50 As a grantor trust, all of the income and
deductions of the trust would be reported on the donor spouse’s income tax return. The donor
spouse is considered the owner of the assets held in the lifetime QTIP for income tax purposes.
Pursuant to section 677(a), the grantor is treated as the owner of “any portion of a trust …
whose income” is or may be distributed to the grantor or grantor’s spouse, or is accumulated for
the benefit of the grantor or the grantor's spouse. If the QTIP trust limits the donee spouse to
income, then, depending on its other terms, the trust may not be a grantor trust as to principal
items.51 In most cases, for wealth transfer tax planning purposes, it will be desirable for the
QTIP trust to be a wholly grantor trust and, if necessary, grantor trust triggers should be
included.52 For example, to ensure that the trust is a grantor trust as to the corpus, the lifetime
QTIP could grant the trustee authority to make discretionary principal distributions.
Additionally, as a grantor trust, the lifetime QTIP automatically qualifies to own S corporation
stock.53 If the lifetime QTIP is not a wholly grantor during the donor’s lifetime, it could not
qualify as a QSST,54 but may qualify as an ESBT. 55
2.
After Divorce
After divorce what is the result? After divorce, it appears that section 682 requires that income
paid to the former spouse be taxed to the former spouse, and that capital gains would remain
taxable to the donor spouse, if the QTIP trust remains a grantor trust as to principal. These
issues are discussed in greater detail in Section III.F.1 below.
3.
Section 1014 Basis Adjustment
a)
Automatic Basis Adjustment under Section 1014(a)
Section 1014’s general rule is that the income tax basis of property acquired from a decedent is
the fair market value of such property at the date of the decedent's death, or, if the decedent's
48
Regs. § 25.2651-1(c), Ex. 3.
Regs. § 25.2651-1(c), Ex. 4.
50
See generally, Danforth and Zaritsky, 819 T.M., Grantor Trusts: Income Taxation Under Subpart E, IX.
51
Regs. § 1.677(a)-1(g), Ex. 1.
52
See Danforth and Zaritsky, 819 T.M., Grantor Trusts: Income Taxation Under Subpart E, XII.
53
IRC § 1361(c)(2)(A)(i).
54
Zaritsky, Family Wealth Transfers, ¶ 6.03[2][b] (WG&L 2013](fifth disadvantage).
55
Regs. § 1.1361-1(j)(4) provides a specific rule on lifetime QTIPs: “[I]f property is transferred to a QTIP trust under
section 2523(f), the income beneficiary may not make a QSST election even if the trust meets the requirements set
forth in paragraph (j)(1)(ii) of this section because the grantor would be treated as the owner of the income portion
of the trust under section 677. In addition, if property is transferred to a QTIP trust under section 2523(f), the trust
does not qualify as a permitted shareholder under section 1361(c)(2)(A)(i) and paragraph (h)(1)(i) of this section (a
qualified subpart E trust), unless under the terms of the QTIP trust, the grantor is treated as the owner of the entire
trust under sections 671 to 677 [i.e., a wholly grantor trust].”
49
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executor so elects, at the alternate valuation date (the “general basis adjustment rule”).56 Other
than section 1014(e) applicable to transfers to the decedent within one year of death (discussed
below), the main exception to this rule relates to items of income in respect of a decedent.57
The general basis adjustment rule applies whether or not an estate tax return is filed.58 If QTIP
property is included in a spouse’s estate pursuant to section 2044, then pursuant to section
1014(b)(10) the QTIP property is considered to have been acquired from or to have passed from
that spouse, and thereby the general basis adjustment rule will apply to the QTIP property.
b)
Exception of 1014(e)
If the donee spouse dies within one year after the donor spouse establishes the lifetime QTIP,
will the general basis adjustment rule be applicable to the assets of the trust upon the donee
spouse’s death? Section 1014(e) prohibits the general basis adjustment rule from applying
when appreciated property was acquired by the decedent by gift during the 1-year period
ending on the date of the decedent's death, and such property is acquired from the decedent by
(or passes from the decedent to) the donor of such property (or the spouse of such donor).
Therefore, consider whether this rule prevents a basis adjustment for QTIP trust property that
passes back to the donor spouse after the donee spouse’s death within one year of the donor
spouse funding the QTIP trust. Some commentators believe that section 1014(e) should not
apply if the property passes to a trust for the donor spouse’s benefit as distinct from passing
outright to the donor spouse or, if applicable, only to the proportionate part of the trust
representing the donor spouse’s interest in the trust.59
II.
Specific Uses of Lifetime QTIPs
A.
Funding Testamentary use of Donee Spouse’s Applicable Exclusion
Amount
A lifetime QTIP could be used to enable the full funding of the donee spouse’s federal applicable
exclusion amount, if the donee spouse is the first spouse to die. Because the lifetime QTIP will
be included in the donee spouse’s estate under section 2044, the donee spouse’s applicable
exclusion can be used upon the donee spouse’s death. The QTIP format allows the donor
spouse to control the disposition of the remainder interest after the donee spouse’s death.
Particularly in second (and third and fourth …) marriages, the lifetime QTIP may be more
palatable than outright gifts to the donee spouse for this purpose. See Appendix B-1 for an
illustration of this plan.
56
IRC § 1014(a); Treas. Reg. § 1.1014-1(a).
Treas. Reg. § 1.1014-1(c)(1). Also excepted from the general basis adjustment rule are unexercised incentive stock
options and options to purchase pursuant to an employee stock purchase plan. Treas. Reg. § 1.1014-1(c)(2).
58
Treas. Reg. § 1.1014-2(b)(2).
59
For more on this section 1014(e) issue, see Akers, Current Developments and Hot Topics, p. 47 – 48 (June
2014)(available at www.bessemer.com/advisor).
57
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Example 2: W’s first husband, H1, died in 2004. W has two
children by H1. W has $25 million. W then marries H2, who has
no children and $500,000 in assets. W would like to ensure that
H2’s applicable exclusion amount is used if H2 predeceases her.
They could rely on portability to transfer H2’s remaining
applicable exclusion to W. Alternatively, W could create a
lifetime QTIP for H2, fund the trust with approximately $5
million of assets, and make the gift tax QTIP election.
Advantages of this approach include: (i) the donor spouse’s design of the lifetime QTIP controls
the management and disposition of the assets at all times, (ii) the donee spouse’s estate tax
applicable exclusion amount and GST tax exemption can be used notwithstanding the order of
the spouses’ deaths, and (iii) the assets can be protected from the donee spouse’s creditors by
being a spendthrift trust. The assets funding the lifetime QTIP should also be protected from
the donor spouse’s creditors if the transfer to the trust is not a fraudulent transfer.
B.
Funding Lifetime use of Donee Spouse’s Applicable Exclusion Amount
A lifetime QTIP could be used to establish a controlled plan to use the donee spouse’s applicable
exclusion amount during his or her lifetime (i.e., as a gift). Suppose the donor spouse has used
her entire applicable exclusion amount and wishes to use the applicable exclusion of the donee
spouse, but does not wish to give assets directly to the donee spouse (i.e., subjecting the assets
to the donee spouse’s control). The donor spouse could fund a lifetime QTIP with an amount
equal to the donee spouse’s applicable exclusion amount and elect QTIP treatment to qualify
the lifetime QTIP for the federal gift tax marital deduction on a gift tax return reporting the gift.
If the election is made, the gift to the lifetime QTIP would not cause any federal gift tax liability
and the value of the trust would be included in donee spouse’s estate for federal estate tax
purposes at the time of his or her death.
Thereafter, if the donee spouse entirely released his interests in the lifetime QTIP the donee
spouse would be treated as having made a gift of 100% of the QTIP property.60 The gift would
consume the donee spouse’s applicable exclusion amount. A caveat to this plan is to consider
any possible application of the step transaction doctrine.
C.
Funding use of Donee Spouse’s GST Exemption
Similar to using a lifetime QTIP to enable the use of the donee spouse’s applicable exclusion
amount, a lifetime QTIP could be used to establish a plan to use the donee spouse’s GST
exemption during his or her lifetime (i.e., through allocation to gifts) or upon the donee spouse’s
death. This may be part of a plan to use the donee spouse’s applicable exclusion amount or
independent of it. When the lifetime QTIP is established, if the donor spouse does not make the
reverse QTIP election, the donee spouse would become the transferor of the QTIP property for
GST tax purposes and his GST exemption could be allocated to the QTIP assets. The donee
spouse becomes the transferor of the QTIP property upon a section 2519 transfer during the
donee spouse’s lifetime or upon inclusion of the QTIP assets in his or her estate pursuant to
section 2044 upon the donee spouse’s death.
60
IRC § 2519. See Section III.C below for a discussion of section 2519 and Section III.D below regarding spendthrift
clauses.
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Example 3: W’s first husband, H1, died in 2004. W has two
children by H1. W has $25 million. W then marries H2, who has
1 child and $6,000,000 in assets. H2 plans to leave his entire
estate outright to his child. W would like to ensure that H2’s
GST exemption is used if H2 predeceases her. Portability cannot
transfer H2’s remaining GST exemption to W. W could create a
lifetime QTIP for H2, fund the trust with approximately $5.34
million assets, and make the gift tax QTIP election and not make
the reverse QTIP election.
Upon H2’s death, he becomes the transferor of the QTIP trust for GST tax purposes and his GST
exemption can be allocated to the trust. If he predeceases W, the QTIP trust could continue for
W in a continuing trust that again qualifies for the QTIP election, and in this case H2’s estate
would make both the QTIP election and reverse QTIP election (i.e., allocating his GST exemption
to the trust). This defers the estate tax until W’s later death. W can waive application of section
2207A and direct that the estate tax on the reverse QTIP property be paid by her other
nonexempt assets.
D.
Funding Lifetime use of Donor Spouse’s Applicable Exclusion Amount
Rather than use a Petter61 formula allocation clause (“FAC”), a lifetime QTIP could be used as a
means to mitigate gift tax risk associated with a gift of a hard to value asset. See Appendix B-2
for an illustration of this plan.
1.
Formula QTIP Election
Regs. § 25.2523(f)-1(b)(3) provides that the taxpayer may make the gift tax QTIP election by
means of a formula that relates to a fraction or percentage of the QTIP trust, but the gift tax
regulations provide no examples of such an election. The estate tax QTIP regulations, however,
are helpful in illustrating such formula elections. Examples 7 & 8 of Regs. § 20.2056(b)-7(h)
provide:
“Example 7. Formula partial election.
D’s will established a trust funded with the residue of D's estate. Trust
income is to be paid annually to S for life, and the principal is to be
distributed to D's children upon S's death. S has the power to require
that all the trust property be made productive. There is no power to
distribute trust property during S's lifetime to any person other than S.
D's executor elects to deduct a fractional share of the residuary estate
under section 2056(b)(7). The election specifies that the numerator of
the fraction is the amount of deduction necessary to reduce the
Federal estate tax to zero (taking into account final estate tax values)
and the denominator of the fraction is the final estate tax value of the
residuary estate (taking into account any specific bequests or liabilities
of the estate paid out of the residuary estate). The formula election is
of a fractional share. The value of the share qualifies for the marital
deduction even though the executor's determinations to claim
administration expenses as estate or income tax deductions and the
final estate tax values will affect the size of the fractional share.
61
Est. of Petter v. Comm’r, 653 F.3d 1012 (9th Cir. 2011), aff’d. T.C. Memo. 2009-280 (Dec. 7, 2009).
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Example 8. Formula partial election.
The facts are the same as in Example 7 except that, rather than
defining a fraction, the executor's formula states: ‘I elect to treat as
qualified terminable interest property that portion of the residuary
trust, up to 100 percent, necessary to reduce the Federal estate tax to
zero, after taking into account the available unified credit, final estate
tax values and any liabilities and specific bequests paid from the
residuary estate.’ The formula election is of a fractional share. The
share is equivalent to the fractional share determined in Example 7.
2.
Simulated FAC Gift
A formula QTIP election could be implemented with respect to a lifetime gift designed to use,
for example, the balance of the donor spouse’s $5.34 million gift tax exclusion amount. The
donor spouse could make a gift to a lifetime QTIP, wherein descendants would be relegated to
being remainder beneficiaries. In many cases this would be acceptable, but perhaps inefficient
because the income is required to be distributed to the spouse. A formula QTIP election on the
donor’s gift tax return could be worded as follows:
I elect to treat as qualified terminable interest property that portion of
the gift, up to 100%, necessary to reduce the Federal gift tax to zero,
after taking into account the available gift tax exclusion amount and
final gift tax values. [i.e., tracking the language quoted in Regs. §
20.2056(b)-7(h), Ex. 8.]62
3.
Formula Disclaimer
The second alternative is that the donee spouse would have the ability to “disclaim” (i.e., refuse
to accept) a portion or all of the interests transferred to the lifetime QTIP,63 thereby allowing the
disclaimed assets to pass into another, discretionary trust for the donee spouse and
descendants. The donee spouse’s disclaimer must occur within nine months of the donor
spouse’s transfer of assets to the lifetime QTIP.
The disclaimer by the donee spouse can be by a formula clause based on final gift tax values.64
Example 20 of Regs. § 25.2518-3(d) sanctions such a disclaimer:
Example (20)
A bequeathed his residuary estate to B. B disclaims a fractional share
of the residuary estate. Any disclaimed property will pass to A's
surviving spouse, W. The numerator of the fraction disclaimed is the
smallest amount which will allow A's estate to pass free of Federal
62
For a more extensive discussion of using a formula QTIP election in relation to gift planning, see PRACTICAL DRAFTING,
The Lifetime QTIP Trust, iii. Formula QTIP Elections (October 2006). It is not clear that the regulations (Regs. §
th
20.2056(b)-7(d)(3)) issued in response to Est. of Clayton, 976 F.2d 1486 (5 Cir. 1992), apply for gift tax purposes. See
Akers, Planning Flexibilities with Inter Vivos QTIP Trusts, Heckerling Inst. (workshop materials Jan. 2004).
63
Regs. § 25.2518-3(b) provides in part: “A disclaimer of an undivided portion of a separate interest in property
which meets the other requirements of a qualified disclaimer under section 2518(b) and the corresponding
regulations is a qualified disclaimer. An undivided portion of a disclaimant's separate interest in property must
consist of a fraction or percentage of each and every substantial interest or right owned by the disclaimant in such
property and must extend over the entire term of the disclaimant's interest in such property and in other property
into which such property is converted.”
64
See e.g., Cline, 848-3rd T.M., Disclaimers — Federal Estate, Gift and Generation-Skipping Tax Considerations, IV.D.
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estate tax and the denominator is the value of the residuary estate. 65
B's disclaimer is a qualified disclaimer.
Therefore, the donee spouse of a lifetime QTIP trust could implement a fractional formula
disclaimer by reference to the largest amount which could pass free of federal gift tax on
account of the donor spouse’s gift tax exclusion amount and considering final gift tax values.
The portion of the lifetime QTIP disclaimed could also be defined by a fraction that simply has a
numerator that is a set number and a denominator that is the finally determined gift tax value of
the asset transferred to the lifetime QTIP trust. The example below illustrates the latter.
Example 4: For years prior to 2014, Husband’s prior taxable
gifts are $1.5 million. On January 31, 2014, Husband funds
lifetime QTIP for Wife with a 35% limited partnership interest
(the “Transferred Partnership Interest”) in HWC Family Limited
Partnership. The appraised value of the 35% interest is $3.5
million on January 31, 2014. Pursuant to the trust instrument,
any portion of the lifetime QTIP disclaimed by Wife passes to a
discretionary trust for Wife and descendants. On August 1,
2014, Wife disclaims a fractional share of lifetime QTIP, as
follows:
“Wife (Disclaimant) irrevocably disclaims a fractional portion of
all of her rights and interests in the QTIP Trust. The numerator
of this fraction is (i) Three Million Five Hundred Dollars
($3,500,000), plus (ii) 5 percent (5%) of the excess, if any, of the
fair market value of the Transferred Partnership Interest on
January 31, 2014 as finally determined for federal gift tax
purposes over Three Million Five Hundred Thousand Dollars
($3,500,000).66 The denominator of this fraction is the fair
market value of the Transferred Partnership Interest on January
31, 2014, as finally determined for federal gift tax purposes.”
On April 15, 2015, Husband files a 2014 gift tax return and
reports the transfer to the lifetime QTIP, the fractional
disclaimer and resulting taxable gift, and makes the gift tax QTIP
election for any portion of the lifetime QTIP that is not
disclaimed.
65
While this regulatory example does not use the language “as finally determined for federal estate tax purposes,”
many rulings have been issued where such language was used and the disclaimers approved. For example, in PLR
8624066 the facts recited “S disclaimed under local law a fractional portion of the assets passing to her under Article
Fourth of D's Will. The fraction disclaimed is based on a formula, the numerator of which is the value of D's probate estate
that can pass to persons other than D's surviving spouse free of federal and state estate tax by reason of the unified credit
under the Internal Revenue Code (section 2010), and the denominator of which is the value of D's gross estate as finally
determined for federal estate tax purposes.” [emphasis added].
66
The clause (ii) of this language is an attempt to prevent a public policy argument by the Service that such clauses
reduce their incentive to audit since any adjustment in value would not result in a taxable gift. With this clause, any
valuation adjustment on audit would increase the taxable gift by 5% of the increase in valuation. See McCaffrey,
Formulaic Planning to Reduce Transfer Tax Risks, 45 Heckerling Inst., ¶ 701.6 (Jan. 10, 2011).
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a)
Decedent’s Surviving Spouse v. Transferor’s Spouse
Under section 2518 and the Regulations thereunder, the property disclaimed must pass without
any direction on the part of the disclaiming spouse to the disclaiming spouse or another person.
Regarding this rule, section 2518(b)(4)(A) refers to the “spouse of the decedent.” The first
sentence of Regulations § 25.2518-2(e)(2) uses the words “decedent” and “surviving spouse”:
“In the case of a disclaimer made by a decedent's surviving spouse with respect to property
transferred by the decedent, the disclaimer satisfies the requirements of this paragraph (e) if the
interest passes as a result of the disclaimer without direction on the part of the surviving spouse
either to the surviving spouse or to another person.” [Emphasis added] What about a
disclaimer by the donee spouse in respect to a transfer to a lifetime QTIP when the disclaimed
property will pass to a by-pass like trust in which the donee spouse and descendants are
beneficiaries? There is no decedent or surviving spouse in this setting. One authority reasons
that the references to the “decedent’s surviving spouse” should be read to apply to the spouse
of a transferor.67
An alternative analysis might also be possible. Suppose that the donee spouse disclaims within
nine months of the gift and it’s a valid disclaimer for state law purposes, thereby causing the
property to drop down to the by-pass trust arrangement in which the donee spouse is only a
discretionary beneficiary. A QTIP election cannot be made for the by-pass trust so a taxable gift
is triggered. The idea is that the QTIP election would only be made for the fraction of the QTIP
that is not disclaimed. Even so, if a fractional formula disclaimer is desired to mitigate the gift
tax risks with a hard to value asset, it would be desirable for the disclaimer to be qualified under
section 2518 to enable reliance upon the regulatory provision authorizing such a formula
disclaimer.
E.
“Grantor” By-Pass Trust
Typically, if a by-pass trust is funded upon the first spouse’s death, that by-pass trust is a nongrantor trust for income tax purposes as to the surviving spouse. Wouldn’t it be great if the bypass trust could be a grantor trust as to the surviving spouse? The lifetime QTIP structure can be
used to establish a by-pass trust for the benefit of the donor spouse that is a grantor trust for
income tax purposes as to the donor spouse, which enables other estate planning advantages.68
See Appendix B-3 for an illustration of this plan.
1.
The Plan Described
The essence of this lifetime QTIP trust planning is to enable the estate tax applicable exclusion
amount of the donee spouse to be used on a trust that will be a grantor trust as to the donor
spouse. For example, Wife establishes a lifetime QTIP trust for Husband’s benefit and transfers
$5.34 million of assets to the trust. Wife elects QTIP treatment to qualify the trust for the
federal gift tax marital deduction on a timely filed gift tax return reporting her gift. Because the
QTIP election is made, Wife’s gift to the lifetime QTIP trust would not cause any federal gift tax
67
Cline, 848-2nd: Disclaimers — Federal Estate, Gift and Generation-Skipping Tax Considerations, III.A note 101
(“…presumably §2518(b)(4)(A) will be read to apply to the ‘spouse of the transferor.’”).
68
SM
See Jonathan Blattmachr, Mitchell Gans and Dianna Zeydel, “Supercharged Credit Shelter Trust , 21 Prob. & Prop.
52 (July/Aug. 2007)(hereinafter “Supercharged”); Jonathan Blattmachr, Mitchell Gans and Dianna Zeydel,
SM
“Supercharged Credit Shelter Trust versus Portability, 28 Prob. & Prop. 10 (March/April 2014). See also Portability –
The Game Changer, ABA-RPTE, Income and Transfer Tax Group, Estate and Gift Tax Committee Project (distributed at
th
47 Heckerling Inst., Jan 2013 and available on Committee’s webpage); Franklin and Law, Portability's Role in the
Evolution Away from Traditional By-Pass Trusts to Grantor Trusts, Vol. 37, No. 2 Bloomberg BNA, Tax Management's
Estates, Gifts and Trusts Journal (March-April 2012).
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liability at the time of the trust funding and the value of the trust would be included in
Husband’s estate for federal estate tax purposes at the time of his death pursuant to section
2044. Wife has the option of making a reverse QTIP election under section 2652(a)(3) so that
the trust is exempt for generation-skipping transfer (GST) tax purposes.
The primary reason for establishing the lifetime QTIP trust is to set the stage for creating the
grantor by-pass trust in the event that Wife survives Husband. Wife must put the plan into
effect while Husband is living – think of it as staging before the important and critical second act.
During the first act, while Husband is alive, he would be the sole beneficiary of the lifetime QTIP.
Upon Husband’s death, if Wife is then living, an amount of the lifetime QTIP trust’s assets equal
to Husband’s applicable exclusion amount could be distributed to the grantor by-pass trust for
Wife’s benefit and the balance (if any) could be held in a second QTIP trust for Wife’s benefit. A
QTIP election would be made for this second QTIP trust on H’s estate tax return.
The grantor by-pass trust could provide for Wife and any of Wife and Husband’s descendants
(i.e., similar to a traditional by-pass trust). The creation of a grantor by-pass trust is the key to
this plan. Because the trust was included in Husband’s estate under section 2044, the grantor
by-pass trust will not be included in Wife’s estate pursuant to sections 2036 or 2038 even
though Wife is a beneficiary of the trust. Reg. § 25.2523(f)-1(f), Examples 10 and 11. Careful
attention must also be given to avoid inclusion in Wife’s estate pursuant to section 2041 (e.g.,
based on application of the rule against self-settled spendthrift trusts thereby enabling Wife’s
creditors to reach her interests in the trust) (see Section III.A.2 below).
For GST purposes, if Wife made a reverse QTIP election, Wife will be deemed to be the
transferor, and as such the assets in both the grantor by-pass trust and the second QTIP trust for
the donor spouse would be GST exempt.
The central idea of this arrangement is that for income tax purposes, Wife remains the grantor
of any continuing trust for her benefit under the grantor trust rules, even though the QTIP trust
assets have been included in Husband’s estate under section 2044. This allows Wife to have the
benefits of grantor trust status as to the grantor by-pass trust and to be a discretionary
beneficiary of the trust’s income and principal. This result is reliant upon the language of Reg
1.671-2(e)(5), which provides:
"If a trust makes a gratuitous transfer of property to another trust, the
grantor of the transferor trust generally will be treated as the grantor
of the transferee trust. However, if a person with a general power of
appointment over the transferor trust exercises that power in favor of
another trust, then such person will be treated as the grantor of the
transferee trust, even if the grantor of the transferor trust is treated as
the owner of the transferor trust under subpart E of the Internal
Revenue Code." (Emphasis added.)
Pursuant to this regulation, a change in grantor for income tax purposes occurs only if someone
possesses a general power of appointment over the transferor trust and actually exercises it in
favor of another trust. In the example above, Husband would not hold a general power of
appointment over the lifetime QTIP and therefore Wife will remain the grantor of the trust for
income tax purposes.69
69
See Pennell, Myths, Mysteries, & Mistakes, sec. 3. Note that Regulation 1.671-2(e)(5), quoted above, was adopted
in 1999. T.D. 8831 (August 23, 1999).
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This technique is also discussed in Barry Nelson’s outline: Nelson, Seeking and Finding New
Silver Patterns in a Changed Estate Planning Environment: Creative Inter Vivos QTIP Planning,
ABA RPTE Section Spring Symposia (Chicago May 2014)(hereinafter “Nelson, Creative Inter Vivos
QTIP Planning”).
F.
Minority Interest Planning
When properly structured, interests owned by a lifetime QTIP trust are not subject to being
aggregated to determine voting control with the interests owned by either spouse.70 Therefore,
a lifetime QTIP may be used to avoid a control premium and engender a minority interest
discount being applicable to the interests owned by the QTIP trust (and, perhaps, even as to the
remaining interests owned by either spouse). In dealing with a large private company, this is a
fantastic way to reduce estate taxes without triggering a gift tax upon establishing the plan or
transferring the equity interests beyond the benefit of the spouses when either of them is
living.71
Example 5: Wife owns 100% of Waddles, Inc., an S corporation.
Without planning upon Wife’s death, 100% of the stock is taxed
for estate tax purposes without any minority interest discount.
Alternatively, Wife creates a lifetime QTIP for Husband’s benefit
and transfers 49% of the stock to the trust. Wife values the
transfer to the QTIP trust as a minority interest and makes the
gift tax QTIP election on a timely filed gift tax return. Upon the
Wife’s death, her Will leaves the remaining 51% of stock
outright to Husband. Upon the Husband’s subsequent death,
the 49% of the stock owned by the QTIP trust is included in his
estate under section 2044 and valued as a minority interest and
the 51% of the stock owned by him is included in his estate
under section 2033 and valued as a controlling interest.
The idea of this plan is to save the estate tax on the minority interest discount relating to the
49% of the stock owned by the QTIP trust.
Example 6: Same as Example #5, except that Wife recapitalized
the stock to create two classes of equity, voting shares
representing 5% of the equity and nonvoting shares
representing 95% of the equity. Wife transfers nonvoting
shares representing 80% of the equity to the lifetime QTIP.
The idea of this plan is to save the estate tax on the minority interest discount relating to the
80% of the stock owned by the QTIP trust.
1.
Estate of Mellinger72
Mr. and Mrs. Mellinger owned 4,921,160 shares of common stock in Frederick’s of Hollywood,
Inc. (FOH), which Mr. Mellinger founded, in a joint revocable community property trust. Mr.
Mellinger predeceased Mrs. Mellinger and his community property shares passed to a QTIP trust
70
See Grassi, supra note 1, at 30.
It’s important to understand that this planning idea will have the effect of reducing the income tax basis of the
interest by the minority interest discount.
72
Mellinger v. Comm’r, 112 T.C. 26 (1999), acq., 1999-35 I.R.B. 314, as corrected by Ann. 99-116, 1999-52 I.R.B. 763
(12/27/1999).
71
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for her benefit. The QTIP election was made on his estate tax return. Independent persons
were named as trustees of the QTIP trust. After Mr. Mellinger’s death, Mrs. Mellinger
transferred the remaining shares (her share of the community property) to a new revocable
trust she created.
At the time of Mrs. Mellinger’s death, each of her revocable trust and the QTIP trust owned
27.8671% of the FOH stock. Together the two trusts owned 55.7% of the FOH stock and a
controlling position.
The executors for Mrs. Mellinger’s estate filed her estate tax return on the basis of valuing the
stock owned by each trust as a separate block. While FOH was a public company, each separate
block was sufficiently large as to justify a blockage discount. The two appraisers for the estate
opined, respectively, that a 30% and 31% blockage discount was appropriate. The estate tax
return reported a value of $4.79 per share. Upon Mrs. Mellinger’s death, the average price of
FOH on the NYSE was $6.9375.
The Service argued that the blocks owned by the trusts should be combined for valuation
purposes and issued a notice of deficiency using a value of $8.46 per share. The Service’s
position was that Mrs. Mellinger’s stock was included in her estate under section 2033 and the
QTIP trust’s stock was included in her estate under section 2044. Therefore, Mrs. Mellinger is
considered to have owned all of the stock. Furthermore, the Service argued that the combined
block of stock was a controlling interest in FOH and should be valued with a premium.73
The Tax Court found that section 2044 inclusion in the surviving spouse’s estate is the quid pro
quo for obtaining the marital deduction under section 2056(b)(7) in the estate of the transferor
spouse. While the property is treated as passing from the surviving spouse for estate tax
purposes under section 2044, the property does not actually pass from the surviving spouse.
The court could not find any evidence that Congress intended to have aggregation of interests in
the QTIP trust with that of the surviving spouse for valuation purposes.
2.
Action on Decision 1999-006
In this AOD, the Service indicated that it will no longer litigate the aggregation issue presented in
Mellinger. This opens the door to using lifetime QTIPs to achieve the result of having a greater
portion of the equity interests in a business taxed on a minority interest basis.
3.
Same Result for Continuing QTIP for Donor Spouse’s Estate after
Section 2044 Inclusion in Donee Spouse’s Estate
The same non-aggregation should apply if the donee spouse dies first and the QTIP property
continues in trust for the donor spouse’s benefit in the format of a second QTIP. Consider the
following example:
73
Prior to Mellinger, the Service had already lost cases on family aggregation. See e.g., Est. of Bright v. U.S., 658 F.2d
th
th
999 (5 Cir. 1981). In Propstra v. U.S., 680 F.2d 1248 (9 Cir. 1982), the Service lost the argument for aggregating
th
undivided interests in real property owned between spouses. Then, in Est. of Bonner v. U.S., 84 F.2d 196 (5 Cir.
1996), the Service lost the argument for aggregating undivided interests in real property owned by the surviving
spouse and a QTIP trust for his benefit.
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Example 7: Wife owns 75% of High-Up, Inc., an S corporation.
Son owns 25% of the stock. Wife creates a lifetime QTIP for
Husband’s benefit and transfers 37.5% of the stock to the trust.
Wife values the transfer to the QTIP trust as a minority interest
and makes the gift tax QTIP election on a timely filed gift tax
return. Husband predeceases Wife. Upon Husband’s death, the
QTIP trust is included in his estate under section 2044 and
valued as a minority interest. The QTIP trust then continues for
the Wife’s benefit (i.e., the donor spouse has a backend interest
in the format of a QTIP trust) and the estate tax QTIP election is
made in Husband’s estate. Upon Wife’s subsequent death, the
37.5% of the stock owned by the QTIP trust is included in her
estate under section 2044 and the remaining 37.5% of the stock
owned by her individually is included in her estate under section
2033. Each block of stock is valued separately and as a minority
interest.
The idea of this plan is to save the estate tax on the minority interest discount relating to 75% of
the stock. The plan is arranged to defer all estate taxation until the surviving spouse’s death.
The plan achieves the same result notwithstanding the order of the spouses’ deaths.
If the donor spouse will have a backend interest in the form of a QTIP trust, it will be important
to ensure that inclusion occurs in the donor spouse’s estate only under section 2044. See below
in Section III.A the discussions regarding sections 2036, 2038 and 2041 with respect to a
backend interest held by the donor spouse. If the Service could effectively argue that inclusion
of the QTIP assets should be under section 2033 or 2041, then aggregation may apply.74 Since
the donor spouse originally transferred the assets to the QTIP trust, this is an especially tricky
issue.
4.
Planning Concerns
a)
Trustee
To be cautious, neither the donor spouse nor the donee spouse should be a trustee of the
lifetime QTIP to prevent an argument that they actually controlled both blocks of stock
immediately prior to the taxable event. Note that in Mellinger, the trustees of the QTIP trust
were independent. It is not clear from the opinion whether this made a difference in the end
result. Note that in Norwell75 the decedent and a grandchild were co-trustees of the QTIP trusts
and the court ruled against aggregation.
b)
Special Powers of Appointment
The premise of the foregoing cases is that the donee spouse does not control the QTIP trust
property; therefore for valuation purposes the QTIP property should not be aggregated with
non-QTIP property included in the donee spouse’s estate. If the donee spouse possesses a
special power of appointment and, at least to some extent, controls the QTIP trust property,
74
Est. of Fontana v. Comm’r, 118 T.C. 318 (2002)(stock owned by surviving spouse aggregated with stock owned by
GPOA marital trust for surviving spouse’s benefit, because, at the moment of death, the surviving spouse had control
and power of disposition over the property). See also FSA 200119013 (decedent's 50% interest includible under
section 2033 aggregated with the 44% interest subject to decedent's testamentary GPOA and includible under
section 2041, and valued as a single 94-percent block).
75
See infra note 77 and accompanying text.
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should aggregation apply? In Est. of Bonner76 the court alluded to that possibility: "Caveat: this
case does not seem to have a special power of appointment in the marital deduction trust,
which could possibly change the outcome, as a special power of appointment could be viewed
as some control over the disposition of those assets." To be cautious, consider limiting the use
of special powers of appointment in QTIPs where minority discounts are important or, at least
limit the use of such powers to trust property other than that for which a discount is desired.
c)
LLCs and LPs
While Mellinger involved corporate stock, the planning strategy of using lifetime QTIPs to
achieve minority interest valuation on a portion of the equity interests also applies to interests
in LLCs and limited partnerships.77
d)
Fractional Interests in Real Property
The idea is likewise applicable to fractional interests in real property.78
e)
Important Difference Between Estate and Gift Taxes
There are differences between estate and gift taxation that should be carefully considered when
deciding on a lifetime versus testamentary disposition.79 If in Example #5 above Wife kept 100%
of the stock until death, simply giving 49% of the stock to a testamentary QTIP trust would not
achieve the same result as using the lifetime QTIP to receive the same interest as a gift. Having
100% of the stock in Wife’s estate would cause it to be valued as a controlling block. However,
the Service would likely take the position that the estate tax marital deduction available for a
49% interest passing to the QTIP should be reduced because it is a minority interest.80 Hence,
there is a mismatch – i.e., the disappearing value would be a taxable disposition. On the other
hand, in Example #5, when Wife funds the lifetime QTIP, the interest being transferred is just
49% of the stock. It is valued for gift tax purposes on the basis of being a minority interest and
the gift tax marital deduction matches that amount.81 Wife’s remaining 51% would still be
76
84 F.2d 196 (5th Cir. 1996).
Nowell Est. v. Comr., T.C. Memo 1999-15, the court refused to aggregate for valuation purposes interests owned in
limited partnerships by the decedent’s revocable trust and QTIP trusts: “These [Mellinger] principles are equally
applicable to the case before us. Analysis of section 2044 and the accompanying regulations thereunder does not
indicate that Congress intended that property interests includable under section 2044 should be merged or
aggregated with interests in the same property included in the estate pursuant to section 2038 for purposes of
determining Federal estate tax value. Section 2044 provides only that the value of property in the gross estate shall
include property in which the decedent had a qualifying income interest for life and that the inclusion of such
property shall be at its fair market value. Sec. 20.2044-1(d), Estate Tax Regs. Section 2044(c) treats QTIP property as
“passing from the decedent” but does not indicate that the decedent should be treated as the owner of such
property for purposes of aggregation. Thus, the partnership interests included pursuant to section 2038 and section
2044 should be valued separately.”
78
See Est. of Bonner v. U.S., 84 F.2d 196 (5th Cir. 1996).
79
Ahmanson Foundation v. U.S., 674 F.2d 761 (9th Cir. 1981)(Discussed differences in estate and gift taxation: “There
is nothing in the statutes or case law that suggests that valuation of the gross estate should take into account that the
assets will come to rest in several hands rather than one.”).
80
Chenoweth v. Comr., 88 T.C. 1577 (1987) (51% of stock passing to surviving spouse included control premium);
TAM 9403005 (Service ruled that the decedent’s entire stock holdings must be valued with a control premium in
decedent’s estate, and because the stock was divided between a by-pass trust and marital trust, “… the marital
deduction may be taken only with respect to the net value of any deductible interest which passed from the
decedent to the surviving spouse. Because the value of the interest that passed to the surviving spouse is a minority
interest in Company, the value deductible for purposes of section 2056 must reflect this fact. Accordingly, we
conclude that, for purposes of the estate tax marital deduction, a minority discount is appropriate in valuing the
portion of the decedent's stockholding in Company that passes to the surviving spouse.”).
81
In TAM 9449001, the Service determined: “Unlike the estate tax where the tax is imposed on an aggregation of all
77
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valued on a controlling basis upon her death (and upon Husband’s death if she gives the stock to
him). There is no mismatch in this paradigm.
In Example #7 above, when Wife transfers 37.5% of her 75% to the lifetime QTIP, while she is
left with a minority interest, the fact that her remaining interest becomes less valuable is not a
transfer for gift tax purposes. However, the Service might attempt a “swing” vote argument to
offset any minority interest discount on the gift to the QTIP or the value of the separate blocks
upon death.82
G.
Donee of Excess Value under Formula Allocation Gift or Sale (a la
Petter)
When the IRS questions the valuations applicable to inter-family transfers of interests in closely
held entities, the bone of contention is usually the level of valuation discounts used by the
taxpayer for lack of control as to a minority interest and lack of marketability for a closely held
interest with no ready market. If the IRS can sustain a higher value for the sold interests, it will
likely argue that the taxpayer has made a deemed gift of the additional value.
In Est. of Petter v. Comm’r,83 the mother used formula language (the “formula allocation clause”
or “FAC”) to make both gifts and sales of interests in LLCs to her children.84 The documents
referred to specific blocks of LLC interests and provided that dollar amounts of the LLC interests
would be given and sold based on the final gift tax value of the LLC interests. Any LLC interests
not given and sold under the formula were given to a donor advised fund (“DAF”) and thereby
qualified for the charitable gift tax deduction.
The key to the Petter decision is that valuation is an accounting/legal function that may be
determined in hindsight, and therefore, legally speaking, the parties know precisely the amounts
transferred and to whom under a FAC on the date of the transaction. This analysis leads to the
conclusion that a non-charity as the donee under a FAC, such as a lifetime QTIP, ought to be
effective in mitigating gift tax risk.85
In Petter, the Tax Court reasoned that charities, as recipients of the excess value, will be
regarded as third parties dealing at arm’s length. The charities are obligated to ensure the
proper valuation of the interests being transferred. Similarly, it could be argued that lifetime
the decedent's assets, the gift tax is imposed on the property passing from the donor to each donee and it is the
value of that property passing from the donor to the donee that is the basis for measuring the tax. Thus, where a
donor makes simultaneous gifts of property to multiple donees, the gift tax is imposed on the value of each separate
gift. Accordingly, the value of property that is the subject of multiple simultaneous gifts may be different from the
value of that same property if that property were included in the donor's gross estate at his death.” See also Rev.
Rul. 93-12, 1993-1 C.B. 298 (“If a donor transfers shares in a corporation to each of the donor's children, the factor of
corporate control in the family is not considered in valuing each transferred interest for purposes of section 2512 of
the Code. *** This would be the case whether the donor held 100 percent or some lesser percentage of the stock
immediately before the gift.”).
82
Est. of Winkler v. Com’r., T.C. Memo 1989-231; TAM 9436005 (“As the court concluded in Estate of Winkler, swing
block potential is one such factor. In this case, each 30 percent block of stock has swing vote characteristics. The
extent to which the swing vote potential enhances the value of each block transferred is a factual determination.
However, all relevant factors including the minority nature of each block, any marketability concerns, and swing vote
potential, should be taken into account in valuing each block.”).
83
th
653 F.3d 1012 (9 Cir. 2011), aff’d T.C. Memo. 2009-280 (Dec. 7, 2009).
84
For new sales to defective grantor trusts, see Akers, Sale to Grantor Trust Transaction (Including Note With Defined
Value Feature) Under Attack, Estate of Donald Woelbing v. Commissioner (Docket No. 30261-13) and Estate of
Marion Woelbing v. Commissioner (Docket No. 30260-13)(February 4, 2014)(Available at www.bessemer.com).
85
Notwithstanding that lifetime QTIPs are discussed herein as possible donees under a FAC, the reader is cautioned,
however, to consider the limits of the cases.
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QTIP trustees would be obligated to ensure the proper valuation of the interests being
transferred. Like the trustees of a charitable trust, the trustees of the marital trust have an
obligation to protect the interests of the trust.86
1.
No Procter Reversion
Using a lifetime QTIP should not be construed as an invalid Procter87 reversion to the donor. The
gift to the lifetime QTIP is real, is irrevocable, and is for the life of the spouse, notwithstanding
the possibility of a subsequent divorce. Moreover, a gift to a lifetime QTIP would be subject to
gift tax but for the QTIP election – a Congressionally authorized period of tax deferral. While the
donor may be a remainder beneficiary of the lifetime QTIP following the donee spouse’s death,
this beneficial interest is necessarily contingent on survival and subject to the very real
possibility of not occurring. For these reasons, using a lifetime QTIP should not be viewed as
being akin to a reversion in the donor.
2.
Analogy to Estate Tax Credit Shelter/Marital Trust Formula
Using a lifetime QTIP as the donee under a FAC is perhaps more similar to a credit
shelter/marital trust formula. Assume a preresiduary credit shelter trust formula bequest,
residuary bequest to a QTIP marital trust, and that the value of the estate is $5.34 million (with a
$5.34 million applicable exclusion amount), at the time the estate tax return is filed. The
funding of the credit shelter/marital trusts is based on final estate tax values. If the IRS can
sustain a higher value for the estate assets, the excess over $5.34 million would spill over into
the marital trust as to which a QTIP election is made. Similarly, if the final gift tax values
increase under a FAC, the excess spills over into the lifetime QTIP.
In Petter, the IRS argued that for policy reasons a formula clause like that which the taxpayer
used should not be allowed. The taxpayer countered that various types of formula clauses are
specifically allowed in the regulations, such as the gift tax regulations that allow a formula
disclaimer of a fractional amount with a numerator that is “the smallest amount which will allow
A’s estate to pass free of Federal estate tax and the denominator is the value of the residuary
estate.” The IRS argued that all of these instances of allowing formula clauses involve situations
where money passing under the formula will not escape taxation (i.e., money passing by the
marital deduction will be taxed when the spouse dies). When using a lifetime QTIP as the donee
under a FAC, any amount passing to the lifetime QTIP would necessarily be subject to taxation
when the donee spouse dies. Therefore, the IRS should be less concerned with using a lifetime
QTIP as the donee under a FAC than using a DAF, where, as in Petter, the IRS argued that the
property escapes taxation by passing to a charity.
3.
Gift Tax
The idea of using a lifetime QTIP as the donee under a FAC is that the gift tax QTIP election can
be made on the gift tax return for the calendar year of the sale for the interest passing to the
86
See Holbrook, Where There's a Will: Value Definition Clauses, Part 4: Tax Court in ‘Christiansen’ Unanimously
Rejects IRS Public Policy Arguments, Tenn. Bar J. (2009)(“IRS’s public policy argument is clearly weakest with charity
as the remainder donee, but even the trustee of a marital trust or other trust as donee has fiduciary responsibilities
that cannot be ignored.”).
87
Comm’r v. Procter, 142 F.2d 824 (4th Cir. 1944)(operative clause essentially provided that if certain transferred
property were found to be subject to the gift tax, it would automatically be removed from the conveyance and
remain the property of the transferor).
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lifetime QTIP trust. The gift tax return would be filed reporting the sale transaction with the
DGT as a non-gift and reporting the gift to the lifetime QTIP trust.88
a)
Not a Contingent or Protective QTIP Election
Some are concerned that the amount passing to the QTIP under a FAC is contingent, thereby
making the QTIP election unavailable, or that the QTIP election is contingent. The estate tax
QTIP regulations specifically allow for a protective QTIP election.89 There is no sister provision
permitting a protective gift tax QTIP election in the gift tax regulations.
Arguably, if the type of FAC in Petter did not work neither a charitable deduction nor a marital
deduction would be available for the donee interest under these clauses, notwithstanding in the
case of the marital deduction whether the donee is a spouse outright, lifetime GPOA marital
trust or QTIP. That is, if FACs fail, it will be because the donee interest itself is contingent.
Therefore, in the case of the charitable deduction, the argument would be that the interest is
subject to a precedent event or, in the case of the marital deduction, the amount passing under
the FAC is a nondeductible terminable interest and/or not passing from the donor spouse or
considered passing to the donee spouse and another person (i.e., in violation of Treas. Reg. §
25.2523(b)-1(b)). If FACs fail with lifetime QTIP trusts it would most likely be because the
interest passing is contingent, not because the QTIP election is contingent.
This is visible in the context of what the government argued in the Petter appeal. The
government argued that the excess value passing under the FAC was “dependent upon … a
precedent event,” within the meaning of Treas. Reg. § 25.2522(c)-3(b)(1). Pursuant to the gifts
and sales in Petter, if the irrevocable grantor trusts received an initial allocation of units in
excess of their rightful share, the trusts were obligated to transfer the excess to the charities.
The government’s position was that the charitable gifts “kick in” only if the IRS audits the
taxpayer’s gift tax return and there is an adjustment to the valuation. According to the
government, the audit itself constitutes a “precedent event” in violation of the cited regulation.
The government reasoned that no change would occur but for the audit and therefore a gift that
occurs to the charity as a result of the audit is by definition contingent. If the government’s
theory of the FAC was correct, then no marital deduction (or charitable deduction) would be
available for the excess value – again notwithstanding the format of the marital conveyance.
The taxpayer argued and the courts accepted that the gifts under the FAC were not conditioned
on any event post-transfer. The values were determinable as of the date of transfer. A
disagreement over valuation between the taxpayer and the IRS does not equate to a posttransfer contingency. In Petter, the charitable contributions were not conditioned on any
subsequent event. At the time of transfer the legal rights were vested and enforceable and
determinable.
If valuation is the only element in play under a FAC, a QTIP election should be available for the
donee interest passing under a FAC to a lifetime QTIP. The transfer agreement would give a
defined legal entitlement. It is that legal entitlement for which the QTIP election would be
made. There is not a contingency involved with the election. What’s in play is determining the
value of the legal entitlement.
88
See Franklin, Walls, Bradt, Donee Selection and Practical Considerations Under Formula Allocation Clauses, Vol. 36
Bloomberg BNA, Tax Management's Estates, Gifts and Trusts Journal, 271 (November 10, 2011)(sample disclosures
for non-gift transactions provided).
89
Treas. Reg. §20.2056(b)-7(c).
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The estate tax protective election provision, 20.2056(b)-7(c), deals with different situations. It
primarily addresses when it is unclear that a particular asset is includible or the extent to which
it is includible. Examples of situations for which a protective election would be appropriate
include:
 There is an ongoing will contest action that makes the marital bequest
uncertain.
 TAM 8937001 – protective election proper when the calculated amount under
formula marital language was in question (issue in play was not valuation).
According to Acker, 855-2nd T.M., Estate and Trust Administration — Tax Planning, VI.A.4:
“An executor may make an irrevocable, protective QTIP election only
if, at the time of filing the estate tax return, the executor reasonably
believes that there is a bona fide issue that concerns: (1) whether an
asset is included in the decedent's gross estate; or (2) whether
property that is included in the gross estate is eligible for the QTIP
election. The protective election must identify either the specific asset,
group of assets or trust to which the election applies and the specific
basis for the protective election.
Note: The only situation where a protective election will be used is
when the executor contends that an asset is not included in the gross
estate. In this situation, the executor may wish to make a protective
QTIP election if the particular asset is determined ultimately to be
included in the gross estate. If an asset is included in the gross estate
but may not be eligible for the QTIP election, the executor could make
the QTIP election directly for such asset. If it is later determined that
such asset was not so eligible, then the QTIP election was never valid
and, as a result, never applied to the disputed asset.” [citations
omitted]
It seems that a protective election is not appropriate when just dealing with a difficult to value
asset. Suppose that the estate has $3.6 million of assets, $100,000 of cash and $3.5 million of
XYZ private company stock. Assume an exemption of $3.5 million. Expenses are $100,000. The
family trust is funded by a formula with the maximum amount that can pass free of estate taxes,
$3.5 million. The QTIP trust is to receive the balance, $0. Since the stock is subject to valuation
discounts, one cannot be sure where the final estate tax values will come to rest. On the estate
tax return one would explain the formula on Schedule M and indicate that, based on returned
values, the QTIP has a zero value but the election is being made for the legal entitlement the
trust has under the formula and that final estate tax values control. If the value of the stock is
increased, the election is therefore made for the value spilling over to the QTIP. This is also a
situation where valuation is the only element in play. This is not a protective election situation.
There is no dispute that XYZ stock is included in the estate.90 This is the same as the Petter
situation.
90
nd
Acker, 855-2 T.M., Estate and Trust Administration — Tax Planning, VI.A.3 seems to reach this conclusion by
implying that its posited situation does not fit the “true protective election” scenario: “The question remains
unanswered as to whether a protective formula election can be made if the filing level is close and the estate
contains assets that are difficult to value. (The formula would be set to solve to zero estate tax due.) Increasing asset
values slightly in order to reach the 706 filing threshold allows the QTIP election but subjects the QTIP property to tax
in the surviving spouse's estate. The regulations are clear that a true protective election can only be made in certain
circumstances: if there is a question as to the includibility of property in the taxable estate or the eligibility of the
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b)
QTIP Election on Form 709
A disclosure of the FAC gift that indicates substantially as follows should suffice for making the
gift tax QTIP election when a lifetime QTIP is the donee under a FAC:
The Taxpayer, JANE SMITH, elects QTIP treatment for the Doe QTIP
Marital Trust under Section 2523(f)(4). [GST alternative: However, the
Taxpayer makes a reverse QTIP election under Section 2652(a)(3) so
that upon the death of the Taxpayer’s spouse, [the donee spouse], the
decedent shall be deemed the transferor of the Doe QTIP Marital
Trust.] The property passing to the Doe QTIP Marital Trust is
described below.
The Taxpayer owned a 99% Class B membership interest (the
“Transferred Interest”) in the NEWCO, LLC (EIN _________). Pursuant
to the Transfer Agreement made on ______________, 2014, by the
Taxpayer, the Doe Family Trust (“Purchaser”), and the Doe QTIP
Marital Trust, the Taxpayer sold a portion of the Transferred Interest
(the “Purchased Interest”) to the Purchaser. Pursuant to the Transfer
Agreement, the Purchased Interest was the lesser of the Transferred
Interest and a fraction of the Transferred Interest, the numerator of
which was the Purchase Price and the denominator of which was the
fair market value as of the date of the Transfer Agreement of the
Transferred Interest as finally determined for Federal gift tax
purposes. The Purchase Price is $XXX. The sale of the Purchased
Interest to the Purchaser is disclosed as a non-gift transfer at Item
____ of this return.
The Taxpayer gave to the Doe QTIP Marital Trust all of the Taxpayer’s
right, title and interest in and to the portion of the Transferred Interest
that is the difference between the Transferred Interest and the
Purchased Interest (the “Gift Interest”).
The value of the Transferred Interest was determined by an
independent appraisal, prepared by ________________.
The
Taxpayer hereto attaches a copy of the appraisal used for determining
the value of the Transferred Interest consistent with Regs. §
301.6501(c)-1(f)(2)(iv) and § 301.6501(c)-1(f)(3). Pursuant to this
appraisal, the Transferred Interest is valued on a noncontrolling,
nonmarketable interest basis at $XXX. Based on values as returned,
the Purchased Interest equals 100% of the Transferred Interest
pursuant to the formula set forth in the Transfer Agreement and the
Gift Interest is zero.91
The values represented for the Transferred Interest, the Purchased
Interest and the Gift Interest for purposes of this QTIP election are
being made on the basis of the values reported on the return as filed.
For purposes of the final amounts to be used, the values and the
property for the QTIP election. Once made, the protective election becomes effective and irrevocable if the property
is determined to be includible or eligible, as the case may be.”
91
One could consider having the QTIP’s economic rights valued under the Transfer Agreement. Even though based
on the appraisal the Gift Interest has a zero value, a valuation of the economic rights may have a positive value.
Consider whether this could be the reported value for the QTIP election. In addition to the legal entitlement under
the FAC, a small gift of cash could be made to the lifetime QTIP upon creation for which the QTIP election would
apply.
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components of the formula shall be those finally determined for
Federal gift tax purposes. Thus, if the values or amount of a
component as so finally determined shall be different from the values
or amount as reported on this return, the values and amount are
changed accordingly.
4.
Comparison to Using a Charity under FAC
An advantage to using a lifetime QTIP is that the excess value remains with the family unit rather
than passing to charity. This advantage, however, may also be its weakness since it would not
allow for reliance on the public policy of encouraging charitable gifts that helped the taxpayer
prevail in Petter.
If an interest in a given or sold asset passes to the lifetime QTIP under a FAC sale, the lifetime
QTIP could retain the interest. Unlike most charities, the lifetime QTIP will be under no
compulsion to liquidate the investment, subject to the donee spouse’s right to force the trustee
of the trust to make the property productive of a reasonable amount of income.92 However, the
donor spouse’s goal was likely to move all of the interest to the purchasing irrevocable defective
grantor trust (“DGT”), thereby removing future appreciation from the taxable estates of the
donor and spouse.
The donor or the DGT could reacquire the interest that passes under the FAC to the lifetime
QTIP by purchase. Since the lifetime QTIP trust is a grantor trust, such a sale would be ignored
for income tax purposes. The DGT could provide a promissory note as consideration for the
purchase. Being able to structure the reacquisition at the time of the family’s choosing and
perhaps with favorable terms is an advantage of using the lifetime QTIP as the donee under a
FAC rather than a DAF. The income tax reporting as to an interest in an operating company will
also be easier to address in the context of a lifetime QTIP that is a wholly grantor trust as to the
donor spouse.
5.
Comparison to using a GRAT under FAC
Using a grantor retained annuity trust or GRAT as the donee in a FAC gift or sale offers the
following advantages as to any excess value passing under the FAC: (i) it removes any
appreciation in excess of the section 7520 rate from the transferor’s estate if he or she survives
the GRAT term, (ii) it allows the excess value to pass to family members, rather than charity, and
(iii) income tax reporting clean-up after the FAC ownership comes to rest is made simpler
because the GRAT is a grantor trust.
The GRAT and the lifetime QTIP share many of these advantages, as potential donees. One
advantage that the GRAT has, as compared to the QTIP, is that future appreciation in any excess
value passing under the FAC transaction is removed from the grantor’s taxable estate. On the
other hand, the lifetime QTIP offers other estate planning opportunities, such as enabling the
funding of a donee spouse’s federal estate tax exemption while also allowing the donor spouse
to control the disposition of the remainder interest after the donee spouse’s death. The lifetime
QTIP could be used as the donee under multiple FACs relating to multiple sales and gifts over
time, whereas a GRAT would be a single use device as a GRAT can be funded only once. The
same lifetime QTIP could also be used for other estate planning purposes.
As a practical matter, section 2702 of the Code places certain administrative demands on the
GRAT trustee – the annuity must be paid annually out of the assets in the GRAT (i.e., the trustee
cannot distribute a note or other debt instrument and no additional contributions can be made
92
See Regs. § 25.2523(e)-1(f)(4), made applicable to lifetime QTIP by Regs. § 25.2523(f)-1(c).
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to the GRAT). In a FAC sale situation, if the asset sold is retained by the purchasing DGT, then
the annuity payments relating to any excess value passing to the GRAT would presumably be
satisfied by interests in the same asset, subject to similar valuation discounts. Remember, it
may be several years after the formula transaction is implemented before any adjustment
occurs and the parties would need to go back and make adjustments to the annuity payments
after the fact. If the value used in the FAC sale is eventually adjusted upward, then the GRAT
trustee would need to prepare a valuation for each annuity payment date that has passed, in
order to determine precisely what the GRAT owns and what the grantor owns following the
annuity payments. This assumes that the GRAT is prepared to essentially deem the payments to
occur automatically. Note that the GRAT rules under section 2702 do not provide protection for
valuation risks with respect to payment of the annuity amount, so that paying the annuity
amount with discounted assets, prior to final determination of value, may result in technical
violation of the rules under section 2702. With a lifetime QTIP, revaluations would generally be
unnecessary.
If the government could successfully argue that the FAC gift to a GRAT does not qualify for GRAT
treatment, so that the grantor’s retained interest is valued at zero under Section 2702, then a
taxable gift occurs as to 100% of the GRAT. In addition, annuity payments still must be made to
the grantor.93 With a lifetime QTIP, on the other hand, if the gift to the trust fails to qualify for
QTIP treatment, a taxable gift occurs, but none of the property returns to the grantor, and none
would be included in either spouse’s estates.
H.
Income Tax Basis Adjustment
The donor spouse could transfer appreciated assets to a lifetime QTIP trust with the expectation
that the assets will obtain a basis adjustment pursuant to section 1014 (as described above in
Section I.E.3(a)). This might be useful if the donee spouse is expected to die quickly. For
example, in Est. of Kite v. Comm’r,94 Mrs. Kite transferred certain stock into a lifetime QTIP trust
for Mr. Kite seven days before his death on February 23, 1995. Upon Mr. Kite’s death, the QTIP
property was included in his estate under section 2044, but a QTIP election was made in his
estate for the continuing QTIP trust benefiting Mrs. Kite (i.e., she had a back-end QTIP interest).
The 1014(e) question was not analyzed in the court’s opinion.95 Footnote 9, however, states:
“All of the underlying trust assets, including the OG&E stock transferred to Mr. Kite in 1995 [the
lifetime QTIP trust],96 received a step-up in basis under sec. 1014.”
The donor spouse could retain a successive QTIP backend interest that would in effect allow the
donor spouse to make gifts (via releases of the QTIP interest) of the trust assets after having the
basis adjustment in the donee spouse’s estate.97
I.
Creditor Protection Planning
In addition to the estate planning advantages it may offer, a lifetime QTIP could provide creditor
protection benefits if the trust funding is not a fraudulent transfer.
93
The mitigation provisions under Treas. Reg. § 20.2702-6 might provide some relief.
T.C. Memo. 2013-43 (2013). For an analysis of the court’s order and Rule 155 computations issued in an
unpublished opinion on October 25, 2013, see Akers on Estate of Kite V. Commissioner, Leimberg Est. Plan.
Newsletter (Jan. 21, 2014).
95
See Ryan, Kite: IRS Wins QTIP Battle but Loses Annuity War, Tax Notes, 2013 TNT 239-9 (Dec. 12, 2013).
96
The court loosely refers to “the stock transferred to Mr. Kite” in the quoted sentence from footnote 9. However,
when read together with footnote 5 and the accompanying text in the body of the Kite opinion, it is clear that the
court is referring to the stock transferred to the lifetime QTIP trust. See Section I.E.3(b) above.
97
See PRACTICAL DRAFTING, The Lifetime QTIP Trust, a. In General (October 2006).
94
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Example 8: Husband, a resident of the District of Columbia, is an
entrepreneur with substantial business loans from third parties.
Husband is paying debts as due, is not insolvent, and has
nonbusiness assets of $10 million. Husband has prenuptial
agreement with Wife2 that requires him to leave Wife2 an
amount outright equal to the elective estate (i.e., 30%). Wife2
has $1 million of assets. Husband and Wife2 would like to save
estate taxes and protect some of their wealth from the claims of
future creditors.
Husband establishes a lifetime QTIP for Wife2 with $4 million of
nonbusiness assets. The purpose of the planning is to enable
the use of Wife2’s estate tax exclusion amount and GST
exemption, if she is the first spouse to die. If Husband survives
Wife2, the trust continues in the form of a by-pass trust that can
provide discretionary distributions to Husband and
descendants. To enable Husband to be a beneficiary without
running afoul of the rule against self-settled spendthrift trusts
and section 2041,98 the lifetime QTIP is structured as a qualified
disposition within the meaning of section 3570(7) of Title 12 of
the Delaware Code (i.e., a DAPT).99 Husband and Wife2 amend
prenuptial agreement to count the lifetime QTIP interest
towards the amount Husband is otherwise required to leave
Wife2 upon his death. Husband and Wife2 also agree in
amendment to prenuptial agreement as to ultimate disposition
of lifetime QTIP assets given that these assets will not be
distributed outright to her.
The idea of this planning is to create a plan that enables the use of Wife2’s estate tax exclusion
amount and GST exemption if she is the first spouse to die. Relying on the portability of Wife2’s
estate tax exclusion would be another way to use her exclusion, if she is the first spouse to die,
but portability does not permit the use of her GST exemption amount or enable the “grantor”
by-pass trust benefits. Critical to this planning is not to run afoul of the fraudulent transfer rules
and to be cautious about staying within the purported tax planning rationale (i.e., limit the
funding of the lifetime QTIP to an amount that does not exceed the exclusion amounts).
It is important to appreciate that structuring the lifetime QTIP under Delaware’s qualified
disposition statutes provides creditor protection features for Husband. This is possibly helpful
as a creditor protection device, but it is also critical to achieve the tax objectives of this plan.
That is, it is necessary to structure the lifetime QTIP as an asset protection trust to prevent
application of the rule against self-settled spendthrift trusts. If this rule applied, then section
2041 may be applicable to Husband’s continuing backend interests if he survives Wife2, thereby
destroying the whole reason for implementing the arrangement to use Wife2’s exclusion
amount. Hence, the creditor protection features are driven by the tax planning goals and not
included purely for creditor protection reasons. The complexity of the estate tax and disposition
98
99
See discussion below in Section III.A.2.
This would be the type of grantor by-pass trust referred to in Section II.E.
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planning are likely helpful facts in convincing a court (or mediators, arbiters or creditors) that
the motivations were not fraudulent.
J.
Elective Share Planning
A lifetime QTIP trust could be used to set aside property not subject to a spouse’s right of
election. Alternatively, if a lifetime QTIP is included in the elective estate, the commuted value
of the surviving spouse’s life interest in the QTIP trust would typically satisfy her right of election
in respect to the QTIP property, and could perhaps count towards satisfying the elective share
attributable to non-QTIP property included in the elective estate. The goal of this planning
strategy is not to deprive the surviving spouse of benefiting from the decedent’s estate, but
rather to control the disposition of the property passing for the benefit of the surviving spouse.
This strategy can be used to reduce the surviving spouse’s ability to use the elective share as a
device to receive property outright, and, in some cases, can completely eliminate any property
passing under the right of election outright to the surviving spouse.
To illustrate the idea, the discussion below is limited to the UPC’s form of elective share and
Florida’s augmented elective share. Carefully considering the elective share law of the
decedent’s domicile is critical to determining if this planning strategy will be advantageous.
1.
UPC
The 2010 version of the Uniform Probate Code100 provides an elective share arrangement based
on a marital partnership theory. Under this new approach, the elective-share percentage is 50
percent of the marital-property portion of the augmented estate. The marital-property portion
of the augmented estate is (under Alternative A of section 2-203 of the Uniform Probate Code)
determined based on a sliding scale, which reaches 100% after 15 years of marriage. The
augmented estate includes all of the couples’ assets and nonprobate transfers to other persons.
The elective amount is then satisfied, in the following order, by (i) amounts that pass or have
passed from the decedent to the surviving spouse by testate or intestate succession, (ii) by
nonprobate transfers to the surviving spouse, (iii) by the marital-property portion of amounts
included in the augmented estate owned by the surviving spouse, and (iv) lastly from property in
the net probate estate or owned by others.
Example 9: Husband and Wife own their residence and other
assets as tenancy by the entirety worth $4 million. Husband
owns 100% of YRED Co. (YRED), an S corporation, which has a
value of $20 million (i.e., on a control basis and without any
minority interest discount). Husband and Wife are both 65
years of age and have been married for 32 years. In 2011,
Husband, desiring to avoid Wife ever having any direct
ownership of YRED stock, transferred 49% of YRED stock to
lifetime QTIP for Wife’s benefit. Husband dies in 2014 as a
resident of a state that recently enacted the 2010 version of the
UPC’s elective share. Husband’s Will leaves the balance of his
estate to a trust for his children.
Under the UPC, if the Husband had not created the lifetime QTIP, the augmented estate and
elective share amount would be as follows:
100
Uniform Probate Code, National Conference of Commissioners on Uniform State Laws (revised 2010)(hereinafter
“UPC”). The elective share provisions are in Part 2 in sections 2-201 – 214.
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Augmented Estate
Husband’s net probate estate
Marital-Property
Portion (100%)
$20,000,000
$20,000,000
$0
$0
Husband’s nonprobate transfers to Wife
$2,000,000
$2,000,000
Wife’s assets and nonprobate transfers to
others
$2,000,000
$2,000,000
$24,000,000
$24,000,000
Husband’s nonprobate transfers to others
Augmented Estate
Elective-Share Amount (50% of Marital-property portion) ..............................$12,000,000
Less amount already Satisfied .............................................................................$4,000,000
Unsatisfied Balance .............................................................................................$8,000,000
The value of the tenancy by the entirety property first satisfies the Wife’s elective share amount.
The balance would be satisfied from the net probate estate.
Alternatively, the result when the lifetime QTIP is created and funded more than 2 years before
Husband’s death with 49% of YRED stock is shown below. Assume for this purpose that
Husband’s remaining 51% of the YRED stock is valued as a pro rata amount of the assumed
enterprise value, and the 49% transferred to the lifetime QTIP is entitled to a 20% minority
interest discount. Also assume that the commuted value of Wife’s life interest in the lifetime
QTIP is worth 30.814% of the trust’s value (using the March 2014 section 7520 rate of 2.2%). 101
The commuted value of the Wife’s life interest is included the value of the Wife’s assets
((($20,000,000 x .49) x .80) x .30814) plus $2 million or 50% of the tenancy by the entirety
property.102 The remaining value of the QTIP property is not included in the Husband’s
nonprobate transfers to others since the QTIP was created and funded more than 2 years prior
to Husband’s death.103
Augmented Estate
Husband’s net probate estate
Marital-Property
Portion (100%)
$10,200,000
$10,200,000
$0
$0
Husband’s nonprobate transfers to Wife
$2,000,000
$2,000,000
Wife’s assets and nonprobate transfers to
others
$4,415,818
$4,415,818
Husband’s nonprobate transfers to others
Augmented Estate
$16,615,818
$16,615,818
Elective-Share Amount (50% of Marital-property portion) ................................$8,307,909
Less amount already Satisfied .............................................................................$6,415,818
Unsatisfied Balance .............................................................................................$1,892,091
101
This life estate factor is the same set forth in the IRS’ Aleph Volume. The assumption is the life estate factor is an
appropriate way to determine the commuted value of the Wife’s interest in the QTIP trust.
102
UPC § 2-207, Ex. 33.
103
UPC §§ 2-205(3)(C), 2-207, Ex. 33.
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Without the lifetime QTIP planning, the Wife was entitled to be paid $8 million from the net
probate estate; with the lifetime QTIP, the amount is reduced by approximately $6.1 million
($8,000,000 - $1,892,091).
Alternatively, assume XRED is recapitalized to have voting and nonvoting shares, with the voting
shares representing 5% of equity. Husband keeps all of the voting shares and nonvoting shares
representing 15% of the equity and transfers nonvoting shares representing 80% of the equity
to the lifetime QTIP for Wife’s benefit. Assume the Husband’s retained shares are valued on a
controlling basis and the transferred nonvoting shares are valued with a 20% minority interest
discount. The commuted value of the Wife’s life interest is included the value of the Wife’s
assets ((($20,000,000 x .80) x .80) x .30814) plus $2 million or 50% of the tenancy by the entirety
property.
Augmented Estate
Husband’s net probate estate
Marital-Property
Portion (100%)
$4,000,000
$4,000,000
$0
$0
Husband’s nonprobate transfers to Wife
$2,000,000
$2,000,000
Wife’s assets and nonprobate transfers to
others
$5,944,192
$5,944,192
$11,944,192
$11,944,192
Husband’s nonprobate transfers to others
Augmented Estate
Elective-Share Amount (50% of Marital-property portion) ................................$5,972,096
Less amount already Satisfied .............................................................................$7,944,192
Unsatisfied Balance ...........................................................................................................$0
By increasing the funding of the lifetime QTIP and increasing the portion of the estate qualifying
for a minority interest discount, the Wife’s elective share amount has no unsatisfied balance.
The plan also enables a much larger portion of the company’s equity to be taxed on a minority
interest basis.
Alternatively, the result when the lifetime QTIP is created and funded within 2 years of the
Husband’s death with 49% of YRED stock is shown below. In this case, the entire value of the
QTIP property is included in the augmented estate. The commuted value of the Wife’s life
interest is included the value of the Wife’s assets ((($20,000,000 x .49) x .80) x .30814) plus $2
million or 50% of the tenancy by the entirety property.104 The remaining value of the QTIP
property is included in the Husband’s nonprobate transfers to others since the QTIP was created
and funded within 2 years of Husband’s death.105
104
105
UPC 2-207, Ex. 33.
UPC §§ 2-205(3)(C), 2-207, Ex. 33.
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Augmented Estate
Husband’s net probate estate
Marital-Property
Portion (100%)
$10,200,000
$10,200,000
Husband’s nonprobate transfers to others
$5,424,182
$5,424,182
Husband’s nonprobate transfers to Wife
$2,000,000
$2,000,000
Wife’s assets and nonprobate transfers to
others
$4,415,818
$4,415,818
$22,040,000
$22,040,000
Augmented Estate
Elective-Share Amount (50% of Marital-property portion) ..............................$11,020,000
Less amount already Satisfied .............................................................................$6,415,818
Unsatisfied Balance .............................................................................................$4,604,182
Without the lifetime QTIP planning, the Wife was entitled to be paid $8 million from the probate
estate and with it the amount is reduced by approximately $3.4 million ($8,000,000 $4,604,182). Note also that the commuted value of the Wife’s lifetime interest in the QTIP
would increase as the section 7520 increases, thereby reducing further the unsatisfied balance
in this example.
Again, alternatively assume that XRED is recapitalized to have voting and nonvoting shares, with
the voting shares representing 5% of equity. Husband keeps all of the voting shares and
nonvoting shares representing 15% of the equity and transfers nonvoting shares representing
80% of the equity to a lifetime QTIP for Wife’s benefit. Assume the Husband’s retained shares
are valued on a controlling basis and the transferred nonvoting shares are valued with a 20%
minority interest discount.
Augmented Estate
Marital-Property
Portion (100%)
Husband’s net probate estate
$4,000,000
$4,000,000
Husband’s nonprobate transfers to others
$8,855,808
$8,855,808
Husband’s nonprobate transfers to Wife
$2,000,000
$2,000,000
Wife’s assets and nonprobate transfers to
others
Augmented Estate
$5,944,192
$5,944,192
$20,800,000
$20,800,000
Elective-Share Amount (50% of Marital-property portion) ..............................$10,400,000
Less amount already Satisfied .............................................................................$7,944,192
Unsatisfied Balance .............................................................................................$2,455,808
Therefore, even in the scenario when the Husband’s death occurs within 2 years of the gift, by
increasing the funding of the lifetime QTIP and the increasing portion of the estate qualifying for
a minority interest discount, the Husband has reduced the amount that would be satisfied from
his net probate estate. The children could much more easily manage raising approximately $2.5
million to retain control of the company during Wife’s lifetime.
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2.
Florida Illustrates a Twist
A lifetime QTIP would not be part of the elective estate, unless the funding occurred within one
year of the donor’s death. However, if a testamentary QTIP were used, it would be part of the
elective estate. The surviving spouse is entitled to a 30% elective share. The testamentary QTIP
(or the lifetime QTIP funded within one year of the donor’s death) would be an “elective share
trust” and at least fifty percent of its value would count toward satisfying the 30% elective share
(or 80% if the trustee has an invasion power for health, support and maintenance of the donee
spouse). Therefore, under the Florida rules, at least 20% of an included QTIP counts in satisfying
the elective share attributable to non-QTIP property in an elective estate. A lifetime QTIP not
included in the elective estate does not offer this advantage.106 However, since the value of the
lifetime QTIP would not be part of the elective estate, the amount of the elective share is
reduced and in effect the decedent spouse can control the ultimate disposition of the assets
through the QTIP. This feature combined with other benefits, such as the minority interest
discount planning outlined in Section II.F above, could be appealing.
K.
Pre-Separation/Divorce Planning
A lifetime QTIP might be used in connection with a divorce settlement agreement107 or used as
part of a pre-divorce strategy to control assets that are otherwise expected to be allocated to a
divorcing spouse in the event of a divorce. Either of these strategies should be implemented
with the guidance of a marital lawyer.
Example 10: Wife owns 100% of the membership interests in
LuxStyle Design Enterprises LLC (LUX), a marital property asset.
Wife envisions that she and Husband may divorce in the future
based on their tempestuous relationship. She wants to ensure
Husband’s care and support, but does not wish for him to have
any control in her company. Wife creates a lifetime QTIP for
Husband’s benefit and funds it with a 49% membership interest
in LUX.
In the event of divorce, the Husband’s interests in the lifetime QTIP should be considered
marital property (most likely the entire lifetime QTIP would be considered marital property) and
counted toward satisfying Husband’s share of any equitable distribution. A court would not
likely consider a QTIP trust interest as a fraud on Husband’s marital rights given that fiduciary
duties are owed to minority owners and that, to qualify for QTIP treatment Husband’s interests
must meet the “all income” requirement for life (including the requirement that “the trust
should produce for the donee spouse during her life such an income, or that the spouse should
have such use of the trust property as is consistent with the value of the trust corpus and with
its preservation”). See the discussion in Section III.F.1 regarding marital law issues.
The advantage of this approach is that Wife’s design of the lifetime QTIP controls the
management and disposition of the assets at all times. The design might achieve other benefits
such as enabling minority interest discounts, the use of the donee spouse’s estate tax applicable
exclusion and GST tax exemption, and protection of the trust assets from creditors.
106
Fla. Stat. §§ 732.2035, 732.2075.
Note that pursuant to IRC § 2516 certain transfers will be deemed made for adequate consideration and,
therefore, not a gift. This section applies if the parties divorce within the three-year period beginning one year
before execution of the agreement. See generally, Wofford, 515-2nd T.M., Divorce and Separation, A.2.d.
107
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III.
Practical Planning Implications
A.
Planning for Donor Spouse to be a Beneficiary after Donee Spouse’s
Death
Can the donor spouse retain an interest in the lifetime QTIP if the donor spouse survives the
donee spouse? Will the donor spouse’s retention of a backend interest cause the lifetime QTIP
to fail to qualify as a gift or disqualify the interest in the donee spouse for the gift tax QTIP
election? The lifetime QTIP planning technique has more appeal if the donor spouse can benefit
from the property if he or she survives the donee spouse and do so without jeopardizing the
gift, estate and GST tax planning. If this is possible, then the lifetime QTIP can be arranged so
that it is always benefiting one of the two spouses throughout their lifetimes, notwithstanding
the order of their deaths.
1.
Estate Tax Pursuant to Sections 2036 and 2038
Pursuant to section 2523(f)(1), no part of the QTIP property is treated as having been
transferred to anyone other than the donee spouse. For QTIP property, section 2523(f)(1)(B)
abrogates the rule of section 2523(b)(1), which disallows the gift tax marital deduction if the
donor retains in himself or transfers to any person other than the donee spouse an interest in
such property and if by reason of such retention or transfer the donor or such person may
possess or enjoy any part of such property after such termination or failure of the interest
transferred to the donee spouse. Section 2523(f)(1)(B) provides that as to the QTIP property no
part is treated as having been retained by the donor spouse or transferred to any person other
than the donee spouse. This enables the gift tax marital deduction to be available upon
establishing the lifetime QTIP trust, even if the donor spouse could benefit from the trust if the
donor spouse survives the donee spouse’s death. Correspondingly, section 2044’s inclusion of
the QTIP property in the donee spouse’s estate means that for estate and GST tax purposes, the
QTIP property is treated as property passing from the donee spouse (the “fiction of 2044
inclusion”).108
Based on this statutory construction, the following regulatory examples conclude that a donor
spouse’s retained backend interest after the donee spouse’s death will not be a retained
interest pursuant to sections 2036 or 2038.
Example 10, Retention by donor spouse of income interest in property.
On October 1, 1994, D transfers property to an irrevocable trust under
the terms of which trust income is to be paid to S for life, then to D for
life and, on D's death, the trust corpus is to be paid to D's children. D
elects under section 2523(f) to treat the property as qualified
terminable interest property. D dies in 1996, survived by S. S
subsequently dies in 1998. Under Section 2523(f)-1(d)(1), because D
elected to treat the transfer as qualified terminable interest property,
no part of the trust corpus is includible in D's gross estate because of
D's retained interest in the trust corpus. On S's subsequent death in
1998, the trust corpus is includible in S's gross estate under section
2044.
108
IRC § 2044(c). The exception to this rule is that the donor spouse will be treated as the transferor for GST tax
purposes if the donor spouse made the reverse QTIP election. See Section I.D.1 above.
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Example 11, Retention by donor spouse of income interest in property.
The facts are the same as in Example 10, except that S dies in 1996
survived by D, who subsequently dies in 1998. Because D made an
election under section 2523(f) with respect to the trust, on S's death
the trust corpus is includible in S's gross estate under section 2044.
Accordingly, under section 2044(c), S is treated as the transferor of the
property for estate and gift tax purposes. Upon D's subsequent death
in 1998, because the property was subject to inclusion in S's gross
estate under section 2044, the exclusion rule in Section 25.2523(f)1(d)(1) does not apply under Section 25.2523(f)-1(d)(2). However,
because S is treated as the transferor of the property, the property is
not subject to inclusion in D's gross estate under section 2036 or
section 2038. If the executor of S's estate made a section 2056(b)(7)
election with respect to the trust, the trust is includible in D's gross
estate under section 2044 upon D's later death.109
2.
Estate Tax Pursuant to Section 2041 and the Rule Against SelfSettled Spendthrift Trusts
Section 2041 is the remaining inclusionary provision to consider. In Examples 10 and 11 from
the gift tax QTIP Regulation quoted above, the trust’s income would be paid to the donor
spouse for life, if the donor spouse survived the donee spouse. The fiction of 2044 inclusion in
the donee spouse’s estate is that the donee spouse is the transferor of the QTIP property.
Therefore, for estate tax purposes the donee spouse, not the donor spouse funded the trust.
Typically, if the donee spouse funded a trust for the donor spouse, in which the donor spouse is
granted an income interest, that income interest alone would be insufficient to result in the
trust fund being includible in the income beneficiary/donor spouse’s estate for federal estate
tax purposes. The same non-inclusionary result should apply if the trustee is granted the
authority to distribute principal to the donor spouse (again, only if the donor spouse survives
109
Regs. § 25.2523(f)-1(f), Exs. 10 and 11. Treasury Decision 8522 (Fed. Reg. February 28, 1994), explains these
examples as follows:
Examples 9, 10, and 11 of §25.2523(f)-1(f) have been added, illustrating the application of section
2523(f)(5) and §25.2523(f)-1(d). Under these sections, where the donor spouse retains an interest
in a trust subject to a section 2523(f) QTIP election (e.g., the trust provides an income interest to
the spouse for life, then to the donor for life, with remainder to children), the trust corpus is not
subject to inclusion in the donor's gross estate under section 2036 (by virtue of the retained life
estate) if the donor predeceases the spouse. Further, any transfer of the retained interest during
the donor's lifetime prior to the death of the donee spouse is not subject to gift tax. However,
under section 2523(f)(5)(B), this exclusion rule does not apply if, prior to the donor's death (or the
transfer of the interest), the property is included in the donee spouse's gross estate under section
2044 or is treated as a gift by the donee spouse under section 2519. The examples clarify, inter
alia, that if the property is included in the donee spouse's gross estate (or is subject to a gift tax
under section 2519), the donee spouse is treated as the transferor of the property for estate and
gift tax purposes. Accordingly, on the subsequent death of the donor spouse, the donor is not
treated as the transferor of the property in which the donor possesses an income interest. In such
circumstances, notwithstanding section 2523(f)(5)(B), the property is not includible in the donor's
gross estate under section 2036. However, the property could be subject to inclusion in the donor's
gross estate under another applicable section of the Code, the application of which is not
dependent on the donor's status as a transferor of the property. For example, if the donee
spouse's estate made an election under section 2056(b)(7) with respect to the property, then the
property would be includible in the donor spouse's gross estate under section 2044 (a so-called
lifetime reverse QTIP trust). [Emphasis added]
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the donee spouse) subject to the “health, education, maintenance and support” ascertainable
standard or if an independent trustee has the authority to distribute principal to the donor
spouse pursuant to a non-ascertainable standard, such as best interests or general welfare.
The concern is that the fiction of 2044 inclusion may not apply to all circumstances. For state
law purposes, the fiction of 2044 inclusion does not apply. Under state law, the donor spouse
remains the grantor of the lifetime QTIP trust, even after the donee spouse’s death. Of
particular concern is the effect of the state law rule against self-settled spendthrift trusts.
Pursuant to this rule, the donor spouse’s creditors are able to reach his or her interests in the
trust even if there is a spendthrift clause that applies to the donor spouse.110 For example,
Uniform Trust Code Section 505(a)(2) provides that notwithstanding the presence of a
spendthrift clause:
“(2) With respect to an irrevocable trust, a creditor or assignee of the
settlor may reach the maximum amount that can be distributed to or
for the settlor’s benefit. If a trust has more than one settlor, the
amount the creditor or assignee of a particular settlor may reach may
not exceed the settlor’s interest in the portion of the trust attributable
to that settlor’s contribution.”111
If the donor spouse’s creditor can reach the donor spouse’s interest in the continuing trust, the
concern is that section 2041 may apply to result in the continuing trust being included in the
donor spouse’s gross estate. After all, a general power of appointment includes a power
exercisable in favor of creditors.112 The idea is that “in effect” it’s a general power of
appointment because the donor spouse could incur debts and those creditors could pursue the
collection of such debts from the trust.
Whether this analysis is correct is unclear. Complicating matters is a provision of the 2041
Regulations that specifically indicates the donor spouse cannot retain a general power of
appointment in himself or herself: “For purposes of §§ 20.2041-1 to 20.2041-3, the term "power
of appointment" does not include powers reserved by the decedent to himself within the
concept of sections 2036 to 2038. (See §§ 20.2036-1 to 20.2038-1.)”113 This language combined
with the Examples 10 and 11 from the gift tax QTIP Regulations quoted above and several
favorable private rulings might lead one to conclude that this creditor’s rights concern is a nonissue.114 But some worry115 and some conclude it’s a concern to plan around.116 That the Inter
110
There are private rulings in which a discussion of this concern is absent and the IRS held that the backend interest
(which included a special testamentary power of appointment) would not cause inclusion the donor spouse’s estate if
the QTIP election was not made in the donee spouse’s estate. See PLR 200406004 (February 6, 2004); PLR 9437032
(June 20, 1994).
111
UTC § 505(a)(2) (NCCULC 2010). The Commentary to that section provides in part: “Subsection (a)(2), which is
based on Restatement (Third) of Trusts Section 58(2) and cmt. e (Tentative Draft No. 2, approved 1999), and
Restatement (Second) of Trusts Section 156 (1959), follows traditional doctrine in providing that a settlor who is also
a beneficiary may not use the trust as a shield against the settlor’s creditors. The drafters of the Uniform Trust Code
concluded that traditional doctrine reflects sound policy.”
112
Regs. § 20.2041-1(c)(1).
113
Regs. § 20.2041-1(b)(2).
114
See PRACTICAL DRAFTING, Marital Deduction Regulations, D. The Lifetime QTIP Trust, 1. Retained Interests of Donor
Spouse (July 1994).
115
Zaritsky, Family Wealth Transfers, ¶ 6.03[3][b][i] (WG&L 2013].
116
Supercharged #1 at p.56.
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Vivos QTIP Trust Jurisdiction statutes (discussed below) exist illustrates the level of concern with
respect to this creditor’s rights issue.117
One solution to the creditor’s rights concern is to limit the donor spouse’s backend interest to
receiving distributions limited by an ascertainable standard relating to health, education,
support or maintenance. If the applicable state law would limit the rights of a potential creditor
to the maximum amount that the trustee could distribute (such as the UTC provision quoted
above) and if the trustee’s right to distribute is limited by such an ascertainable standard, a
section 2041 general power of appointment should not exist. This is because section
2041(b)(1)(A) provides an exclusion for powers limited by an ascertainable standard.
The ascertainable standard alternative is not, however, a perfect solution for several reasons.
First, in some of the lifetime QTIP plans outlined above, it may be desirable to structure the
backend interest for the donor spouse in a format that could again qualify for QTIP treatment.
In such cases, the donor spouse must be entitled to the trust income for life – i.e., it’s an interest
not subject to an ascertainable standard. Second, in other lifetime QTIP plans, it would be
preferable to have the backend interest in the donor spouse to be wholly discretionary. This
would permit greater flexibility in accumulating or distributing property based on all
circumstances without being required to distribute or limit distributions by an ascertainable
standard.
The second and likely more palatable solution to the creditor’s rights concern is to “situs” or
locate the lifetime QTIP trust in a domestic asset protection trust (DAPT) state such as Alaska,
Nevada or Delaware and use its laws to govern the creation and administration of the trust.
Carefully structuring the lifetime QTIP under one of these DAPT laws creates an argument that
the trust is protected from the claims of the donor spouse’s creditors, if the donor spouse
survives the donee spouse. This provides a layer of protection, an argument at least, against the
creditor’s rights concern. In effect, in many of these cases, the asset protection feature of the
DAPT state’s law would be used, not because of an overarching concern for asset protection
itself, but because the asset protection feature supports the desired tax planning result.
In recognition of the creditor’s rights concern, some Non-DAPT states have enacted statutes to
specifically abrogate the rule against self-settled spendthrift trusts for lifetime QTIP trusts
(adopting Barry Nelson’s nomenclature, these states are referred to herein as Inter Vivos QTIP
Trust Jurisdictions).118 These include: Arizona, Delaware, Florida, Kentucky, Maryland, Michigan,
North Carolina, South Carolina, Tennessee, Texas, Virginia and Wyoming. These statutes are
quoted in Appendix A.
Under the Arizona statute, the settlor of a lifetime QTIP trust is not considered the settlor of the
trust for creditor’s rights purposes if (i) the QTIP election is made pursuant to section 2523(f)
and (ii) the settlor is the beneficiary of the trust after the death of the donee spouse. Arizona
117
See e.g., Reporter’s Comment to Mich. Comp. Laws § 700.7506(4)(“Before the enactment of this section, there
had been concern that the donor spouse’s retained right to benefit from the overlife estate might permit the creditor
of the donor spouse to reach the property of the trust on a self-settled trust theory. [citation omitted] Subsection
7506(4) makes clear that the donor spouse, who establishes a lifetime QTIP trust under IRC 2523 and retains an
interest in the trust contingent on surviving the donee spouse, is not a ‘settlor’ for purposes of §7506(1). This brings
the state law creditor treatment into alignment with the IRS position that the donee spouse who benefits from an
inter vivos QTIP trust is the transferor of the property at death.”).
118
For a discussion of the techniques to consider in avoiding inclusion under section 2041 and of the Inter Vivos QTIP
Trust Jurisdictions see Nelson, Creative Inter Vivos QTIP Planning (fully cited at the end of Section II.E above).
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has a rule against self-settled spendthrift trusts based on UTC 505(a)(2) (quoted above).119 But,
if the settlor is not considered the settlor for purposes of this rule, Arizona’s other rules
governing creditor’s rights in non-self settled trusts would apply, which generally permit
spendthrift trust protection of a trust beneficiary’s interests.120 The laws in Delaware, Florida
Maryland, Michigan, North Carolina, South Carolina and Texas similarly deem the donor spouse
to not be the settlor of the lifetime QTIP after the donee spouse’s death, if the donor spouse has
a backend interest. Tennessee’s statute takes a slightly different approach. Rather than
deeming the donor spouse to not be the settlor, Tennessee’s statute deems the backend
interest in the lifetime QTIP to not be property that may be distributed to the donor spouse.
It’s worth noting that in Kite,121 Mrs. Kite transferred certain stock into a lifetime QTIP trust for
Mr. Kite seven days before his death. Upon Mr. Kite’s death, the QTIP property was included in
his estate under section 2044, but a QTIP election was made in his estate for the continuing
QTIP trust benefiting Mrs. Kite (i.e., she had a backend QTIP interest). It appears that the QTIP
trust instrument was created and governed by the law of Oklahoma. When the trust was
established Mrs. Kite, a resident of Oklahoma, and Boatmen’s Trust Co., were the trustees;
thereafter, Bank of Oklahoma, N.A. succeeded Boatmen’s.122 The case does not discuss section
2041 inclusion of the QTIP property in Mrs. Kite’s estate, presumably because upon Mr. Kite’s
death the QTIP election was made for the continuing trust, so that the trust property was
includable in Mrs. Kite’s estate under section 2044. Oklahoma is a DAPT state, and not an Inter
Vivos QTIP Trust Jurisdiction, which is perhaps why they felt secure in using Oklahoma law.
Alternatively, if the Kite plan was that in all events a QTIP election would be made in Mr. Kite’s
estate for the backend interest retained by Mrs. Kite, then, under that plan, section 2044
inclusion in Mrs. Kite’s estate would apply and it would not be necessary to create the lifetime
QTIP arrangement in either a DAPT state or Inter Vivos QTIP Trust Jurisdiction (i.e., the section
2041 concern becomes irrelevant).123
3.
Avoid Concerns by Establishing Lifetime QTIP in a DAPT State or
Inter Vivos QTIP Trust Jurisdiction
If the donor spouse lives in one of the Inter Vivos QTIP Trust Jurisdictions should the donor
spouse use his or her home state’s law to govern the lifetime QTIP in which the donor spouse
will retain the backend interest or select one of the DAPT states in which to situs the trust? An
advantage of using the home state’s laws is that no special effort to situs the trust in another
state is needed.124 Some attorneys believe that the using the home state’s laws will more likely
result in the courts respecting the credit protection feature.
119
Ariz. Rev. Stat. § 14-10505(A)2 provides in part: “Subject to the requirements of this section, with respect to an
irrevocable trust, a creditor or assignee of the settlor may reach the maximum amount that can be distributed to or
for the settlor's benefit. If a trust has more than one settlor, the amount the creditor or assignee of a particular
settlor may reach may not exceed the settlor's interest in the portion of the trust attributable to that settlor's
contribution. This paragraph does not apply to any trust from which any distribution to the settlor can be made
pursuant to the exercise of a power of appointment held by a third party or abrogate otherwise applicable laws
relating to community property…”
120
See Ariz. Rev. Stat. §§ 14-10501 – 10504.
121
See supra note 94.
122
Mrs. Kite’s father served as chairman of a family owned bank, which through merger and acquisition became part
of the Bank of Oklahoma, N.A.
123
See Regs. § 25.2523(f)-1(f), Ex. 11 (last sentence); PLR 9007015 (November 16, 1989)(ruling 3).
124
If the donor spouse resides in an Inter Vivos QTIP Trust Jurisdiction, that state’s law might be used as the fallback
position. For example, a Florida client might establish the lifetime QTIP in Delaware (a DAPT state) for the reasons
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A disadvantage of the Inter Vivos QTIP Trust Jurisdiction statutes is that each such statute is
designed to permit domestic asset protection to a limited class of trust interests created by and
for the settlor. Yes, each of these Inter Vivos QTIP Trust Jurisdictions allow domestic asset
protection trusts. It’s just that they are allowing them only for married couples and, for
purposes of our discussion, only for married couples that create lifetime QTIP trusts. It’s these
limitations that may prove less desirable by comparison to, for lack of a better description, a full
blown DAPT state. To understand the potential implications of this choice it is necessary to look
into the future and consider the planning permutations that may occur with the proposed
lifetime QTIP.
For example, all of the Inter Vivos QTIP Trust Jurisdictions, other than Maryland and Michigan,
allow the desired protection only after the donee spouse’s death. That is, other than the
Maryland and Michigan statutes, they do not contemplate that the donee spouse’s interests in
the QTIP might terminate for reasons other than death. Therefore, the backend interest in the
donor spouse after a full release of the donee spouse’s interests during the donee spouse’s
lifetime (and section 2519 transfer) may not be protected from the claims of donor spouse’s
creditors. Michigan’s statute seems to contemplate this by using language that refers to the
“termination of the individual’s spouse’s prior beneficial interest in the trust.”125 In a full blown
DAPT state, the donor spouse’s backend interests would likely be protected in such a
circumstance too.
Another example relates to the idea that the continuing trust for the donor spouse (the backend
interest) would be a “grantor trust” for income tax purposes. For example, suppose that after
the lifetime QTIP is created, the donee spouse dies, and the trust continues in the form of a bypass trust in which the donor spouse is a beneficiary, and it is a grantor trust as to the donor
spouse. Suppose the donor spouse then sells assets at a discount to the trust for a promissory
note – i.e., the sale to a defective grantor trust technique. After all, this is one of the advantages
of the by-pass trust being a grantor trust versus the traditional by-pass trust that is not a grantor
trust. Suppose further that the IRS could sustain a higher value for the sold property and a
deemed gift occurs for the excess over the sales price. The deemed gift is not protected by Fla.
Stat. § 736.0505(3) since there would be no QTIP election as to the deemed gift. It is simply a
transfer by the donor spouse to a trust in which the donor spouse is a beneficiary. If the donor
spouse’s interest qualifies as a “qualified disposition” under Delaware law,126 there may be no
estate tax inclusion as to the deemed gift.127 Preserving that argument is perhaps one
advantage of the DAPT states over most of the Inter Vivos QTIP Trust Jurisdictions.
4.
Avoid Concerns by Subsequent Transfer of Interests by Donor
Spouse During Donee Spouse’s Lifetime
Under section 2523(f)(5)(A), if the donor spouse retains a backend interest in a lifetime QTIP,
any subsequent transfer by the donor spouse of the retained interest during the donee spouse’s
lifetime is not treated as a transfer for gift tax purposes.128 Therefore, if the donor spouse
discussed below. If a court determines that Delaware’s laws cannot control the issues (see e.g., Hanson v. Denckla,
357 U.S. 235 (1958)), then the issues would most likely be controlled by application of Florida law, being one of the
Inter Vivos QTIP Trust Jurisdictions.
125
The Maryland statutory language is similar to that in Michigan.
126
Delaware Code, Title 12, § 3570(7).
127
See PLR 200944002 (approved DAPT based on Alaskan law).
128
Regs. § 25.2523(f)-1(d)(1). Also, under authority of 2523(f)(5)(A), the IRS in PLR 200406004 (February 6, 2004)
holds that the donor spouse having a power as trustee to distribute the donee spouse not subject to an ascertainable
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initially retains an interest and later determines that it is unlikely to be needed or useful, the
donor spouse could release the interest and remove any lingering estate tax inclusion issue.
While the donor spouse should not retain any interest that is subject to assignment, a simple
release should be available.
Furthermore, as a practical matter, any retained interest in the donor spouse is contingent on
surviving the donee spouse (i.e., since the donee spouse’s interest must be for life). As such, the
donor spouse’s interest is subject to the very real possibility of not being realized. In the event
the donor spouse does predecease the donee spouse, the retention of the contingent interest
until the donor spouse's death does not cause the property subject to the retained interest to
be includible in the gross estate of the donor spouse.129
Under section 2523(f)(5)(B), these rules do not apply after the donee spouse’s death or a
transfer subject to section 2519.130 Therefore, the concerns with inclusion under section 2041
apply with respect to any donor spouse retained interest in the lifetime QTIP once the donor
spouse survives the donee spouse.
5.
Avoid Concerns with Donor Spouse Retaining a Special Power of
Appointment
Can the donor spouse retain a special power of appointment as part of a backend interest in a
lifetime QTIP trust? This is another grey area.131 While some private letter rulings appear to
sanction it,132 the cautious play may be to avoid the concern.
A suggested alternative for creating flexibility is to grant an independent trustee broad authority
to make distributions to the donor spouse (i.e., not limited to an ascertainable standard, as
defined in the regulations under section 2041). If a QTIP election is made in the donee spouse’s
estate for the continuing QTIP interest in the donor spouse, then the backend interest of the
donor spouse will be subject to estate taxation in the donor spouse’s estate. In this situation, if
circumstances change, the independent trustee could exercise its discretionary power to make
outright distributions to the donor spouse, who could then make adjustments in the ultimate
distribution of the trust property. The distributions from the continuing QTIP trust will be
included in the donor spouse’s estate pursuant to section 2033 rather than section 2044 – i.e.,
the property is taxable in either case. Alternatively, if the backend interest is the nature of a bypass trust, the independent trustee could utilize the distribution power to decant the trust to
another trust based on the change in circumstance.
6.
When Section 2041 is Not a Concern with Retained Backend
Interest
The retained interest strings are less of a concern if the donor spouse does not retain a backend
interest. But are there circumstances when section 2041 is not a concern for a retained backend
interest, such that the lifetime QTIP would not need to be established in a DAPT state or Inter
Vivos QTIP Trust Jurisdiction? Yes, there is at least one such circumstance.
standard will not cause inclusion in the donor spouse’s estate if the donor spouse predeceases the donee spouse.
129
Id. See Regs. § 25.2523(f)-1(f), Ex. 10.
130
Regs. § 25.2523(f)-1(d)(2).
131
Pennell, 843-3rd T.M., Estate Tax Marital Deduction, VI.F.6, note 518; Zaritsky, Family Wealth Transfers, ¶
6.03[3][b][ii] (WG&L 2013].
132
See e.g., PLR 200406004 (February 6, 2004).
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Example 11: The donor spouse establishes a lifetime QTIP for
the donee spouse, timely makes the gift tax QTIP election, and
upon the donee spouse’s death the QTIP is included in the
donee spouse’s estate pursuant to section 2044. The donor
spouse survives the donee spouse and the trust continues in a
format that qualifies for QTIP treatment and the personal
representative of the donee spouse’s estate elects QTIP
treatment on the donee spouse’s estate tax return. The donor
spouse established the trust in the District of Columbia.
Pursuant to DC law, the creditors of the donor spouse can reach
the trust assets to satisfy the donor spouse’s creditors to the
extent distributions can be made to or for the benefit of the
donor spouse.133
The plan illustrated in Example #11 should work if the original intent is that upon the donee
spouse’s death, the QTIP election will be made for the backend interest if the donor spouse is
the surviving spouse.134 But, you may be thinking, if DC’s rule against self-settled spendthrift
trusts would allow the donor spouse’s creditors to reach the trust assets after the donee
spouse’s death, is the QTIP election available at the time of donee spouse’s death? After all, if
the donor spouse has a general power of appointment because the donor spouse’s creditor can
reach the assets, wouldn’t the trust automatically qualify for the section 2056(b)(5) marital
deduction as a general power of appointment marital trust, thereby in effect making the QTIP
election unavailable?135 For this purpose, it is important to note that a “general power” for
section 2056(b)(5) must be exercisable in favor of either the spouse or his or her estate. Even
though the donor spouse might have a general power of appointment pursuant to section 2041
in the above example, a creditor-type power alone would not qualify for the deduction under
section 2056(b)(5) (i.e., as a general power of appointment marital trust).136 This means that in
Example #11, the QTIP election upon the donee spouse’s death should be available. Since the
value of the QTIP trust will be included in the donor spouse’s estate under section 2044 and that
is the intended result, it makes little difference that inclusion may also occur pursuant to section
2041; provided, however, this would not be true with the minority interest discount planning
outlined in Section II.F above or if the desire is to effectively use the GST exemption of the
donee spouse.
Does DC’s rule against self-settled spendthrift trusts impact the ability to make the first QTIP
election in favor of the donee spouse – i.e., is the ability of creditors to reach the assets a power
to appoint to someone other than the donee spouse in violation of section 2056(b)(7)(B)(ii)(II)
(made applicable to lifetime QTIPs by section 2523(f)(3))? This should not be a concern because
the donor spouse’s interests would be contingent on surviving the donee spouse. Nothing could
be distributed to the donor spouse prior to the donee spouse’s death. Therefore, during the
donee spouse’s lifetime, the QTIP trust assets should be protected from claims of the donor
spouse’s creditors.
133
DC Code § 19-1305.05 provides in part: “(a) Whether or not the terms of a trust contain a spendthrift provision,
the following rules apply: *** (2) With respect to an irrevocable trust, a creditor or assignee of the settlor may reach
the maximum amount that can be distributed to or for the settlor's benefit.” (emphasis added)
134
This type of plan might be used with a plan to satisfy marital rights outlined in Section II.J above.
135
Pennell, 843-3rd T.M., Estate Tax Marital Deduction, VI.F.2(d).
136
Id. at VI.B.2.
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When might this be acceptable in the context of the LT QTIP plans discussed in Section II?
Perhaps when the donor spouse’s backend interest is in the form of a secondary QTIP, but not
the by-pass trust part, and not with the minority interest discount planning outlined in Section
II.F above. For example, suppose that a lifetime QTIP is established to ensure use of the donee
spouse’s applicable exclusion amount as outlined in Sections II.A and B, and that upon the
donee spouse’s death a formula allocates an amount equal to the donee spouse’s estate tax
exclusion to a by-pass trust in which the donor spouse is not a beneficiary and the balance, if
any, to a secondary QTIP trust for the donor spouse. It is contemplated that a QTIP election will
be made for the secondary QTIP if the donor spouse survives the donee spouse. In this case,
creating the lifetime QTIP in a DAPT state or Inter Vivos QTIP Trust Jurisdiction may not be
imperative, but some options such as a partial QTIP election could be unavailable given the
potential creditor concern. Perhaps it would also be acceptable for a lifetime QTIP implemented
just for an income tax basis adjustment as outlined in Section II.H or just to control property as
outlined in Sections II.J and K.
7.
GST Tax and Backend Interests
Section I.D. above explains that the donor spouse may reverse the QTIP election for GST tax
purposes when establishing a lifetime QTIP trust. This is generally advantageous if the lifetime
QTIP’s assets appreciate in value over time. It starts to leverage the GST exemption upon
establishing the lifetime QTIP rather than waiting until the donee spouse’s death. By the nature
of QTIP property, income must be paid out to the donee spouse and therefore using GST
exemption on a QTIP trust is “leaky”, at least to that extent. Even so, making the reverse QTIP
election for a lifetime QTIP trust may be an efficient use of the donor spouse’s GST exemption,
particularly if other gifts are not contemplated to which such GST exemption could be allocated.
Suppose that when establishing the lifetime QTIP, the donor spouse makes both the QTIP
election and reverse QTIP election on a timely filed gift tax return, then the donor spouse
survives the donee spouse’s death and the trust provides the donor spouse with a backend
interest in a form that would qualify for QTIP treatment. If the QTIP election is made in the
donee spouse’s estate, estate taxes on the QTIP trust are deferred until the donor’s spouse’s
subsequent death. For GST tax purposes, the donor spouse will remain the transferor of the
trust because of the reverse QTIP election on the gift tax return reporting the original transfer.
Moreover, the trust will retain its exempt status resulting from the donor spouse’s original
allocation of GST exemption. This makes sense because the reverse QTIP election made on the
donor spouse’s gift tax return has the effect of deeming the gift tax QTIP election as having not
been made (i.e., and if that QTIP election had not been made, there would have been no
inclusion in the donee spouse’s estate, no QTIP election could have been made in the donee
spouse’s estate, and no inclusion in the donor spouse’s estate). Therefore, the inclusion ratio
should track back to the allocation of GST exemption on that gift tax return, even though the
trust property has been subsequently included in both the donor and donee spouses’ estates.137
B.
Planning to Reduce Estate Tax on Donee Spouse’s Death
Section II outlines uses of lifetime QTIPs to achieve estate tax savings. For example, Section II.F
above explains using a lifetime QTIP to achieve estate tax savings by enabling a greater portion
of the equity interests in a private company to be valued on a minority interest basis. However,
the potential estate tax savings opportunities for QTIPs do not end on funding. The trustees of
QTIPs can engage in planning designed to lessen the eventual estate tax burden upon the
137
See Supercharged at note 55.
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surviving spouse’s death. Kite138 is a good example of that. Following Mr. Kite’s death on
February 23, 1995, a QTIP trust, a GPOA marital trust and a residuary GST by-pass trust were
created for Mrs. Kite’s benefit. Seven days prior to his death, Mrs. Kite had created a lifetime
QTIP for Mr. Kite. As mentioned above, upon Mr. Kite’s death, the lifetime QTIP property was
included in his estate under section 2044, and a QTIP election was made in his estate for the
backend QTIP interest in Mrs. Kite. In December 1996, these trusts, along with Mrs. Kite’s
revocable trust, formed a limited partnership (FLP#1), with each trust transferring assets to the
FLP#1 and taking back limited partnership interests. There is no discussion in the Kite case
regarding the fiduciary or tax issues implicated in using QTIP property to fund an FLP.
About a month after forming FLP#1, in January 1997, Mrs. Kite transferred to her children onethird of the limited partnership interests. She made these transfers as trustee of the trusts,
including the QTIP trusts.139 Section 2519 is not discussed as a concern with respect to these
1997 transfers. Mrs. Kite filed a 1997 gift tax return reporting the transfers with a value of
$2,954,067, reflecting an aggregate lack of marketability and minority interest discount of
34.354% and paid $1,485,132 in gift tax. Apparently the IRS did not audit Mrs. Kites’ 1997 gift
tax return. Therefore, Kite is an example of how QTIPs can participate in forming FLPs, which
enable valuation discounts for transfer tax purposes.
As the commercials say, “that’s not all.” After reorganizing FLP#1 and its general partner under
Texas law (“FLP#2”), but keeping the same ownership structure, in May 1998 Mrs. Kite, acting
through the trusts (including the QTIPs), sold her remaining interests in FLP#2 to her children (or
trusts for them) for promissory notes, which were secured and recourse.140 The opinion doesn’t
say so, but presumably the value of the sold limited partnership interests reflected valuation
discounts similar to the 1997 gifts, again reflecting that estate planning is possible with QTIPs.
The purchase notes required quarterly payments of interest and principal for 15 years. As
discussed below in Section III.C.1, it is important not to deprive the QTIP beneficiary of the
income interest, and therefore it was appropriate that the notes paid interest and that interest
on the notes had not accumulated.141 Mrs. Kite was also cautious to amortize the principal over
a reasonable period of time. The opinion doesn’t indicate whether these sales were disclosed
on Mrs. Kite’s 1998 gift tax return as a non-gift pursuant to Regs. §§ 301.6501(c)-1(f)(2) - (4).142
If the transfers were “adequately disclosed” on a gift tax return, perhaps the IRS would have
been limited to a period of three years to dispute the valuation; otherwise, gift tax may be
assessed at any time.143 The IRS apparently did not challenge the valuation of the sold assets or
138
See supra note 94.
Presumably distributions of the limited partnership interests were made from the QTIPs to Mrs. Kite and
thereafter she made the gifts individually to avoid section 2519, but this is not clear in the opinion.
140
For any new sales consider the Woelbing litigation. See supra note 84.
141
See PLR 9418013.
142
This Regulation sets forth the information that must be disclosed for a “non-gift” situation to start the statute of
limitations. This regulation is applicable to transfers after December 31, 1996, and for which the gift tax return is
filed after December 3, 1999. Regs. § 301.6501(c)-1(f)(8).
143
IRC § 6501(a). Regs. § 301.6501(c)-1(f)(1). Consider whether the QTIP trust sales will achieve valuation finality
under this regulation if the Donor spouse is not the purchaser. If the QTIP trust is a wholly grantor trust, the donor
spouse is the deemed owner for income tax purposes (Rev. Rul. 85-13), but not for gift tax purposes. Disclosure of
the QTIP trust sale under this regulation may be advisable in any event to notice the government as to a transaction
that if for less than fair value would have the potential of triggering a deemed section 2519 disposition. See Section
III.C.1 below.
139
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allege any deemed gift transfer arising from the sales as part of auditing Mrs. Kite’s estate tax
return.
Mrs. Kite and her lawyer were not done, however. In December 2000, Mrs. Kite’s trusts (again
including the QTIPs) contributed the notes receivable from the FLP#2 sales to a new general
partnership. The idea was to sell the interests in the new partnership to the children for private
annuities. Mrs. Kite sold her interests in the general partnership for their liquidation value. It
appears that no valuation discounts were taken on the value of the promissory notes or the
interests in the general partnership. The estate tax savings of the plan hinged on the nature of
the private annuity arrangement rather than valuation. Therein lies the rub for QTIP purposes.
The Kite plan involved using 10-year deferred private annuities. Such a long period of deferral
would arguably deprive Mrs. Kite of her required income interest in the QTIP trusts. This likely
motivated the termination of the QTIP trusts prior to pulling the trigger on the annuities. The
trusts’ terminations, followed by immediate or simultaneous asset sales, lead to the court
applying section 2519, discussed further below in Section III.C. Perhaps this last round of
transactions would have been successful had the trustees of the QTIP trusts sold the general
partnership interests for immediate rather than deferred annuities.
1.
Distribution of QTIP Assets to Donee Spouse to Make Gifts or
Sales
The lifetime QTIP could include provisions that permit distributions to the donee spouse to
enable gifts by the donee spouse. Regs. § 25.2523(f)-1(c)(1)(iv) provides:
The fact that property distributed to a donee spouse may be
transferred by the spouse to another person does not result in a failure
to satisfy the requirement of section 2056(b)(7)(B)(ii)(II). However, if
the governing instrument requires the donee spouse to transfer the
distributed property to another person without full and adequate
consideration in money or money's worth, the requirement of section
2056(b)(7)(B)(ii)(II) is not satisfied.
The Kite case is a cautionary tale, however, because the court viewed the termination of the
QTIP marital trusts and the subsequent sale by Mrs. Kite of the distributed assets for a deferred
private annuity as integrated transactions. A substance over form analysis resulted in
application of section 2519.
2.
Funding Family LLC/FLPs
See FSA 199920016 discussed below, in Section III.C.1.
3.
Sales of Discounted Assets for Promissory Notes
See the Kite case discussed herein, as well as FSA 199920016 discussed below, in Section III.C.1.
C.
Section 2519 Concerns
Evaluating the risks under section 2519 is critical when considering any tax planning strategy for
a QTIP trust or its assets. Virtually all questions considered during a QTIP trust’s operation
should have as a component considering the impact, if any, of section 2519.
Section 2519 is complicated. Understanding the net gift structure and reimbursement
provisions of section 2207A(b) are necessary before embarking on any gift strategy. The
complexity is illustrated in Est. of Morgens v. Comm’r.144 The Tax Court held in Morgens that the
gift tax paid by the donees pursuant to sections 2519 and 2207A(b) was subject to being
144
133 T.C. 402 (2009).
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included in the gross estate under section 2035 when the decedent died within the 3 year
inclusionary period. The Court found:
“We agree that Congress intended that as between QTIP
recipients and the surviving spouse, it is the QTIP recipients who
should bear the ultimate financial burden for transfer taxes.
However, we do not believe that by allocating the financial
burden for gift tax to recipients of QTIP, Congress shifted to
them liability for the gift tax. Section 2207A(b) does not provide
that the donees of QTIP should be liable for the applicable gift
tax. Rather, section 2207A(b) refers to the right to recover the
gift tax. The estate’s argument would read section 2207A(b) out
of the gift tax architecture. Section 2502(c) clearly provides that
gift tax is the liability of the donor: ‘The [gift] tax imposed by
section 2501 shall be paid by the donor.’ Section 25.2511-2(a),
Gift Tax Regs., also provides that ‘the tax is a primary and
personal liability of the donor, is an excise upon his act of
making the transfer, is measured by the value of the property
passing from the donor’. The donee is liable only if the gift tax is
not paid by the donor when due. It is the donor who must file a
gift tax return and pay the tax on or before April 15 of the year
following the year in which a gift was made. Any gift tax, if not
paid, can be assessed against the donor within 3 years after the
gift tax return is filed.” [citations omitted]
1.
Risk of Transactions with Lifetime QTIP
A purchase by the donor spouse, for example, of an asset from a lifetime QTIP comes with the
risk that section 2519 could apply. Section 2519(a) provides that “any disposition of all or part
of a qualifying income interest for life in any property…shall be treated as a transfer of all
interests in such property other than the qualifying income interest.” If a portion or fractional
share of the spouse's QTIP interest is disposed of, the entire trust, other than the value of the
income interest retained, is treated as transferred for both gift and estate tax purposes under
section 2519. If that is not bad enough, a section 2519 transfer can trigger the special valuation
rules of section 2702 (if another interest in the property is held by a member of the transferor's
family) and can result in estate tax inclusion under section 2036(a) (if the remaining portion of
the qualifying income interest is retained until death).145
Regs. § 25.2519-1(f) provides that a sale and reinvestment of the QTIP trust corpus is not
considered a disposition of the income interest, but is merely a change of the income source.
The question is whether a deemed “disposition” for purposes of section 2519 would occur if an
asset is sold by the trustees of a lifetime QTIP to a related party for less than fair market value
(i.e., the IRS is able to sustain a higher value for the asset sold than sale value, which presumably
would be by appraisal).
In FSA 199920016, the income beneficiary of a QTIP trust (the petitioner), her daughter, the
daughter’s two children and the QTIP trust formed a family limited partnership. The daughter
and her two children were general partners. The income beneficiary and the QTIP trust were
145
See generally, Stephens, Maxfield, Llind, Calfee & Smith, FEDERAL ESTATE AND GIFT TAXATION, ¶10.08 (WG&L 2010).
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limited partners. The daughter was also a limited partner. The Advice concluded that the
section 2519 disposition issue should not be pursued. It stated:
“As applied to the facts of our case, petitioner’s conversion of the trust
assets into FLP interests is not the typical disposal of the income
interest envisioned under the provisions of section 2519. By converting
the trust assets into FLP interests, she has disposed of the corpus
rather than the qualifying income interest. Facially this appears to be
a permissible conversion. Thus, in order to invoke 2519, the conversion
of the trust assets must work such a limitation of her right to the
income as to amount to a disposition of that income. Although the
conversion to partnership interests could yield this result, it does not
necessarily follow. An investment in a partnership, despite possible
restrictions on distribution, could be, under the right circumstances, a
very lucrative investment.
Moreover, although the managing partner of the FLP had the right to
accrue and not distribute the partnership income, the facts show that
such has not been the case. Petitioner has continued to receive her
income unabated since the formation of the FLP. No action of
Petitioner’s has affected her right to income from the trust; that right
still exists. The fact that she might not, in a hypothetical world,
actually receive income does not destroy her right to any income, if
such income exists. Moreover, QTIPs can be originally funded with
partnership interests or, for that matter, closely held stock. Both of
these investments could distribute no income in any given year. The
right to annual income is not tantamount to a fixed right to yearly
income, rather it is a right to any income to the extent it exists, on at
least an annual basis.”
In PLR 9418013, the IRS determined that section 2519 would not apply when a QTIP trust loaned
trust funds to the three sons of the deceased spouse whose Will established the QTIP for the
surviving spouse:
“In the present case, the trustee proposes to make loans of up to $Y to
each of decedent's three sons from the corpus of the Marital Trust.
The interest on the loans will be a rate of interest that meets the
requirements of §7872. The interest however, will accrue instead of
being paid on a current basis. Under the proposed loan arrangement,
the trustee will make principal distributions to the spouse each year in
an amount equal to the accrued interest. This distribution will offset
the loss of ‘real income’ to spouse. Under these circumstances, the
spouse will not be deprived of the income that she would receive from
the Marital Trust if the loans were not made. Therefore, the quality of
the spouse's qualifying income interest for life will remain
substantially unchanged as a result of the proposed transaction. In
addition, the promissory notes that will be given in exchange for the
loans will accrue interest over the life of the spouse and upon her
death, the promissory notes and the accrued interest thereon, will be
includible in spouse's estate under section 2044.”
Similar to these rulings, a sale of assets by the lifetime QTIP in exchange for a promissory note
should not affect the quality of the donee spouse’s interest for life. The donee spouse should
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not be deprived of income. In some cases, cash flow from the note could be more than that of
the assets sold.
Before the QTIP trust sells an asset, one option is to divide the lifetime QTIP into two separate
trusts, one for the asset to be sold and one for the remaining assets. This should help minimize
the risks for the trust with the remaining assets. For example, in PLR 200044034, the IRS
permitted a division of a QTIP trust into two trusts to be made on a non-pro rata basis before
the spouse assigned her income interest in one of those trusts, causing sections 2519 and
2207A(b) to apply to that trust but not to the other continuing trust. Other private letter rulings
have similarly held that a marital trust could be divided into two separate trusts, after which
time the spouse could renounce or sell her interest in one divided trust without a section 2519
disposition occurring as to the other divided trust.146 Unless authorized by the trust instrument
or state law,147 court approval may be required to divide a single trust into separate trusts. Regs.
§ 25.2519-1(c)(5) provides:
If the donee spouse's interest is in a trust consisting of only qualified
terminable interest property, and the trust was previously severed (in
compliance with Section 20.2056(b)-7(b)(2)(ii) of this chapter or
Section 25.2523(f)-1(b)(3)(ii) from a trust that, after the severance,
held only property that was not qualified terminable interest property,
only the value of the property in the severed portion of the trust at the
time of the disposition is treated as transferred under this section.
a)
Deemed Gift
Suppose that the trustee of a QTIP trust sells a discounted asset for a promissory note (a la the
1998 Kite sales discussed in Section III.B. above), in an attempt to freeze the value of the QTIP in
the donee spouse’s estate for estate tax purposes. If the IRS audits a sale transaction and is
successful in sustaining a higher valuation for the interests exchanged or sold, the IRS may argue
that the donee spouse made a gift to the purchaser for the difference between the higher
valuation and the exchange/sales price or perhaps the entire value of the lifetime QTIP. Of
course, the lifetime QTIP is not making a gift because the trustee has no authority to make a gift
– the trustee has a duty to administer the property for the donee spouse’s benefit. Rather, the
IRS would argue that the failure of the donee spouse to object to the trustee transferring assets
it holds for his or her benefit for inadequate consideration results in a deemed gift.148 The gift
would likely arise when the statute of limitations on asserting a claim has expired.
The following arguments support the contention that the “deemed gift” theory lacks merit.
First, the Tax Court has said “we do not believe that a taxable event can occur for gift tax
purposes unless there is first and in fact an act of transfer by the donor; and there can be no act
of transfer unless the act is voluntary and the transferor has some awareness that he is in fact
making a transfer of property, that is, he must intend to do so.”149 The issue would be whether
allowing the statute to lapse was a voluntary act to transfer property or not; if the lapse was
involuntary or unwitting, one could argue that the lapse should not be categorized as a taxable
146
See PLRs 200230017, 200122036, 201426016 (Jul. 1, 2014).
Section 417 of the UTC permits a trustee to divide a trust into two or more trusts, even if the resulting trusts are
dissimilar, as long as a beneficiary’s rights are not impaired or the purposes of the trust are not adversely affected.
148
For example, the IRS held the surviving spouse made a deemed gift to children by not asserting her right to have
her marital trust fully funded, when the executor underfunded the marital trust by $40,000 that passed to the
decedent’s child as the residuary beneficiary. Rev. Rul. 84-105, 1984-2 C.B. 197 (1984).
149
DiMarco v. Comm’r, 87 T.C. 653 (1986).
147
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gift. No cases could be found where the IRS argued that the lapse of a statute of limitations
resulted in a taxable gift.
Second, the donee spouse would not have a cause of action against the trustees for selling at
too low a price unless the trustees acted negligently. Negligence does not mean just being
wrong, it is a failure to use care that a reasonably prudent and careful person would use under
similar circumstances. Pursuant to Section 804 of the Uniform Trust Code, a trustee must
administer the trust as a prudent person would and must “exercise reasonable care, skill and
caution.” The sale should be free of negligence if the trustee reasonably relied upon the
determination of values by a professional independent appraisal firm, an expert in the particular
industry. Therefore, the argument would be that if the trustee is not guilty of negligence
because the trustee satisfied the standard of care, no cause of action could arise, and the failure
to pursue the matter could not give rise to a gift. While this is a legally correct argument, the
IRS may argue “form over substance” where the trustee is a related party.
b)
Disclose Lifetime Marital Trust Sale
Consider recommending that the donee spouse disclose the sale by the lifetime QTIP as a nongift transaction.150
2.
Section 2702
Section 2702 may be applicable to any section 2519 deemed disposition when the beneficiary
spouse of the QTIP trust retains an interest in the QTIP trust.151 Section 2702 is applicable to any
transfer by a donor to a trust for a family member if the donor retains an interest in the same
trust. Family member means the donor’s spouse, ancestors, descendants (including ancestors
and descendants of the donor’s spouse), brothers and sisters, and spouses of such persons. If
applicable, any retained interest by the donor is valued at zero unless the retained interest is in
the nature of a qualified annuity interest (GRAT) or qualified unitrust interest (GRUT).
Example 12: In 2012, Husband gives $5.34 million to a lifetime
QTIP for Wife’s benefit to enable the use of her estate tax
exclusion amount (as described above in Sections II.A and B).
The Wife is entitled to all the income and discretionary
payments of principal in the trustee’s discretion for her health,
maintenance and support needs. Husband’s descendants are
the remainder beneficiaries of the lifetime QTIP trust. Husband
timely makes the gift tax QTIP election on his 2012 gift tax
return.
In 2014, Wife releases 25% of her interest in the lifetime QTIP.
In Example #12, the Wife has made a gift under section 2511 of 25% of her life interest.
Additionally, pursuant to section 2519, she has made a deemed disposition of the entire
remainder interest in the QTIP trust, not just 25%. Moreover, since the Wife has retained a 75%
interest as the life beneficiary, section 2702 would apply to the 75% deemed disposition under
section 2519. Because the Wife’s life interest is not in the form of a GRAT or GRUT, her retained
150
Regs. §§ 301.6501(c)-1(f)(2) - (4) set forth the information that must be disclosed for a “non-gift” situation to start
the statute of limitations.
151
Regs. § 25.2519-1(g) Ex. 4.
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life interest is valued at zero. Therefore, in effect, wife has made a taxable gift of 100% of the
lifetime QTIP’s value.152
There are at least two possible solutions to the application of section 2702 as described above.
The lifetime QTIP could provide that following any partial release (or partial assignment or
transfer) of the life interest by the donee spouse, that the QTIP trust thereafter will provide the
donee spouse with the greater of the trust’s income or a qualifying annuity as defined in section
2702(b)(1) equivalent in value to the portion of the life interest retained (e.g., 75% in Example
#12).153 This solution requires the trust to contain governing instrument requirements for a
GRAT from the outset.
Alternatively, prior to implementing the release, the trustee could divide the QTIP into two
separate trusts of 75% and 25%, thereby allowing the donee spouse to effect the release as to
the separate trust containing 25%. Many private letter rulings have been issued concluding that
a section 2519 transfer only occurs as to severed trust over which the spouse has implemented
the release or assignment.154 This solution is likely the preferred approach as it would minimize
the impact of section 2519. Also it may allow less leakage from the severed 75% QTIP as
compared to distributing the greater of the trust’s income or annuity involved in the first
solution.
D.
Spendthrift Clauses
A release of the spouse’s interests in a QTIP (or severed QTIP) should not be in violation of a
typical spendthrift clause. See the commentary under Section 58 of the Restatement (Third) of
Trusts:
§
58
Spendthrift
Trusts:
Validity
and
General
Effect
(1) Except as stated in Subsection (2), and subject to the rules in
Comment b (ownership equivalence) and § 59, if the terms of a trust
provide that a beneficial interest shall not be transferable by the
beneficiary or subject to claims of the beneficiary's creditors, the
restraint on voluntary and involuntary alienation of the interest is
valid.
(2) A restraint on the voluntary and involuntary alienation of a
beneficial interest retained by the settlor of a trust is invalid.
Comment c. What acts are precluded "transfers"? A spendthrift
restraint prevents the transfer of a trust beneficiary's interest to
another, whether the attempted assignment is by gift, sale, or
exchange, or as security for a new or existing debt. On other effects of
an attempted transfer, however, see Comment d.
A designated beneficiary of a spendthrift trust is not required to
accept or retain an interest prescribed by the terms of the trust. Thus,
an intended beneficiary may reject a beneficial interest or power of
152
See Pennell, 843-3rd T.M., Estate Tax Marital Deduction, VII.A.3,d (outlines the issues under sections 2036 and
2001(b) at the time of the donee spouse’s death, the application of the Regs. §25.2702-6 adjustment, and the right of
reimbursement and net gift concepts under 2207A).
153
See PRACTICAL DRAFTING, Qualified Terminable Interest Property (QTIP) Dispositions, E. Planning 1.b.(ii) Issues and
Analysis (January 1999).
154
See supra note 144 and accompanying text; Pennell, 843-3rd T.M., Estate Tax Marital Deduction, VII.A.3,d, note
697.
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appointment by a proper disclaimer. Even the release of an interest in
a spendthrift trust, including by purported disclaimer following
expressed or implied acceptance, is permissible and serves to
terminate the beneficiary's interest even though the release is treated
for other purposes as a transfer. On the other hand, a purported
disclaimer by which the beneficiary attempts to direct who is to
receive the interest is a precluded transfer and will not be given effect
because of the spendthrift restraint. See generally § 51, Comment f, on
disclaimers and releases as possible "transfers" of beneficiaries'
interests or of property subject to powers of appointment. See also
Comment f below.
Some authorities seem to believe that the Restatement 3rd may not be stating the current law.
The commentary to Section 502, Spendthrift Provision, of the UTC, however, refers to this
Restatement provision relating to releases not being affected by a spendthrift clause. This
seems reasonable as one should be able to simply walk away from an interest (as opposed to
assigning it to someone else or selling it).
For example, DC Code section 19-1513(b)(1) applies to a disclaimer that would not be qualified.
Section 19-1513(f) says that a disclaimer of an interest in property which is barred by this
section takes effect as a transfer of the interest disclaimed to the persons who would have
taken the interest under this chapter had the disclaimer not been barred. Consider whether this
means that it becomes a “transfer” in violation of the spendthrift clause. This likely just means
upon the nonqualified disclaimer/release, the property does not stay in limbo while the
disclaimant is living; it moves on to the next beneficiaries.
Planning Pointer: New QTIP trusts should always permit a release as distinct from an
assignment. For example, the spendthrift clause might read:
Spendthrift Provisions
Except for the right to disclaim, and except as specifically provided by
powers of appointment, no principal or income distributable from any
trust created hereunder, including the proceeds of any life insurance
policy held hereunder, shall be subject to transfer, conveyance,
anticipation, assignment, mortgage, pledge or any other form of
alienation in any manner by any beneficiary, nor shall any such
interest in any manner be liable for or subject to the claims of any
creditor or to any legal, equitable or other process, including
bankruptcy, receivership or other proceedings, in satisfaction of any
debt or liability of a beneficiary prior to receipt by the beneficiary,
including those claims of any beneficiary's spouse against such
beneficiary. This Section shall not apply to me.
If the Trustee is prevented by any transfer, conveyance, anticipation,
assignment, mortgage, pledge or any other form of alienation or any
proceeding brought by any creditor, or by any bankruptcy, receivership
or other proceeding, from distributing property directly to or for the
benefit of any beneficiary, the Trustee shall hold and accumulate the
property which would otherwise have been distributed until the
Trustee is able to distribute such property directly to or for the benefit
of such beneficiary, or until the death of such beneficiary, whichever
first occurs; and on the death of such beneficiary any such property so
held and accumulated shall be distributed as otherwise provided
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herein. This Paragraph (b), however, shall not apply to income
distributable from any Marital Trust or to any non-discretionary
distribution of property to my spouse.
For purposes of this Section, a release of an interest in a trust
hereunder, without any attempt to direct who is to receive the
interest, shall not be considered a form of prohibited alienation
pursuant to Paragraph (a) above.
Also, consider whether the next successive interest in the trust would advance as if the releasing
beneficiary had died.
E.
QDOTs
The planning outlined in this paper is only available for transfers to a lifetime QTIP for a US
citizen spouse. Section 2523(i) precludes a gift tax marital deduction (in trust or otherwise) for
transfers to a non-US citizen spouse. Therefore, there is no lifetime QDOT that is analogous to
the lifetime QTIP.155 Moreover, even if such device existed it would be ineffective to utilize the
applicable exclusion of the donee spouse, given that QDOTs are taxable as if they are part of the
donor spouse’s estate.
F.
Divorce Issues
1.
Divorce and Income Taxation of the QTIP Trust
Section 672(e)(1)(A) provides that a grantor shall be treated as holding a power or interest held
by an individual who was the spouse of the grantor at the time of the creation of the power or
interest. Section 682 provides that “[t]here shall be included in the gross income of a wife who
is divorced . . . the amount of the income of any trust which such wife is entitled to receive and
which, except for this section, would be includible in the gross income of her husband, and such
amount shall not, despite any other provision of this subtitle, be includible in the gross income
of such husband.” This means that following divorce, the trust accounting income of the
lifetime QTIP, which must be distributed to the donee spouse even following the divorce, will be
taxed to the divorced/donee spouse.
The items of income attributable to principal for trust accounting purposes, however, may
remain taxable to the donor spouse, if the trust continues to be a grantor trust as to principal, or
to the QTIP trust, if the trust is no longer a grantor trust as to principal. Obviously, the donor
spouse might be upset to learn he or she must continue to pay income taxes on the income of a
trust benefiting the ex-spouse. Therefore, this income tax issue should be considered in the
drafting stage and the client advised accordingly.156
Some of the uses for lifetime QTIPs have little or no exposure to this concern. For example, if
the lifetime QTIP is being used as a donee under a Petter formula allocation clause, the QTIP
trust may be funded only nominally or with modest amounts passing under the formula clause.
Also, if the lifetime QTIP is designed to provide a structure for using the donor spouse’s AEA as
in Section II.D, the QTIP trust may have little or no assets following a disclaimer by the donee
155
See e.g., TMP 837-3RD: NON-CITIZENS — ESTATE, GIFT AND GENERATION-SKIPPING TAXATION, VI.A (“Where the gift is to a
non-citizen spouse, no marital deduction is available (even if the transfer is to a trust satisfying the requirements of a
QDOT). But, a substantial exclusion applies: The annual gift tax marital exclusion is $100,000, as adjusted for inflation
(instead of the lesser amount allowed under §2503(b)).”).
156
Section 682 would have a similar impact in QPRTs, GRATs, SLATs, ILITs where the divorced spouse is a beneficiary
post-divorce. Many of these trust instruments may terminate the spouse’s interests as a beneficiary post-divorce,
whereas this is not possible for the income interest in a QTIP.
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spouse. In either case, the potential exposure to the donor spouse for income taxes following a
divorce is small.
The concern will be applicable when the lifetime QTIP has provisions designed to cause wholly
grantor trust status, such a power to substitute assets of equivalent value or if the donor spouse
retained a backend interest in the QTIP trust. One suggested solution is to create some
alternatives for turning off grantor trust status as to principal. For example, the lifetime QTIP
could have a trust protector authorized to terminate grantor trust status as to principal,
including the ability to terminate the backend interests of the donor spouse. Moreover, the
donor spouse could release his or her backend interests to terminate that incident of grantor
trust status. The gift tax QTIP rules specifically provide that a transfer of such retained interests
during the donee spouse’s lifetime is not a transfer for gift tax purposes.157
Prior to divorce, a discretionary power to distribute principal to the donee spouse would cause
grantor trust status as to principal under section 677(a). After divorce, under the rule of section
672(e)(1)(A), the same result would continue to apply since the section 677(a) power is
determined at the time of creation. Whether a discretionary power is subject to section 682 is
not clear. For purposes of section 682 is the divorced/donee spouse “entitle to receive” the
discretionary principal distributions? Moreover, distribution of principal would not typically
carryout items of income attributable to principal for trust accounting purposes. As mentioned
above in Section I.A.4, any discretionary principal distribution provision could be designed to
terminate upon divorce. Therefore, consider whether the principal distribution provisions
should terminate on divorce to terminate the continuation of grantor trust status as principal.
Other alternatives to consider in mitigating the post-divorce income tax consequences to the
donor spouse might include: swapping assets, at least prior to the actual divorce to restrict
future capital gains (e.g., swapping in bonds) or restructuring the investments to control the
degree of concern (e.g., selling stocks and buying bonds). Having a friendly trustee may be
important. Given that divorce does not happen overnight there should be time to consider
these alternatives once divorce becomes the desired end. After the divorce, perhaps the QTIP
trust could loan funds to the donor spouse, if necessary, to pay the taxes on capital gains.
While the donor spouse may find paying such taxes inconvenient and annoying post-divorce, in
very wealthy families, the donor spouse’s payment of the capital gains taxes may have a positive
effect from a wealth transfer tax point of view. In some cases, the income tax payments may be
an additional potential cost to obtain the desired estate tax savings (e.g., the minority interest
discount planning outlined in Section II.F above).
A lifetime QTIP could be used to control assets the donee spouse may otherwise be entitled to
outright upon divorce.158 In these situations, having some potential tax exposure in exchange
for the desired control would likely be acceptable.
The flexibilities commonly used in irrevocable trusts (i.e., powers to change trustees, protectors,
etc.) should create options to deal with the income tax concern should it arise. As discussed
below, a marital agreement may be an important part of implementing a lifetime QTIP. The
post-divorce income tax issues could also be addressed in such a marital agreement (for
example, the donee spouse could agree to some level of reimbursement to the donor spouse for
157
158
See Section III.A.4.
See Section II.K above.
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income taxes paid by the donor spouse post-divorce). Of course, the income tax issues are
another potential entanglement that may require attention in the divorce negotiation.
Other implications must also be considered with the termination of wholly grantor trust status
upon divorce. The lifetime QTIP trust would begin filing separate annual income tax returns.159
In the case of a trust holding S corporation stock, the lifetime QTIP would need to qualify as a
QSST within 2 months and 15 days after the divorce to continue being a qualified owner of S
corporation stock.160
2.
Funded with Separate or Marital Property
What happens upon divorce if a lifetime QTIP is funded with separate property, or alternatively,
funded with marital property? In the event of a divorce, is the gift or property interest created
in the donee spouse counted in the division of the marital assets? This is an important question
to consider in some lifetime QTIP plans.
Example 13: Husband owns 100% of stock in HumCor Inc., a
marital property asset. Husband would like to fund 49% of his
stock into lifetime QTIP for Wife’s benefit to enable a minority
interest discount on this portion of the equity (as described
above in Section II.F). If a divorce occurs, however, Husband
questions whether Wife will be entitled keep her interest in the
QTIP trust and receive one-half of the remaining 51% of the
stock owned by him – i.e., in effect receiving 75% of the stock.
a)
Separate Property
If separate property is used to fund the lifetime QTIP, then depending on applicable state law,
the donee spouse’s interest in the trust may be considered marital property in the event of a
divorce and subject to equitable distribution (i.e., presumably the value of the trust interest
would be counted in the division of the marital property). In Theismann v. Theismann,161 the
husband titled separate real property into his and his wife’s names. The court determined that
the transfer was a gift that provided a basis to award part of the property to the wife as marital
property. In effect, the transfer changed the separate property into marital property.
Converting separate property into marital property to obtain a tax advantage should be done
knowingly and with acceptance of the associated risk. If marital property is available, it may be
a better choice for funding a lifetime QTIP, especially if the nature of the property for purposes
of divorce remains marital property.
b)
Marital Property
If marital property is used to fund the lifetime QTIP, then, again, depending on applicable state
law, the trust may be considered marital property in the event of a divorce and subject to
equitable distribution (i.e., presumably the value of the trust interest would be counted in the
division of marital property). For example, Caccamise v. Caccamise, 130 Md. App. 505, 747 A.2d
221 (Md. Ct. Spec. App. 2000), cert. denied, 359 Md. 29 (2000), indicates this is the result with
159
Regs. § 1.671-4(a).
IRC § 1361(d)(2)(D). The election is made by the donee spouse. IRC § 1361(d)(2)(A). A grantor trust automatically
qualifies as permitted owner of S corporation stock and a 2-year window of time is permitted after the grantor’s
death to qualify the continuing trust as a QSST or ESBT, but this 2-year window does not apply to a termination of
wholly grantor trust status as a result of divorce. IRC § 1361(c)(2)(A)(ii); Regs. §§ 1.1361-1(j)(4), 1.1361-1(j)(6)(iii)(C),
1.1361-1(k)(1), Ex. 10.
161
22 Va. App. 557, 471 S.E.2d 809, aff’d on reh’g en banc, 23 Va. App. 697, 479 S.E.2d 534 (1996).
160
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respect to an irrevocable life insurance trust (the terms of which were very similar to a QTIP)
funded with marital property.
In Virginia, separate property includes property received by gift from persons other than the
spouse.162 Property that is not separate property is marital property. Therefore, it follows that a
transfer of marital property from one spouse to the other spouse, even if a gift for gift tax
purposes, may still be marital property for equitable distribution purposes.163 In the case of a
lifetime QTIP, consider whether the entire trust is marital property or just the actuarial value of
the donee spouse’s life interest. In Caccamise, it appears that the entire life insurance trust was
considered marital property.
c)
Marital Agreement
One approach to this concern is to implement a post-marital agreement to indicate the couples’
desired treatment, in the event of divorce, of the property interest being conveyed to the donee
spouse through the lifetime QTIP. For example, the couple could agree to a formula that
determines the portion of the lifetime QTIP that will be considered marital property and a
formula that determines the value of the donee spouse’s life interest in the QTIP trust, and that
such determined value would count towards any allocation of marital assets in the event of a
divorce. If there is a prenuptial agreement in place already, perhaps an amendment to that
agreement is appropriate. Such agreements could also cover the disposition upon the donee
spouse’s death of the lifetime QTIP property and any offsets to a right of marital election upon
death or obligation by the donor spouse to leave assets upon death to the donee spouse (and
how much the lifetime QTIP counts towards satisfying such obligation).
The resolution of the marital law issues in funding a lifetime QTIP are state specific and, other
than briefly noting the concern, beyond the scope of this outline. Co-counseling with a marital
lawyer is recommended in situations where these points are important.
3.
State Death Taxes
State death taxes remain a significant consideration in about twenty states and the District of
Columbia. In many of these jurisdictions gifts, even deathbed gifts, would completely avoid
state death tax.164 Only Connecticut has a gift tax (just prior to submitting this paper, Minnesota
repealed it’s gift tax retroactive to its 2013 enactment). Therefore, in both lifetime QTIPs and
testamentary QTIPs it is important to build-in the flexibility to trigger a gift as to the QTIP
property. For example, ensuring that the donee spouse can release his or her interests, as
discussed above in Section III.D, is one alternative.
162
VA Code § 20-107.3(A)(1)(“Separate property is (i) all property, real and personal, acquired by either party before
the marriage; (ii) all property acquired during the marriage by bequest, devise, descent, survivorship or gift from a
source other than the other party…”).
163
See Garland v. Garland, 12 Va. App. 192, 403 S.E.2d 4 (Va. App. 1991)(house transferred to wife’s name remained
marital property). In Kelln v. Kelln, 30 Va. App. 113, 515 S.E.2d 789 (Va. App. 1999), the husband and wife transferred
marital property into a joint revocable trust that divided equally into two trusts, one for the husband and one for the
wife. In the event of either spouse’s death, his or her separate trust would divide into a by-pass trust and marital
trust for the surviving spouse. The trial court found that such funding of the joint revocable trust constituted a gift
from one spouse to the other and created separate property in each spouse. The appellate court reversed, finding
that the transfers were not supported by sufficient evidence of donative intent to create separate property.
164
In some instances a gift in contemplation of death would attract state death tax.
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Appendix A – QTIP Trust State Statutes
1.
ARIZ. REV. STAT. § 14-10505(E)
E.
For the purposes of this section, amounts and property contributed to the following
trusts are not deemed to have been contributed by the settlor, and a person who would
otherwise be treated as a settlor or a deemed settlor of the following trusts shall not be treated
as a settlor:
1.
An irrevocable inter vivos marital trust that is treated as qualified terminable
interest property under section 2523(f) of the internal revenue code if the settlor is a beneficiary
of the trust after the death of the settlor's spouse.
2.
An irrevocable inter vivos marital trust that is treated as a general power of
appointment trust under section 2523(e) of the internal revenue code if the settlor is a
beneficiary of the trust after the death of the settlor's spouse.
3.
An irrevocable inter vivos trust for the settlor's spouse if the settlor is a
beneficiary of the trust after the death of the settlor's spouse.
4.
An irrevocable trust for the benefit of a person, the settlor of which is the
person's spouse, regardless of whether or when the person was the settlor of an irrevocable
trust for the benefit of that spouse.
5.
An irrevocable trust for the benefit of a person to the extent that the property
of the trust was subject to a general power of appointment in another person.
2.
DEL. COD ANN. TIT. 12 § 3536(c)
(c) Except as provided in subchapter VI of this Chapter 35, if the trustor is also a beneficiary of a
trust, a provision that restrains the voluntary or involuntary transfer of the trustor's beneficial
interest shall not prevent such trustor's creditors from satisfying their respective claims from the
trustor's interest in the trust to the extent that such interest is attributable to the trustor's
contributions to the trust; provided, however, that the trustor shall not be considered a
beneficiary for purposes of this section merely because the trustor may be named as an
additional trust beneficiary or is a proper object of the exercise of a power of appointment over
trust property held by someone other than the trustor. A trustor's creditors may satisfy their
respective claims from the trustor's interest in the trust to the extent provided in the preceding
sentence except where the trustor has not retained any beneficial interest in the trust other
than either or both:
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(1) A beneficial interest that is contingent upon surviving the trustor's spouse such as,
but not limited to, an interest in an inter vivos marital deduction trust in which the
interest of the trustor's spouse is treated as qualified terminable interest property
under § 2523(f) of the Internal Revenue Code of 1986 (26 U.S.C. § 2523(f)), as amended,
an interest in an inter vivos marital deduction trust that is treated as a general power of
appointment trust for which a marital deduction would be allowed under § 2523(a) and
(e) of the Internal Revenue Code of 1986 (26 U.S.C. § 2523(a) and (e), as amended, and
an interest in an inter vivos trust commonly known as a "credit shelter trust'' that used
all or a portion of the trustor's unified credit under § 2505 of the Internal Revenue Code
(26 U.S.C. § 2505), as amended; and
(2) A right to receive discretionary distributions to reimburse the trustor's income tax
liability attributable to the trust.
3.
(3)
FLA. STAT. § 736.0505(3)
Subject to the provisions of s. 726.105, for purposes of this section, the assets in:
(a)
A trust described in s. 2523(e) of the Internal Revenue Code of 1986, as
amended, or a trust for which the election described in s. 2523(f) of the Internal Revenue Code
of 1986, as amended, has been made; and
(b)
Another trust, to the extent that the assets in the other trust are attributable to
a trust described in paragraph (a), shall, after the death of the settlor’s spouse, be deemed to
have been contributed by the settlor’s spouse and not by the settlor.
4.
KY. REV. STAT. § 386B.5-020(8)(a)
(8)
(a)
For the purposes of this section, amounts and property contributed to the
following trusts are not deemed to have been contributed by the settlor of the trust, and a
person who would otherwise be treated as a settlor or a deemed settlor of the following trusts
shall not be treated as a settlor:
1.
An irrevocable inter vivos marital trust that is treated as qualified
terminable interest property under 26 U.S.C. sec. 2523(f), as amended, if the settlor is a
beneficiary of the trust after the death of the settlor's spouse;
2.
An irrevocable inter vivos marital trust that is treated as a general
power of appointment trust under 26 U.S.C. sec. 2523(e), as amended, if the settlor is a
beneficiary of the trust after the death of the settlor's spouse;
3.
An irrevocable inter vivos trust for the spouse of the settlor that does
not qualify for the gift tax marital deduction if the settlor is a beneficiary of the trust only after
the death of the settlor's spouse;
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4.
A special needs trust as defined in KRS 387.860, including a trust
established pursuant to judicial action under KRS 387.855;
5.
A trust created under 42 U.S.C. sec. 1396p(d)(4)(A) or (C); and
6.
A trust created under 42 U.S.C. sec. 1396p(c)(2)(B).
(b)
For the purposes of this subsection, a person is a beneficiary whether so named
under the initial trust instrument or through the exercise by that person's spouse or by another
person of a limited or general power of appointment.
(c)
For the purposes of this section, the settlor shall be any person who:
1.
Created the trust;
2.
Contributed property to the trust; or
3.
Is deemed to have contributed property to the trust.
5.
MD. EST. & TR. CODE ANN. § 14-116(a)(1)-(2) (after 1/1/15 found
at MD. EST. & TR. CODE ANN. § 14.5-1003)
(a)
An individual who creates a trust may not be considered the settlor of that trust with
regard to the individual’s interest in the trust if:
(1)
That interest is the authority of the trustee under the trust instrument or any
other provision of law to pay or reimburse the individual for any tax on trust income or trust
principal that is payable by the individual under the law imposing that tax; or
(2)
All of the following apply:
(i)
individual’s spouse;
The individual creates or has created the trust for the benefit of the
(ii)
The trust is treated as qualified terminable interest property under §
2523(f) of the Internal Revenue Code of 1986; and
(iii)
The individual’s interest in the trust income, trust principal, or both
follows the termination of the spouse’s prior interest in the trust.
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6.
MICH. COMP. LAWS § 700.7506(4)
(4)
An individual who creates a trust shall not be considered a settlor with regard to the
individual's retained beneficial interest in the trust that follows the termination of the
individual's spouse's prior beneficial interest in the trust if all of the following apply:
(a)
The individual creates, or has created, the trust for the benefit of the
individual's spouse.
(b)
The trust is treated as qualified terminable interest property under section
2523(f) of the internal revenue code, 26 USC 2523.
(c)
The individual retains a beneficial interest in the trust income, trust principal, or
both, which beneficial interest follows the termination of the individual's spouse's prior
beneficial interest in the trust.
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7.
N.C. GEN. STAT. § 36C-5-505(c)
(c)
Subject to Article 3A of Chapter 39 of the General Statutes, for purposes of this section,
if the settlor is a beneficiary of the following trusts after the death of the settlor's spouse, the
property of the trusts shall, after the death of the settlor's spouse, be deemed to have been
contributed by the settlor's spouse and not by the settlor:
(1)
An irrevocable intervivos marital trust that is treated as a general power of
appointment trust described in section 2523(e) of the Internal Revenue Code.
(2)
An irrevocable intervivos marital trust that is treated as qualified terminable
interest property under section 2523(f) of the Internal Revenue Code.
(3)
An irrevocable intervivos trust of which the settlor's spouse is the sole
beneficiary during the lifetime of the settlor's spouse but which does not qualify for the federal
gift tax marital deduction.
(4)
Another trust, to the extent that the property of the other trust is attributable
to property passing from a trust described in subdivision (1), (2), or (3) of this subsection.
8.
S.C. CODE ANN. § 62-7-505(b)(2)
(b)
For purposes of this section:
***
(2)
the assets in a trust that are attributable to a contribution to an inter vivos
marital deduction trust described in either Section 2523(e) or (f) of the Internal Revenue Code of
1986, after the death of the spouse of the settlor of the inter vivos marital deduction trust are
deemed to have been contributed by the settlor's spouse and not by the settlor.
9.
TENN. CODE ANN. § 35-15-505(d)
(d)
With respect to an irrevocable trust for which the settlor made a qualified election
pursuant to 26 U.S.C. § 2523(f), the power of a trustee, and any benefit resulting to the settlor
from any exercise of such power, whether arising under the trust agreement or any other
provision of the law, to make a distribution to or for the benefit of a settlor or to otherwise
permit the settlor to use or benefit from trust property following the death of the settlor's
spouse, shall not be considered an amount that may be distributed to or for the settlor's benefit
for purposes of subdivision (a)(2). This subsection (d) shall not limit a creditor's remedies under
the Uniform Fraudulent Transfer Act, compiled in title 66, chapter 3, part 3, regarding the
settlor's transfers to such trust.
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10.
TEX. PROP. CODE § 112.035(g)
(g)
For the purposes of this section, property contributed to the following trusts is not
considered to have been contributed by the settlor, and a person who would otherwise be
treated as a settlor or a deemed settlor of the following trusts may not be treated as a settlor:
(1)
an irrevocable inter vivos marital trust if:
(A)
the settlor is a beneficiary of the trust after the death of the settlor's
(B)
the trust is treated as:
spouse; and
(i)
qualified terminable interest property under Section 2523(f),
Internal Revenue Code of 1986; or
(ii)
a general power of appointment trust under Section 2523(e),
Internal Revenue Code of 1986;
(2)
an irrevocable inter vivos trust for the settlor's spouse if the settlor is a
beneficiary of the trust after the death of the settlor's spouse; or
(3)
an irrevocable trust for the benefit of a person:
(A)
if the settlor is the person's spouse, regardless of whether or when the
person was the settlor of an irrevocable trust for the benefit of that spouse; or
(B)
to the extent that the property of the trust was subject to a general
power of appointment in another person.
11.
VA. CODE ANN. § 64.2-747(B)(3)
B.
For purposes of this section:
***
3. The assets in a trust that are attributable to a contribution to an inter vivos marital
deduction trust described in either § 2523(e) or (f) of the Internal Revenue Code of 1986, after
the death of the spouse of the settlor of the inter vivos marital deduction trust shall be deemed
to have been contributed by the settlor's spouse and not by the settlor.
A-6
Copyright 2015 Richard S. Franklin. All Rights Reserved.
65
12.
WYO. STAT. ANN. § 4-10-506(f)
(f) For purposes of this section, a person who created a trust for his or her spouse under section
2523(e) of the Internal Revenue Code, or for which the election in section 2523(f) of the Internal
Revenue Code was made, shall not be treated as a settlor of the trust, as of and after the death
of his or her spouse.
A-7
Copyright 2015 Richard S. Franklin. All Rights Reserved.
66
Reproduced Courtesy of Leimberg Information Services, Inc. (LISI)
at http://www.LeimbergServices.Com
Steve Leimberg's Estate Planning Email Newsletter - Archive Message #2244
Date:
From:
15-Sep-14
Steve Leimberg's Estate Planning Newsletter
Barry Nelson & Richard Franklin: Inter Vivos QTIP Trusts Could Have
Subject:
Unanticipated Income Tax Results to Donor Post-Divorce
“Testamentary QTIPs are perhaps the most common form of marital deduction
trust. The rules for structuring a QTIP trust upon the settlor’s death are
generally known and accepted, but the creation of inter vivos QTIP trusts are
less common, even though such trusts offer superb estate planning
opportunities. While the core principles of testamentary and inter vivos QTIP
trusts are exactly the same, inter vivos QTIP trusts require additional
considerations that are not as well known to those who may not be using inter
vivos QTIP trusts on a regular basis.
Numerous articles and presentations have extolled the many benefits of inter
vivos QTIP trusts including asset protection, creation of estate tax discounts
and ‘Superchargingsm.’ However, estate planners and their clients may not
focus on the fact that the donor of an inter vivos QTIP trust may have
continuing obligations to pay income taxes on trust capital gains post-divorce,
notwithstanding that the donor may have no right to trust distributions or
access to trust assets to pay such taxes.”
Barry A. Nelson and Richard Franklin provide LISI members with
commentary that reviews the potential income tax consequences to the donor
of an inter vivos QTIP trust. The authors would like to acknowledge the review
of their commentary by Carlyn S. McCaffrey and Bruce Stone. Their
comments were integral to the issues discussed and are integrated herein. The
assistance of Michael A. Sneeringer, Esq. is also acknowledged and
appreciated.
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Barry A. Nelson, a Florida Bar Board Certified Tax and Wills, Trusts and
Estates Attorney, is a shareholder in the North Miami Beach law firm
of Nelson & Nelson, P.A. He practices in the areas of tax, estate planning,
asset protection planning, probate, partnerships and business law. He provides
counsel to high net worth individuals and families focusing on income, estate
and gift tax planning and assists business owners to most effectively pass their
ownership interests from one generation to the next. He assists physicians,
other professionals and business owners in tax, estate and asset protection
planning. As the father of a child with autism, Mr. Nelson combines his legal
skills with compassion and understanding in the preparation of Special Needs
Trusts for children with disabilities. Mr. Nelson is a Fellow of the American
College of Trust and Estate Counsel and served as Chairman of its Asset
Protection Committee from 2009 to 2012. Mr. Nelson is named in Chambers
USA: America’s Leading Lawyers for Business as a leading estate planning
attorney in Florida. Since 2010, he has been listed as one of less than 10
lawyers receiving their highest rating of “Band 1” in the Florida Estate
Planning category. Mr. Nelson has been listed in the Best Lawyers in
America since 1995 and is a Martindale-Hubbell AV-rated attorney. Mr.
Nelson was recentlynamed by Best Lawyers in America as the 2015 Trusts and
Estates "Lawyer of the Year" in Miami.
As the Founding Chairman of the Asset Preservation Committee of the Real
Property, Probate and Trust Law Section of the Florida Bar from 2004-2007,
he introduced and coordinated a project to write a treatise authored by
committee members entitled Asset Protection in Florida (Florida Bar CLE
2008, 3rd Edition 2013). Mr. Nelson wrote Chapter 5 entitled “Homestead:
Creditor Issues.” He is a past President of the Greater Miami Tax Institute. Mr.
Nelson is a co-founder and current Board Member of the Victory Center for
Autism and Behavioral Challenges (a not-for profit corporation) and served as
Board Chairman from 2000-2008.
Richard Franklin is a member of McArthur Franklin PLLC in Washington,
D.C. He focuses on estate planning, trusts and estate administration, and
beneficiary and fiduciary representation. Mr. Franklin is a member of the
District of Columbia and Florida Bars, is a Fellow of the American College of
Trust and Estate Counsel, and is Group Vice-Chair of the ABA RPTE
Section’s Income and Transfer Tax Planning Group. He serves on the ACTEC
Transfer Tax Study Committee and on the Steering Committee for the DC
Bar’s Estates, Trusts & Probate Law Section. He has spoken at numerous
estate planning programs and written on estate planning topics for Actionline,
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68
BNA Insights, Estate Planning, Journal of Multistate Taxation and Incentives,
Probate & Property, Steve Leimberg’s Newsletters, Tax Notes, The Florida
Bar Journal, The Washington Lawyer, Trusts & Estates and the BNA Estates,
Gifts & Trust Journal. Mr. Franklin is a DC Super Lawyer and is ranked in the
2009 - 2014 editions of the Best Lawyers in America as a leading lawyer in the
Trusts and Estates category.
Here is their commentary:
EXECUTIVE SUMMARY:
Testamentary QTIPs are perhaps the most common form of marital deduction
trust. The rules for structuring a QTIP trust upon the settlor’s death are
generally known and accepted, but the creation of inter vivos QTIP trusts are
less common, even though such trusts offer superb estate planning
opportunities. While the core principles of testamentary and inter vivos QTIP
trusts are exactly the same, inter vivos QTIP trusts require additional
considerations that are not as well known to those who may not be using inter
vivos QTIP trusts on a regular basis. This commentary highlights one of those
considerations.
Estate planners typically understand that the donor spouse of an inter vivos
QTIP trust will generally be taxed on all trust income under the grantor trust
rules provided in Code Sections 672(e) and 677(a).[i] However, the estate
planner (and his or her client) may be surprised that for the reasons discussed
below, grantor trust status may continue with respect to undistributed capital
gains post-divorce during the remaining lifetime of the donee spouse. In such
event the donor spouse will be subject to income taxes, post-divorce, on capital
gains retained in the inter vivos QTIP trust during the remaining lifetime of the
former spouse.
Numerous articles and presentations have extolled the many benefits of inter
vivos QTIP trusts including asset protection, creation of estate tax discounts
and “Superchargingsm.”[ii] However, estate planners and their clients may not
focus on the fact that the donor of an inter vivos QTIP trust may have
continuing obligations to pay income taxes on trust capital gains post-divorce,
notwithstanding that the donor may have no right to trust distributions or
access to trust assets to pay such taxes.
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69
COMMENT:
Code Section 682 Provides Limited Relief Post-Divorce
Code Section 682 provides that upon divorce, the donee spouse pays tax on
distributed income from a trust that otherwise was a grantor trust taxed to the
donor spouse. Specifically, Code Section 682 provides that “[t]here shall be
included in the gross income of a wife who is divorced . . . the amount of the
income[iii] of any trust which such wife is entitled to receive[iv] and which,
except for this section, would be includible in the gross income of her husband,
and such amount shall not, despite any other provision of this subtitle, be
includible in the gross income of such husband.”
Income Is Taxed to Donee Spouse Post-Divorce
For gift tax purposes, qualified terminable interest property is property in
which the donee spouse has a qualifying income interest for life and to which a
gift tax QTIP election has been made.[v] The donee spouse’s right to income
must begin immediately upon establishing the inter vivos QTIP trust and must
continue for the donee spouse’s life. An interest subject to termination upon
the occurrence of a specified event, such as divorce, will not satisfy the
qualifying income interest for life requirement.[vi] This means that following
divorce, the inter vivos QTIP trust income must continue to be distributed to
the donee spouse. Pursuant to Code Section 682, this will be “income” the
donee spouse is “entitled to receive.” But for Code Section 682, this income
would be includible in the gross income of the donor spouse pursuant to Code
Section 672(e)(1)(A). Therefore, Code Section 682 operates to override the
grantor trust rules and tax the income to the divorced donee spouse.[vii]
Capital Gains
Code Section 682 does not apply to shift income tax on accumulated capital
gains from the donor spouse (or the trust itself) to the donee spouse postdivorce. In PLR 200408015,[viii] the Service considered a trust established by
the husband incident to divorce to pay the wife an annuity for
life.[ix] Following the wife’s death, the trust continued for the children. The
husband retained no beneficial interest following the wife’s death that would
attract estate taxation. The husband intentionally retained a non-fiduciary
power to reacquire the trust assets by substituting assets of equivalent value,
thereby causing grantor trust status pursuant to Code Section 675(4)(C). The
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70
Service analyzed the application of Code Section 682 as follows:
Provided that the circumstances surrounding Trust's administration
indicate that the power of administration held by Settlor over Trust (i.e.,
the power to substitute assets for assets of equivalent value) is
exercisable by Settlor in a nonfiduciary capacity without the approval or
consent of a person in a fiduciary capacity, Settlor will be treated as the
owner of Trust. We further conclude that while both Settlor and Wife are
alive, section 682 governs the income taxation of Trust. Accordingly,
distributions from Trust to Wife are deductible by Trust and includible
by Wife in her gross income to the extent provided in sections 661 and
662. Under the terms of Trust, capital gains are not includible in the
distributions to Wife. Accordingly, capital gains are not included in the
distributions to Wife and are included in the gross income of Settlor
under section 675(4) (subject to the conditions noted above regarding
section 675(4)).[x]
We further conclude that if Wife predeceases Settlor, upon the death of
Wife, section 682 would no longer apply and Trust will be treated as a
grantor trust with Settlor as owner, provided that, after the death of
Wife, Settlor retains the same powers of administration that cause Trust
to be a grantor trust under section 675(4) (subject to the conditions noted
above regarding section 675(4)). If Settlor predeceases Wife, section 682
no longer applies and payments to Wife will be deductible to Trust
under section 661 and includible in Wife's gross income under section
662. Income allocable to principal will be taxable to Trust. If neither
Settlor nor Wife is alive, then the income taxation of Trust is also
governed by the rules of subchapter J, other than the grantor trust rules
and section 682.
If the inter vivos QTIP trust is a grantor trust as to principal, the donor spouse
will generally continue to pay the income taxes on undistributed capital gains
post-divorce during the lifetime of the donee spouse. The inter vivos QTIP
trust may be a grantor trust as to principal for any number of reasons. It may
because the assets revert to the donor upon the death of the donee spouse (i.e.,
the donor spouse has a backend interest), or as in PLR 200408015, another
grantor trust trigger could have been intentionally used. In the context of a
lifetime QTIP trust, however, the most obvious way grantor trust status would
be applicable as to principal is that the trustees have the discretion to distribute
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trust principal to the donee spouse.
If capital gains are allocated to income in an inter vivos QTIP trust, Code
Section 682 should apply to shift income tax on capital gains from the trust
donor to the donee spouse post-divorce.[xi] According to PLR 9235032, if
capital gains are properly part of DNI, Code Section 682 operates to switch the
income taxation of such amounts from the donor spouse to the donee
spouse. Therefore, in the context of an inter vivos QTIP trust, the trust
instrument could mandate that capital gains be allocated to income, which then
would be distributed pursuant to the “all income” requirement applicable to a
QTIP trust, and Code Section 682 would require the donee spouse to include
such amounts in gross income, subject to the amounts being included in
DNI.[xii] However, this most likely will not be the desired result post-divorce
as the donor usually would prefer that the capital gains be accumulated rather
than paid to a former spouse.
Flying under the Radar
There are only limited articles that address the post-divorce income tax
consequences to the donor of an inter vivos QTIP trust.[xiii] Attorneys and
other advisors should be aware of the continuing income tax obligations during
divorce negotiations, and the potential continuing income tax burden on the
inter vivos QTIP trust donor should be considered as a part of marriage
settlement agreements. Possibly the issue could be addressed in the form of a
postnuptial agreement executed prior to creation of the inter vivos QTIP trust,
but clients are often reluctant to do so. To avoid a surprise in the event of
divorce where the donor spouse becomes taxed on undistributed trust capital
gains, the issues described herein should be considered in advance of execution
of the inter vivos QTIP trust. The planning options described below should be
considered.
QTIP Qualifications versus Divorce Consequences
Even if the parties recognize the income tax exposure to the donor spouse postdivorce, there is no ability to provide for a tax reimbursement clause in the
inter vivos QTIP trust in favor of the donor spouse, without disqualifying such
trust from the gift tax marital deduction. Code Section 2523(f)(3) applies the
testamentary definition of a qualifying income interest for life for an inter
vivos QTIP trust by reference to Code Section 2056(b)(7)(B)(ii). The donee
spouse has a qualifying income interest for life if: (i) the donee spouse is
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entitled to all the income[xiv] from the property; and (ii) no person has a
power to appoint any part of the property to any person other than the
surviving spouse.
Some inter vivos QTIP trusts provide that in the event of divorce, the donee
beneficiary no longer is entitled to discretionary principal distributions from
the inter vivos QTIP trust. This should terminate grantor trust status under
Code Section 677(a)(1) based on the discretionary right to distribute
principal. In such case, if there is no other trigger creating grantor trust status
as to principal, the capital gains allocated to principal should be taxable to the
trust post-divorce. As noted above, to qualify for the gift tax marital
deduction, the inter vivos QTIP trust income must continue to be paid to the
donee spouse for the lifetime of the donee spouse even after divorce, and no
distributions can be made to anyone other than the donee spouse.[xv] But,
Code Section 682 would switch the taxation of the trust’s income post-divorce
to the donee spouse.
The Potential Income Tax Surprise for the Donor Spouse Post-Divorce
Typically in the event of a divorce, the donor spouse has lost a portion of
marital assets, may have obligations to pay alimony and child support, will no
longer have indirect access to the inter vivos QTIP trust income that is payable
annually to the donee spouse, and yet may be required to pay capital gains
taxes on sales of the assets of the inter vivos QTIP trust where the sales
proceeds either are not or may not be distributed to the donee spouse. Possible
planning techniques to reduce the unanticipated tax liability for capital gains to
the donor spouse post-divorce include:
1. Donor Retains Remainder Interest if Donee Spouse
Predeceases Donor. Inter vivos QTIP Trusts can provide excellent
asset protection in states that have adopted self-settled asset
protection legislation or legislation that provides that if assets held in
an inter vivos QTIP trust revert upon the death of the donee spouse
back to the donor spouse in trust, that such trust held for the benefit
of the donor spouse is deemed to be settled by the donee spouse and
not as a self-settled trust of the donor spouse (referred to as “Inter
Vivos QTIP Trust Jurisdictions”).[xvi] Although there are
significant asset protection benefits for those in jurisdictions with
either self-settled trust asset protection laws or in Inter Vivos QTIP
Trust Jurisdictions where the donor reserves the right to trust assets
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73
upon the death of the donee spouse, Code Sections 677(a) and 672(e)
result in the donor being subject to income taxes post-divorce on
undistributed capital gains. The donor spouse may be willing to
assume such a risk or may take advantage of planning to minimize
the potential income taxes on such capital gains by, for example,
providing the donor spouse with a power to substitute assets of equal
value and thereby control the character of assets in the inter vivos
QTIP trust so they are unlikely to significantly appreciate or if they
do, to acquire the appreciated assets by substituting other assets
without appreciation in the trust. If the donor spouse has liquidity to
pay potential capital gains taxes, the donor spouse may be willing to
do so if the donor and/or the donor’s children are the residuary
beneficiaries of the inter vivos QTIP trust.
2. Donor does not Retain an Interest in the Inter Vivos QTIP
Trust but, the Donor’s Spouse is Provided a Testamentary
Special Power of Appointment (“SPA”) in Favor of the Donor or
Donor’s Lineal Descendants. If the donor is not designated as a
remainder beneficiary under the terms of the inter vivos QTIP trust
upon the death of the donee spouse but the donee spouse has a
special power of appointment in favor of the donor spouse or the
donor’s lineal descendants, would the donor still be subject to tax on
undistributed capital gains post-divorce under Code Section 677(a),
whether or not the power of appointment is in fact exercised in favor
of the donor? This issue appears less clear than where the inter vivos
QTIP trust provides a reversion back to the donor if the donee spouse
predeceases the donor, but it would appear that the IRS could take the
position that grantor trust status continues with respect to
undistributed capital gains post-divorce if the special power of
appointment continues post-divorce. It appears that pursuant to Code
Section 674, any special power of appointment held by the donee
spouse would be attributed to the donor spouse and likely cause
grantor trust status as to principal. Like a discretionary power to
distribute principal, a special power of appointment given to the
donee spouse could terminate automatically in the event of divorce.
3. Terminate Trust Post Divorce. If upon divorce the assets of the
inter vivos QTIP trust are distributed outright to the donee spouse,
then the donor spouse is relieved of any obligation to pay income tax
on accumulated capital gains under the grantor trust
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provisions. However, in order to be sure that trust assets pass to the
donor’s lineal descendants, termination of the trust may be an
unacceptable alternative.[xvii] Furthermore, if the inter vivos QTIP
trust was initially created as part of an asset protection plan, outright
distributions to the donee spouse are unlikely to be an acceptable
alternative.
4. Require Reimbursement of Income Taxes Payable by Donor
from Other Assets of Donee Spouse. Although the inter vivos QTIP
trust cannot permit distributions to anyone other than the donee
spouse during the life of the donee spouse, a marital settlement
agreement can obligate the donee spouse to reimburse the donor
spouse for income taxes paid on accumulated capital gains or enable
the donor spouse to setoff alimony or other payments otherwise due
to the donee spouse by the income taxes payable on accumulated
capital gains. This option is especially fair where the donor spouse
has no retained interest should Code Sections 677(a) and 672(e)
result in grantor trust treatment subjecting the donor spouse to tax
without any rights to trust remainder upon death of the donee
spouse. Perhaps this reimbursement obligation would be coupled
with a right in the donee spouse to require the trustee to pay him or
her an amount equal to the taxes. Without such coupling, the
obligation of the donee spouse to reimburse the donor spouse may be
difficult to secure and it is possible that alimony payments owed by
the donor spouse to the donee spouse could be less than the amount
of income taxes payable by the donor spouse, such that a portion of
the reimbursement to the donor spouse is unsecured.
5. Creation of Nonreciprocal Inter Vivos QTIP Trusts. If non
reciprocal inter vivos QTIP trusts are created by husband and wife,
then each inter vivos QTIP trust can authorize discretionary
distributions of trust principal to the donee spouse of an amount in
excess of trust income to reimburse the donee spouse for any income
tax obligations post-divorce resulting from grantor trust status of
such trust (i.e., the inter vivos QTIP trust created by husband for wife
would provide that in addition to trust income that must be
distributed annually to wife, wife would be entitled to a distribution
from trust principal post-divorce to reimburse wife for any income
taxes payable by wife on any trusts created by wife for husband that
are determined to be grantor trusts). As long as there are sufficient
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75
assets in both inter vivos QTIP trusts, this approach may provide the
security against an unanticipated diminishment of the donor’s estate
so that the consequences of grantor trust status, post-divorce, will not
be burdensome to the donor spouse. However the provisions may
enhance an IRS position that the trusts are in fact reciprocal trusts.
6. Create Options to Terminate Wholly Grantor Trust
Status. One possible solution is to create some alternatives for
turning off grantor trust status as to principal. For example, the inter
vivos QTIP trust could have a trust protector authorized to terminate
grantor trust status as to principal, including the ability to terminate
the backend interests of the donor spouse. Moreover, the donor
spouse could release his or her backend interests to terminate that
incident of grantor trust status. The gift tax QTIP rules specifically
provide that a transfer of such retained interests during the donee
spouse’s lifetime is not a transfer for gift tax purposes.[xviii] These
options could be combined with provisions that automatically
terminate the trustee’s authority to distribute principal and/or any
special power of appointment in favor of the donee spouse upon
divorce.
Conclusion
Although there are numerous asset protection and estate planning benefits of
using inter vivos QTIP trusts discussed at tax conferences and in articles and
treatise materials, potential income tax exposure on undistributed capital gains
in the event of divorce of the donor and donee of the inter vivos QTIP trust
needs to be a part of planning discussions. In light of the potential income tax
consequences to the donor of an inter vivos QTIP trust, practitioners should
address these issues when inter vivos QTIP trust planning is considered and
during marital settlement negotiations. The asset protection and estate planning
benefits of inter vivos QTIP trust planning are exceptional, especially in Inter
Vivos QTIP Trust Jurisdictions.[xix] Yet, a divorce could disrupt the plan and
clients must be aware of potential income tax consequences in the event of
divorce.
HOPE THIS HELPS YOU HELP OTHERS MAKE
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A POSITIVEDIFFERENCE!
Barry Nelson
Richard Franklin
CITE AS:
LISI Estate Planning Newsletter #2244, (September 15, 2014)
at http://www.leimbergservices.com Copyright 2014 Leimberg Information
Services, Inc. (LISI). Reproduction in Any Form or Forwarding to Any
Person Prohibited – Without Express Written Permission.
CITATIONS:
[i] As discussed below, the donor is not subject to the grantor trust rules as to
principal if there are no grantor trust triggers as to principal, post-divorce.
[ii] See Barry A. Nelson, Lester Law & Richard S. Franklin, Seeking and
Finding New Silver Patterns in a Changed Estate Planning Environment:
Creative Inter Vivos QTIP Planning, Address at the ABA Section of Real
Property, Trust and Estate Law Spring Symposia (May 2, 2014) (and
accompanying materials); Jonathan G. Blattmachr, Mitchell M. Gans & Diana
S.C. Zeydel, Supercharged Credit Shelter Trustsm versus Portability, 28 Prob.
& Prop. 10 (Mar./Apr. 2014); Diana S.C. Zeydel, Cutting Edge Estate
Planning Techniques: What Have I Learned From My Colleagues?, NAEPC J.
of Est. & Tax Plan. at 29 (2012); Mitchell M. Gans, Jonathan G. Blattmachr &
11
77
Diana S.C. Zeydel, Supercharged Credit Shelter Trustsm: A Super Idea for
Married Couples Especially in Light of the 2010 Tax Act, AK Tr. Co. Newsl.
(May 2011); Barry A. Nelson & Richard R. Gans, New §736.0505(3) Assures
Tax/Asset Protection of Inter Vivos QTIP Trusts, 84 Fla. Bar J. 50 (Dec. 2010);
Mitchell M. Gans, Jonathan G. Blattmachr & Diana S.C.
Zeydel, Supercharged Credit Shelter Trust, 21 Prob. & Prop. 52 (July/Aug.
2007).
[iii] What is “income” for purposes of Code Section 682 and how does the
reallocation of income (and deductions) work as compared to grantor trust
status? By its terms, the definition of “income” in Code Section 643(b), which
looks to the governing instrument and local law to define income, does not
apply to Code Section 682. This is because Code Section 643(b) applies to
Subparts A, B, C and D of Subchapter J, and Code Section 682 is in Subpart E
of Subchapter J. Even so, it seems that these rules would apply to determine
income.
[iv] Consider when the donee spouse is “entitled to receive” income for
purposes of § 682.
[v] I.R.C. § 2523(f)(2).
[vi] Treas. Reg. §§ 25.2523(f)-1(c), 25.2523(e)-1(f).
[vii] Presumably, the portion rules of Treas. Reg. § 1.671-3(b) would also be
applicable to allocating deductions between the donee spouse.
[viii] PLR 200408015. Please note, Private Letter Rulings (“PLRs”) cannot be
cited as precedent and apply only to the taxpayer who requested the ruling.
[ix] This ruling also explains that Code Section 682 is applicable to trusts
created incident to a divorce, notwithstanding the out of date regulations,
which previously made Code Section 71 apply in such circumstances. “Prior to
1984, the section 682 regulations provided that section 71 would govern trusts
formed in contemplation of divorce such as the one at issue here.”
[x] Presumably, if the donor spouse had not retained the power to substitute
assets to create grantor trust status as to principal, the capital gains allocated to
principal would have been taxed to the trust itself.
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[xi] PLR 9235032.
[xii] Treas. Reg. §§ 1.643(a)-3(b)(2) and (3) also allow capital gains to be
included in DNI if the gains are allocated to principal but consistently treated
as part of the distribution to the beneficiary or actually distributed to the
beneficiary. Will Code Section 682 apply in these situations if the inter vivos
QTIP trust allows the trustee the discretion to distribute principal to the donee
spouse, even after divorce? This question is unanswered.
[xiii] See Carlyn S. McCaffrey, Restructuring and Dissolving Trusts in the
Context of Divorce, 12 (forthcoming 2014); Robert T. Danforth & Howard M.
Zaritsky, Grantor Trusts: Income Taxation Under Subpart E, 819 T.M. Est.
Gifts & Tr. at A-60 (2010); Donna G. Barwick, Divorce: Right up There With
Death and Taxes, Estate Planning Techniques in the Context of Divorce,
Address at the 29th Annual Heckerling Institute on Estate Planning (Jan.
1995),in 29th Annual Heckerling Institute on Estate Planning (Matthew
Bender, Pub., 1995).
[xiv] The term “income” means fiduciary accounting income or “trust
income,” and not taxable income. See Treas. Reg. § 25.2523(f)-1(c)(2).
[xv] I.R.C. §§ 2523(f)(1)(B) & 2056(b)(7)(B).
[xvi] See discussion in materials of Nelson, Law & Franklin, supra note i. The
“Inter Vivos QTIP Trust Jurisdictions” are Arizona, Delaware, Florida,
Kentucky, Maryland, Michigan, North Carolina, Oregon, South Carolina,
Texas, Virginia and Wyoming.
[xvii] Consideration could be given to requiring the donee spouse to make a
payment at death to the descendants of some portion of the value of the
distribution.
[xviii] I.R.C. §2523(f)(5)(A); Treas. Reg. § 25.2523(f)-1(d)(1).
[xix] See ARIZ. REV. STAT. § 14-10505(E); DEL. CODE ANN. TIT. 12 §
3536(C)(2); FLA. STAT. § 736.0505(3); KY. REV. STAT. ANN. §
381.180(8)(a); MD. EST. & TR. CODE ANN. § 14-116(a)(1)-(2); MICH.
COMP. LAWS § 700.7506(4); N.C. GEN STAT. § 36C-5-505(c); OR. REV.
STAT. § 130.315(4); S.C. CODE ANN. § 62-7-505(b)(2); TEX. PROP. CODE
§ 112.035(g); VA. CODE ANN. § 64.2-747(B)(2); WYO. STAT. ANN. § 410-506(e).
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SEEKING AND FINDING NEW SILVER PATTERNS
IN A CHANGED ESTATE PLANNING ENVIRONMENT:
CREATIVE INTER VIVOS QTIP PLANNING
Barry A. Nelson, Esq.
Presented to:
ABA/RPTE Webinar
April 7, 2015
estatetaxlawyers.com
NELSON& NELSON, P.A.
2775 Sunny Isles Boulevard, Suite 118
North Miami Beach, Florida 33160
305.932.2000 T
305.932.6585 F
*Materials supplemented through March 14, 2014. The assistance of Michael Sneeringer, Esq. in preparation of this outline is
acknowledged and appreciated.
80
TABLE OF CONTENTS
I.
Introduction. ..................................................................................................................................... 1
II.
Planning Using Inter Vivos QTIP Trusts. ........................................................................................ 3
III.
Conclusion. .................................................................................................................................... 21
EXHIBITS
EXHIBIT A................................................................................................................................................. 23
EXHIBIT B ................................................................................................................................................. 24
EXHIBIT C ................................................................................................................................................. 25
EXHIBIT D................................................................................................................................................. 26
EXHIBIT E ................................................................................................................................................. 27
EXHIBIT F ................................................................................................................................................. 28
New §736.0505(3) Assures Tax/Asset Protection of Inter Vivos QTIP Trusts
The Florida Bar Journal, December 2010
By Barry A. Nelson and Richard R. Gans
EXHIBIT G................................................................................................................................................. 33
Protecting Trusts From Claims of Alimony or Child Support
Trusts & Estates Magazine, March 2014
By Barry A. Nelson
81
SEEKING AND FINDING NEW SILVER PATTERNS IN A CHANGED
ESTATE PLANNING ENVIRONMENT: CREATIVE INTER VIVOS QTIP
PLANNING
By Barry A. Nelson, Esq. *
I.
Introduction.
Today, gift and estate taxes are unified such that a single graduated rate schedule and
effective exemption amount apply to an individual’s cumulative taxable gifts and
benefits. The tax rate is 40% on all assets subject to transfer tax based upon the existing
exemption that was $5 million in 2010 and 2011 and indexed for inflation. 1 The unified
credit is $2,081,800 for 2014 and exempts a total of $5,340,000 of taxable transfers from
gift tax or estate tax. Married couples each benefit from exemptions so for 2014, $10.68
million can pass free of estate tax to beneficiaries of married couples. A separate
generation skipping transfer tax is imposed on transfers to a beneficiary more than one
generation below the transferor. For 2014, the GST tax rate is 40% of transfers in excess
of $5,340,000.
Until 2010, if a husband or wife did not take advantage of their respective unified credit
amounts, they were wasted. As a result, planning required the creation of trusts upon the
death of the first spouse so that the unified credit amount of the first spouse to die could
be allocated into a trust, typically referred to as a Bypass Trust or a Credit Shelter Trust.
These trusts allowed the surviving spouse access, but if properly drafted, assets in such
trusts were not includible in the gross estate of the surviving spouse. In order to be
certain the first spouse to die had sufficient assets to take advantage of his/her unified
credit amount, clients were advised they needed to divide assets so both husband and
wife had sufficient assets in their own name to take advantage of his or her unified credit
amount. Couples were then forced to make decisions on occasion to restructure assets
previously held by husband and wife as tenants by the entirety, a title that protects the
assets against the claims of only one spouse and avoids probate in many jurisdictions, 2
and instead, re-title such assets by placing such assets in the husband’s sole name or the
wife’s sole name or part in each of their sole names. While this restructuring had
potential estate tax benefits, it created asset protection and probate pitfalls. As a result of
portability, advisors should review their client’s planning to determine if it is safer to
*
Copyright © 2014 Nelson & Nelson, P.A.
Tax Relief Unemployment Insurance Reauthorization and Job Creation Act of 2010, 111 P.L. 312, 124 Stat. 3296
(Dec. 17, 2010) [hereinafter the “2010 Tax Relief Act”].
2
For a comprehensive discussion on tenants by the entirety, see Barry A. Nelson, Asset Protection & Estate
Planning – Why Not Have Both?, 46 PHILIP E. HECKERLING INSTITUTE ON EST. PLAN. 1704 (Matthew Bender &
Co., Inc. Jan. 2012). See also Barry A. Nelson, Tenancy by the Entireties, available at
http://www.actec.org/public/Documents/Studies/Nelson_Tenancy_by_the_Entireties_05_01_12.pdf (listing each
state and differentiating whether the state recognizes tenants by the entirety).
1
Barry A. Nelson
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1
hold assets in an asset protected format that avoids probate (e.g. tenants by the entirety)
rather than have their clients hold significant assets in a husband or wife’s sole name.
The analysis is not simple. There are many factors and already much has been written. 3
For those with larger estates (e.g., over $10.68 million), planning with Credit
Shelter/Bypass Trusts still provides tax benefits as the assets passing into such trusts
upon the death of the first spouse will not be includible in the estate of the surviving
spouse regardless of future appreciation. However, for those whose aggregated estates
are not likely to exceed $10.68 million plus an inflation factor, it is probably better to
have the lifetime benefits of tenants by the entirety ownership for greater asset protection
and to reduce potential income tax after both parents pass away by gaining a full step up
in basis upon the death of the surviving spouse. The reason is that assets owned (outright
but not in a Credit Shelter/Bypass Trust) by the surviving spouse upon death are stepped
up to fair market value as of date of death. As a result, if the surviving spouse has an
estate of $10.68 million and benefits from portability, then if all assets are sold upon the
death of the surviving spouse, no capital gain would be incurred. Instead, if upon the
death of the first spouse, assets of $2.5 million were devised to a Credit Shelter/Bypass
Trust for the benefit of the surviving spouse and such assets appreciated by $3 million
from the death of the first spouse to the death of the surviving spouse, then when the
children inherit the Credit Shelter Trust assets, they will only have $2.5 million of income
tax basis. As a result, a capital gain of $3 million would be incurred upon the liquidation
by the children of assets in the Credit Shelter/Bypass Trust upon the death of the
surviving spouse in the example above. At current capital gains rates, combined with the
Net Investment Income Tax of 3.8%, income taxes in excess of $700,000 could be
incurred upon the sale of the appreciated assets that could have been avoided with
planning.
Portability has a number of shortfalls. For example, if the surviving spouse remarries and
the new spouse also predeceases him or her, then the availability of the unused applicable
exclusion amount is based upon the last deceased spouse. As a result, if the first
predeceased spouse (Joan) left all of her assets outright to her husband (Sam), and then
Sam remarries a wealthy woman (Mary) who already made full use of her applicable
exclusion amount by making gifts to her children, then if Mary predeceases Sam, Sam
will not benefit from portability. Sam’s last deceased spouse had no unused exclusion
amount.
Other shortfalls of portability are that the unused exclusion amount transferred to the
surviving spouse is not indexed for inflation, and portability does not apply to the GST
exemption. 4 The appreciation in value of assets placed in a credit shelter trust passes tax
free to the ultimate beneficiaries. If a surviving spouse lives for an additional ten to
3
See Thomas W. Abendroth, Portability: Now Available in Generic Form, Address at the 48th Annual Heckerling
Institute on Estate Planning (Jan. 2014); Jonathan G. Blattmachr, Austin W. Bramwell, & Diana S.C. Zeydel,
Portability or No: The Death of the Credit-Shelter Trust, J. OF TAX. (May 2013); Howard M. Zaritsky & Diana S.C.
Zeydel, New Portability Temp. Regs. Ease Burden on Small Estates, Offer Planning for Large Ones, J. OF TAX.
(Oct. 2012).
4
Abendroth, supra note 3 at 1-4. See also Temp. Reg. § 25.2505-2T.
Barry A. Nelson
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2
twenty years and the assets inherited outright from the first spouse to die significantly
appreciate in value, the estate tax on the appreciation upon the death of the surviving
spouse could have been avoided if instead the assets were held in a credit shelter trust (to
the extent the surviving spouse had other assets available). Credit shelter trusts may also
provide asset protection to trust beneficiaries. Thus, by using a credit shelter trust, the
first spouse can assure that his or her wealth passes as he or she intends and appreciation
on assets, as well as a cumulative increase in the credit shelter trust, may pass estate and
generation-skipping transfer tax free to children and more remote descendants. The
aforementioned benefits are not possible if portability is relied on and assets are
conveyed outright to a surviving spouse.
Those who are willing to rely on portability may decide that owning the entire $10.68
million of assets jointly is a simple plan that avoids probate after the death of the first
spouse, especially in states such as Florida that protect assets held by a husband and wife
as tenants by the entirety from claims of general creditors that are not joint creditors.
However, there are significant risks with the tenants by the entireties plan. First, assets
are unprotected from creditors of the surviving spouse upon the death of the first spouse.
Next, in blended families, there is no assurance the surviving spouse will leave any share
to the family of the first spouse to die. Among the typical suggestions for a couple with a
$10.68 million net worth, who prefer not to rely on portability, is to divide assets so both
a husband and wife take advantage of their respective $5.34 million exemption. However,
both holding assets in separate revocable trusts and holding the entire $10.68 million in
joint names, even tenants by the entirety, could create potentially devastating asset
protection consequences as described more fully below. Having each spouse create
separate non reciprocal inter vivos QTIP trusts provides asset protection and assures the
use of each spouse’s applicable exclusion amount. If such inter vivos QTIP trusts are
created in Arizona, Delaware, Florida, Kentucky, Maryland, Michigan, North Carolina,
Oregon, South Carolina, Texas, Virginia and Wyoming (referred to hereinafter as the
“Inter Vivos QTIP Trust Jurisdictions”), the anticipated tax and asset protection benefits
are significantly more likely to be achieved as compared to those inter vivos QTIP trusts
created in states that have not modified their spendthrift trust statutes. 5
II.
Planning Using Inter Vivos QTIP Trusts.
The Inter Vivos QTIP Trust Jurisdictions have modified their spendthrift trust statutes to
provide that where an inter vivos QTIP election was made, then, after the death of the
donor’s spouse, any assets passing back into a trust for the initial donor spouse are
deemed to have been contributed by the donor’s deceased spouse and not by the donor. 6
The creation of inter vivos QTIP trusts thereby allows married couples to take advantage
5
See ARIZ. REV. STAT. § 14-10505(E); DEL. CODE ANN. TIT. 12 § 3536(C)(2); FLA. STAT. § 736.0505(3); KY. REV.
STAT. ANN. § 381.180(8)(a); MD. EST. & TR. CODE ANN. § 14-116(a)(1)-(2); MICH. COMP. LAWS § 700.7506(4);
N.C. GEN STAT. § 36C-5-505(c); OR. REV. STAT. § 130.315(4); S.C. CODE ANN. § 62-7-505(b)(2); TEX. PROP. CODE
§ 112.035(g); VA. CODE ANN. § 64.2-747(B)(2); WYO. STAT. ANN. § 4-10-506(e). Since 2009, all said statutes were
amended to provide protection for inter vivos QTIP trusts. It may also be possible to utilize an inter vivos QTIP trust
plan in one of the 15 self-settled asset protection trust jurisdictions referred to in Footnote 26, above.
6
For example, see FLA. STAT. § 736.0505(3).
Barry A. Nelson
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of one another’s federal estate tax exemptions and, at the same time, to enhance asset
protection planning. These statutes (referred to hereinafter as the “Inter Vivos QTIP
Spendthrift Statutes”), coupled with the 2010 Tax Relief Act, provide estate planners
with a great planning opportunity.
A.
Dennis and Debbie – An Example.
In order to illustrate the planning possibilities of an inter vivos QTIP spendthrift
trust plan, a hypothetical example is provided. Dennis and Debbie, both attorneys,
are married with children and reside in Florida. Dennis and Debbie have
accumulated a net worth of approximately $13.5 million, of which $2.82 million
is equity in their Florida homestead, and $10.68 million is invested in a joint
brokerage account (titled “tenants by the entirety”). Dennis and Debbie are
willing to rely on estate tax portability to maintain a “simple” estate plan and
benefit from asset protection provided by tenants by the entireties ownership.
Assuming Debbie dies in January of 2014 and Dennis dies in March of 2014, no
estate tax is due upon Debbie’s death and the tax upon the death of Dennis,
assuming portability, would be $1.128 million (Dennis’ taxable estate of $13.5
million - $10.68 million applicable exclusion amount = $2.82 million x 40 percent
tax rate = $1.128 million). 7 Although all of their assets are protected from
creditors during their joint lifetimes (assuming all debts are owed to individuals as
compared to the IRS or SEC, they remain married to one another, had no joint
debt and all property was held as tenants by the entirety in a jurisdiction that
provides asset protection for tenants by the entirety assets) upon the death of
Debbie, all assets that pass to Dennis by operation of law, other than their Florida
homestead (which we assumed qualified for Florida’s constitutional unlimited
homestead exemption), would be subject to the creditors of Dennis. In order to
enhance the amount of assets that can pass free of tax upon the death of the
surviving spouse by allowing the assets of the credit shelter trust to grow, their
CPA suggests that Debbie’s assets be re-titled so the revocable trust created by
Dennis owns $5.34 million (thereby avoiding probate and taking advantage of his
estate tax exemption if he dies first), and the revocable trust created by Debbie
owns $5.34 million.8 Each of their revocable trusts creates a testamentary credit
shelter trust primarily for the benefit of the surviving spouse of the greatest
amount that can pass free of estate tax upon the death of the first spouse, which
trust is intended to pass free of estate tax upon the death of the surviving spouse.
Dennis and Debbie’s desire is to maintain access to all family wealth until the
survivor of them passes away, but they do not mind having a portion of the funds
held in trust for the surviving spouse, as long as the surviving spouse can serve as
a co-trustee or as sole trustee during his or her lifetime, and as long as
distributions can be made to the surviving spouse based upon an ascertainable
standard (such as for his or her health, maintenance and support). Assuming they
follow their CPA’s suggestion and divide their assets so each has $5.34 million in
7
8
See Exhibit A.
See Exhibit B.
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their respective revocable trusts, none of the $10.68 million owned by their trusts
would be protected from creditors while both spouses were married and living
because assets in a revocable trust are not protected from creditors’ claims.9
Assuming Debbie predeceases Dennis and no claims are made against her estate,
Debbie’s assets can pass into a credit shelter spendthrift trust for Dennis,
generally protected from the creditors of Dennis. During the lifetime of Dennis,
$5.34 million or more (i.e., the assets held in the credit shelter trust for the benefit
of Dennis as well as any growth and accumulated income) is protected from his
creditors, but the $5.34 million held in the revocable trust created by Dennis
remains subject to his creditors. 10 Based upon the assumptions above, upon his
death, Dennis’ estate would pay $1.128 million in estate taxes assuming no
appreciation on his $5.34 million investments and his $2.82 million residence. 11
Dennis and Debbie want a second opinion, so they consult with Mike, an attorney
whose practice combines estate planning and asset protection. Mike explains that
converting $10.68 million of their assets from tenants by the entirety into two
$5.34 million revocable trust accounts changes the character of the assets from
those that are protected from most potential creditors under applicable state law
(as long as the debt was not a joint debt of Dennis and Debbie, and both were
living and married to one another in a state that fully protects tenants by the
entirety assets), and subjects the entire $10.68 million to claims of their respective
creditors because assets in a revocable trust are unprotected. 12 Dennis and Debbie
ask for alternatives that would allow each of them to take advantage of their estate
tax exemptions while at the same time not subjecting their assets to exposure to
the claims of future creditors. They have also heard there may be income tax
benefits using certain irrevocable inter vivos trusts.
Mike explains that as a result of the enactment of Florida’s inter vivos QTIP
spendthrift statute (which has been adopted in various versions but with similar
objectives in 12 states), assuming Dennis and Debbie have no existing actual or
contingent liabilities, 13 Dennis and Debbie can divide their $10.68 million tenants
9
See id. Most of the Inter Vivos QTIP Trust Jurisdictions provide statutorily that assets in a revocable trust are not
protected from creditors’ claims, see ARIZ. REV. STAT. § 14-10505(A)(1); DEL. CODE ANN. TIT. 12 § 3536(d)(3);
FLA. STAT. § 736.0505(1)(a); MICH. COMP. LAWS § 700.7506(1)(a); N.C. GEN STAT. § 36C-5-505(a)(1); OR. REV.
STAT. § 130.315(1)(a); S.C. CODE ANN. § 62-7-505(a)(1); VA. CODE ANN. § 64.2-747 (A)(1); WYO. STAT. ANN. § 410-506(a)(i).
10
See Exhibit B.
11
Dennis’ Gross Estate ($8.16 million, $5.34 million of brokerage assets and $2.82 million in equity from
homestead) – Applicable Exclusion Amount ($5.34 million) = Dennis’ Taxable Estate ($2.82 million). Dennis’
Estate Tax is $1.128 million ($2.82 million x 40 percent). See Exhibit B.
12
FLA. STAT. § 736.0505(1)(a) (“The property of a revocable trust is subject to the claims of the settlor’s creditors
during the settlor’s lifetime to the extent the property would not otherwise be exempt by law if owned directly by the
settlor”). See Exhibit C.
13
While Dennis and Debbie enjoy tenancy by the entireties protection of their jointly owned assets, once Debbie and
Dennis separate their tenants by the entirety property so each of them owns one half in their own names, the tenancy
by the entireties protection is lost. In the event either Debbie or Dennis had any outstanding creditors at that time,
breaking the tenancy by the entirety would subject any assets held in the sole name of Debbie or Dennis to claims of
their creditors and a conveyance by them to an inter vivos QTIP trust at a time where either of them is insolvent
Barry A. Nelson
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by the entireties brokerage account equally between them and create separate inter
vivos QTIP trusts, taking care that the trusts are not reciprocal. 14 Inter Vivos
QTIP Trust Jurisdictions provide a solution to many of Dennis and Debbie’s tax
and asset protection objectives. Rather than maintaining the assets in unprotected
revocable trusts (and thereby subjecting $10.68 million of assets to potential
future creditors), Dennis can create an inter vivos QTIP trust for Debbie and
transfer $5.34 million of assets to the trust, and Debbie can do the same for
Dennis.
Dennis would only be willing to create the trust for Debbie if he had reasonable
assurances that, should Debbie predecease Dennis, he would have access to the
$5.34 million (or such other amount as may be held in the trust upon Debbie’s
death). To maintain flexibility for future planning, the inter vivos QTIP trust can
give Debbie a testamentary special power of appointment that could be exercised
in favor of one or more of Dennis, their children, or a charity. 15 However, if
Dennis wants to be certain that, should Debbie predecease him, the assets would
be held in a trust for him, the QTIP trust could provide that if Dennis survives
Debbie, assets remaining in Debbie’s QTIP trust must pass in trust for the benefit
of Dennis during his lifetime. The trust could provide a formula so, to the extent
assets that were held in Debbie’s trust can pass free of estate tax as a result of
Debbie’s remaining applicable exclusion amount, they would pass into a credit
shelter trust for Dennis with any excess assets passing into a QTIP trust for
Dennis so no estate tax would be payable upon Debbie’s death. 16 Use of this
technique assures that the assets held in the inter vivos QTIP trust for the benefit
of Debbie are protected from her creditors during Debbie’s lifetime because the
QTIP trust is a spendthrift trust. Furthermore, upon Debbie’s death, the assets
remaining in her QTIP trust will be held in an asset-protected spendthrift trust for
the benefit of Dennis (a credit shelter trust and/or a QTIP trust). 17
could be deemed a fraudulent conveyance, thereby subjecting the transfer to attachment or other creditors’ remedies.
See FLA. STAT. §§726.105; 726.108.
14
This should only be done if Dennis and Debbie do not have existing debt because once assets held as tenants by
the entirety are divided and retitled in their respective names, assets that previously were protected from creditors as
tenants by the entirety (assuming no joint debt) would be subject to creditors’ claims of Dennis and Debbie since
they will have outright ownership of $5.34 million each prior to contributing such assets to the new QTIP trusts.
Reciprocal trusts must be avoided. For an excellent article addressing the reciprocal trust issue in great detail, see
Mitchell M. Gans, Jonathan G. Blattmachr & Diana S.C. Zeydel, Supercharged Credit Shelter Trust, 21 PROB. &
PROP. 52, 57-62 (July/Aug. 2007).
15
A special power of appointment provides the power holder with the right to distribute property, subject to the
power, to a limited class of beneficiaries or alternatively to a broad class that excludes the power holder, the power
holder’s estate, the power holder’s creditors, or the creditors of the power holder’s estate. See I.R.C. § 2041.
16
The mandatory reversion in favor of Dennis would be even more critical if he had children from a prior marriage
and he wanted to be certain that upon Debbie’s death the assets would: a) pass for his benefit if he survives Debbie;
or b) to his children if he predeceases Debbie or disclaims the interest otherwise passing to him upon Debbie’s
death.
17
This article assumes assets in a spendthrift trust are protected from general creditors. Exception creditors, such as
the IRS, may circumvent spendthrift protection. See FLA. STAT. § 736.0503(2)
To the extent provided in subsection (3), a spendthrift provision is unenforceable against: (a) A
beneficiary’s child, spouse, or former spouse who has a judgment or court order against the
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Until enactment of the inter vivos QTIP trust statutes, assets passing from the
inter vivos QTIP trust created by Dennis for Debbie back to Dennis at Debbie’s
death, whether based upon the terms of the original trust or through the exercise
of a special power of appointment from Debbie, might have been thought to be
subject to the claims of creditors of Dennis because he created the original trust. 18
In his defense against a creditor’s challenge to the trust, Dennis would argue that
Debbie, and not Dennis, should be considered as the donor of the trust after
Debbie’s death, so Dennis is not properly considered the donor of the trust
passing to him upon Debbie’s death. This argument would be consistent with
Treas. Reg. § 25.2523(f)-1(f), Example 11, which provides that assets held in an
inter vivos QTIP trust for the benefit of the donor after the death of his or her
spouse will not be includible in the donor’s taxable estate under §§ 2036 and 2038
of the Internal Revenue Code. 19 Thus, Dennis and Debbie would argue that
following the reasoning in the Treasury Regulation, the trust created for Dennis
upon Debbie’s death should not be considered settled by Dennis. 20
However, if Dennis retained the right to the assets remaining in Debbie’s trust
upon her death should Debbie predecease Dennis, Dennis’ creditors would argue
such assets should be subject to the creditors of Dennis because he was the initial
donor of the trust. Furthermore, even if the trust created by Dennis did not
reserve an interest in favor of Dennis as described above, should Debbie
predecease him, if Debbie had a testamentary special power of appointment that
beneficiary for support or maintenance. (b) A judgment creditor who has provided services for the
protection of a beneficiary’s interest in the trust. (c) A claim of this state or the United States to the
extent a law of this state or a federal law so provides.
Id.
18
See ARIZ. REV. STAT. § 14-10505(A)(2), N.C. GEN STAT. § 36C-5-505(a)(2), VA. CODE ANN. § 64.2-747(A)(2)
(“with respect to an irrevocable trust…, a creditor or assignee of the settlor may reach the maximum amount that can
be distributed to or for the settlor’s benefit.”); DEL. CODE ANN. TIT. 12 § 3536(a)
A creditor of a beneficiary of a trust shall have only such rights against or with respect to such
beneficiary’s interest in the trust or the property of the trust shall be expressly granted to such
creditor by the terms of the instrument that creates or defines the trust or by the laws of this State.
Id.; FLA. STAT. § 736.0505(1)(b) (“With respect to an irrevocable trust, a creditor or assignee of the settlor may
reach the maximum amount that can be distributed to or for the settlor’s benefit”). If the original donor of an inter
vivos QTIP trust is also treated as the donor of the trust for his or her benefit after the death of the initial beneficiary
spouse, under Florida law prior to § 736.0505(3), the donor’s creditors could reach the trust assets in satisfaction of
their claims; MICH. COMP. LAWS § 700.7506(1)(c) (“With respect to an irrevocable trust, a creditor or assignee of
the settlor may reach no more than the lesser of the following:(i) The claim of the creditor or assignee. (ii) The
maximum amount that can be distributed to or for the settlor’s benefit exclusive of sums to pay the settlor’s taxes
during the settlor’s lifetime”); OR. REV. STAT. § 130.315(1)(b) (“Whether or not the terms of a trust contain a
spendthrift provision:… A creditor or assignee of the settlor of an irrevocable trust may reach the maximum amount
that can be distributed to or for the settlor's benefit.”); S.C. CODE ANN. § 62-7-505(a)(2) (“Whether or not the terms
of a trust contain a spendthrift provision, the following rules apply:… With respect to an irrevocable trust, a creditor
or assignee of the settlor may reach the maximum amount that can be distributed to or for the settlor's benefit.”);
WYO. STAT. ANN. § 4-10-506(a)(ii) (“With respect to an irrevocable trust without a spendthrift provision, a creditor
or assignee of the settlor may attach the maximum amount that can be distributed to or for the settlor’s benefit”).
19
Treas. Reg. § 25.2523(f)(1)(f), Ex. 11.
20
Id.
Barry A. Nelson
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allows her to direct assets back to Dennis, those assets may be subject to his
creditors as a result of the Relation Back Doctrine.
B.
The Effect of the Relation Back Doctrine.
If, upon her death Debbie exercises a special power to create a credit shelter or
QTIP trust for Dennis (the original donor), the trust assets appointed to Dennis
may be considered as if Dennis created his own trust rather than Debbie being
treated as the creator of such trust. The creditor under the Relation Back Doctrine
could argue: (i) the exercise of a special power of appointment constitutes a
transfer “from the donor of the power, not from the donee; 21 and (ii) the power of
appointment is “conceived to be merely an authority to the power holder to do an
act for the creator of the power.” 22 “The appointment is said to ‘relate back’ to the
time of the creation of the power and to operate as if it had been originally
contained in [the creator of the power’s] will.” 23 Cases involving the Relation
Back Doctrine have typically been in conjunction with whether trust assets
subject to a general power of appointment should be considered when
determining fiduciary fees upon the death of the donee spouse who exercised such
power.
In In re Estate of Wylie, a husband created a testamentary trust for his wife. At his
death, wife received all the income from the trust for her life and had a general
power of appointment over the corpus of the trust at her death. 24 The issue on
appeal was whether the value of the husband’s trust was includible in wife’s
estate for purposes of determining fiduciary fees because she exercised her
general power of appointment by her last will and codicil in favor of her
testamentary trustees, and the assets were distributed and paid to the trustees.25
The court found the determinative question to be whether the power of
appointment should be characterized as an interest in property or merely a
mandate or authority to dispose of property. 26 The court noted that:
The doctrine of relation back, minimizing as it does the importance of the donee
of the power, is the mainstay for that rule of law which treats the donee as a mere
agent with no property interest. Although under attack by many commentators in
the field of future interests, the prevailing view still remains that a general power
of appointment is a mere mandate or authority to dispose of property and not an
interest in property itself. 27
21
In re Estate of Wylie, 342 So.2d 996, 998 (Fla. 4th DCA 1977) (quoting RESTATEMENT (FIRST) OF PROPERTY §
318 comment (b) (1940)).
22
American Law Institute, Donative Transfers vol. 2 §§ 11.1-24.4, in RESTATEMENT (SECOND) OF PROPERTY 4
(1986).
23
Id.
24
In re Estate of Wylie, 342 So.2d at 996-97.
25
Id. at 998.
26
Id. at 999.
27
Id. at 998.
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In keeping with the historical origin of powers of appointment and the “spirit of
the law,” the court in Wylie held that the power of appointment was an authority
to dispose of property and not an interest in property. 28
Although none of the reported cases regarding the Relation Back Doctrine address
its application to the donor of a QTIP or credit shelter trust who receives trust
assets upon the death of the donee spouse through the exercise of a special power
of appointment, Inter Vivos QTIP Trust Jurisdictions provide greater protection
for inter vivos QTIP trust donors by avoiding any possible Relation Back
Doctrine attack.
C.
Can an Inter Vivos Credit Shelter Trust Plan Provide Better Overall Results?
The inter vivos QTIP trust plan has limitations when compared to a similar plan
using an inter vivos credit shelter gift to freeze estate tax values. For example,
some attorneys have suggested planning to take advantage of the existing $5.34
million gift exemption. By making gifts in 2014 to an inter vivos credit shelter
trust using a taxpayer’s remaining gift and estate tax exemption, the growth on
any assets remaining in the inter vivos credit shelter trust will pass estate tax-free
upon the death of the beneficiary spouse, even if the estate tax exemption amount
was reduced by Congress upon the date of death of the beneficiary spouse and
even if the initial $5 million gift grew to significantly more within the credit
shelter trust. The problem with using the inter vivos QTIP plan rather than a gift
into a credit shelter type trust is that most Inter Vivos QTIP Trust Jurisdictions
(i.e., Delaware, Florida, Maryland, Michigan, Oregon, South Carolina, Virginia
and Wyoming) require that a gift tax QTIP election be made to obtain the asset
protection benefit (that the beneficiary spouse is considered the donor and not the
initial donor of the inter vivos QTIP) upon the death of the initial donee spouse. 29
As a result, if the plan is to make the inter vivos credit shelter trust assets
available for the surviving spouse who created the initial trust, there is a
possibility such assets will be subject to inclusion in the estate of such spouse
under §§ 2036 or 2041 of the Internal Revenue Code, as the creditors of the initial
donor spouse may be able to reach such assets upon the death of the first spouse.
While Treas. Reg. § 25.2523(f)- 1(f), Example 11, provides that assets held in an
inter vivos QTIP trust — for the benefit of the donor after the death of his or her
spouse — will not be includible in the donor’s taxable estate under §§ 2036 and
2038, no similar regulation exists for an inter vivos credit shelter trust. It would
appear that the favorable treatment is provided by said Regulation based upon the
fact that such assets are includible in the estate of the donee spouse under § 2044
of the Internal Revenue Code which is not the case with a credit shelter trust.
Accordingly the tax treatment of assets reverting back to the original donor of a
credit shelter trust may be subject to estate tax.
28
Id.
See DEL. CODE ANN. TIT. 12 § 3536(c)(2); FLA. STAT. § 736.0505(3); MD. EST. & TR. CODE ANN. § 14-116(a)(1)(2); MICH. COMP. LAWS § 700.7506(4); OR. REV. STAT. § 130.315(4); S.C. CODE ANN. § 62-7-505(b)(2); VA. CODE
ANN. §55-545.05(B)(3); WYO. STAT. ANN. § 4-10-506(e).
29
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D.
Arizona, Kentucky, North Carolina and Texas’ Unique Statute May Create Asset
Protection and Estate Tax Benefits (but it may not!).
Arizona Statutes § 14-10505(E) states:
E. For the purposes of this section, amounts and property
contributed to the following trusts are not deemed to have been
contributed by the settlor, and a person who would otherwise be
treated as a settlor or a deemed settlor of the following trusts shall
not be treated as a settlor:
1. An irrevocable inter vivos marital trust that is treated as
qualified terminable interest property under section 2523(f) of the
internal revenue code if the settlor is a beneficiary of the trust after
the death of the settlor's spouse.
2. An irrevocable inter vivos marital trust that is treated as a
general power of appointment trust under section 2523(e) of the
internal revenue code if the settlor is a beneficiary of the trust after
the death of the settlor's spouse.
3. An irrevocable inter vivos trust for the settlor's spouse if the
settlor is a beneficiary of the trust after the death of the settlor's
spouse.
4. An irrevocable trust for the benefit of a person, the settlor of
which is the person's spouse, regardless of whether or when the
person was the settlor of an irrevocable trust for the benefit of that
spouse.
5. An irrevocable trust for the benefit of a person to the extent that
the property of the trust was subject to a general power of
appointment in another person. 30
North Carolina, N.C. Gen Stat. § 36C-5-505 states:
Subject to Article 3A of Chapter 39 of the General Statutes, for
purposes of this section, if the settlor is a beneficiary of the
following trusts after the death of the settlor's spouse, the property
of the trusts shall, after the death of the settlor's spouse, be deemed
to have been contributed by the settlor's spouse and not by the
settlor:
30
ARIZ STAT. § 14-10505(E). See also TEX. PROP. CODE § 112.035(g)(3)(A).
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(1) An irrevocable intervivos marital trust that is treated as a
general power of appointment trust described in section 2523(e) of
the Internal Revenue Code.
(2) An irrevocable intervivos marital trust that is treated as
qualified terminable interest property under section 2523(f) of the
Internal Revenue Code.
(3) An irrevocable intervivos trust of which the settlor's spouse is
the sole beneficiary during the lifetime of the settlor's spouse but
which does not qualify for the federal gift tax marital deduction.
[Emphasis added.]
(4) Another trust, to the extent that the property of the other trust is
attributable to property passing from a trust described in
subdivision (1), (2), or (3) of this subsection. [Emphasis added.]
For purposes of this subsection, the settlor is a beneficiary whether
so named under the initial trust instrument or through the exercise
of a limited or general power of appointment, and the "settlor's
spouse" refers to the person to whom the settlor was married at the
time the irrevocable intervivos trust was created, notwithstanding a
subsequent dissolution of the marriage. 31
Unlike the above mentioned states that enacted inter vivos QTIP statutes,
Arizona, Kentucky, North Carolina and Texas provide that the initial donor of an
inter vivos irrevocable trust created for the donor’s spouse will not be deemed to
have been contributed by the donor if the donor is the beneficiary of the trust after
the death of the donor’s spouse, even if there is no QTIP election. 32 As a result,
under Arizona, Kentucky, North Carolina and Texas, Debbie, in the example,
above, could have created an inter vivos credit shelter trust for Dennis and even if
the trust assets reverted to Debbie in a credit shelter trust, upon the death of
Dennis, those assets would not be deemed to have been contributed by Debbie. As
such, the assets should retain protection from Debbie’s creditors during her
lifetime despite the fact that she created the initial trust and was the beneficiary of
the trust upon the death of Dennis.
While at first glance the Arizona, Kentucky, North Carolina and Texas statutes
appear to create great asset protection and the possibility of enhanced estate tax
benefits that are afforded to credit shelter trusts as compared to an inter vivos
QTIP Trusts (i.e., all appreciation of assets in the credit shelter trust would avoid
future estate taxes and regardless of whether the applicable exclusion amount is
reduced the assets in a credit shelter trust should not be subject to estate tax
31
N.C. GEN STAT. § 36C-5-505(c)(3). See also KY. REV STAT ANN § 381.180(8).
ARIZ STAT. § 14-10505(E); KY. REV STAT ANN § 381.180(8) N.C. GEN STAT. § 36C-5-505(c); TEX. PROP. CODE §
112.035(g).
32
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inclusion), there are two potential pitfalls to the Arizona, Kentucky, North
Carolina and Texas statutes: (1) the trust needs to have their situs in Arizona,
Kentucky, North Carolina and/or Texas and be subject to income tax there; and
(2) there is no provision similar to IRS Treas. Reg. § 25.2523(f)-1(f), Example 11
that assures that the initial donor will not be subject to tax under §§ 2036 or 2038
of the Internal Revenue Code. As a result, the IRS could take the position that
despite state law, the initial donor has an interest under §§ 2036 and 2038 of the
Internal Revenue Code, resulting in estate tax inclusion.
Providing the initial donee of a credit shelter trust a special power of appointment
to direct the credit shelter assets back to the initial donor, as compared to retaining
a reversion in the credit shelter trust in favor of the donor, may not change the
estate tax consequences to the donor due to the Relation Back Doctrine described
above. 33 As a result, assets passing from an inter vivos credit shelter trust back to
a credit shelter trust for the initial donor may be considered to be held in a selfsettled trust and therefore subject to estate tax inclusion.
Some have suggested the creation of the initial credit shelter trust in a jurisdiction
that recognizes and protects self-settled asset protection trusts. 34 The IRS has
ruled favorably for a trust created under Alaska law. 35 A thorough analysis of this
issue is beyond the scope of these materials. However, creation of a credit shelter
trust, in one of the fifteen states that have enacted self-settled asset protection
trusts, 36 does not assure that trust assets will be excluded from the initial donor’s
gross estate if they are appointed back to the initial donor, especially if there was
an implied agreement that the assets would revert to the donor and there is a
pattern of distributions to the donor. For example PLR 2009440002, which is
frequently cited as support that the creation of an irrevocable Trust in a selfsettled asset protection jurisdiction such as Alaska is a completed gift and assets
will not be included in the Grantor’s gross estate says: “We are specifically not
ruling on whether Trustee's discretion to distribute income and principal of Trust
to Grantor combined with other facts (such as, but not limited to, an
understanding or pre-existing arrangement between Grantor and trustee regarding
the exercise of this discretion) may cause inclusion of Trust's assets in Grantor's
gross estate for federal estate tax purposes under § 2036.” 37 My concern is since
IRS Treas. Reg. § 25.2523(f)-1(f), Example 11 assures that the trust reverting to
the original donor from an inter vivos QTIP trust created for the donee spouse is
33
See In re Estate of Wylie, 342 So.2d at 998.
See Carol G. Kroch et al., Taking a Fresh Look at Lifetime Gift Planning Opportunities, 38 EST. PLAN. 3, 14
(Sept. 2011); Gans, Blattmachr & Zeydel, supra, note 14, at 59.
35
See Gideon Rothschild et al., IRS Rules Self-Settled Alaska Trust Will Not Be In Grantor’s Estate, 37 EST. PLAN 3,
13 (Jan. 2010).
36
ALASKA STAT. §34.40.110; COLO. REV. STAT. § 38-10-111; DEL. CODE ANN. TIT. 12, §§3570-3576; HAW. REV.
STAT. § 554G; MO. REV. STAT. §§456.5-505; N.H. REV. STAT. ANN. § 564-B:8-814; NEV. REV. STAT. §§116.010166.170; OHIO REV. CODE ANN. §5816.03; OKLA. STAT. ANN. tit. 31, § 13, 16; R.I. GEN. LAWS § 18-13-2; S.D.
CODIFIED LAWS §§55.16-1–55-16-17; TENN. CODE ANN. § 35-16-104, 107; UTAH CODE ANN. §25-6-14; VA. CODE
ANN. § 55-545.05; WYO. STAT. §§4-1-505 & 4-10-510–523.
37
PLR 200944002.
34
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protected from estate tax inclusion under Code §§ 2036 or 2038 (and further
protected in states such as Florida and Arizona with a state statute that says the
donor’s spouse is deemed the donor when assets pass back to the donor spouse),
that the inter vivos QTIP result is as close as definite as you get that such assets
will not be includible in the gross estate of the original donor spouse. The credit
shelter trust approach does not have a Treasury Regulation that says the original
donor will not be taxed under Code §§ 2036 or 2038. Further, most inter vivos
QTIP statutes (such as Florida’s) specifically say the initial donee’s spouse is
deemed to be the donor when trust assets revert in trust for the original donor
spouse, only if a QTIP election was made. 38 If a state statute does not shift donor
status to the original donee spouse from the original donor spouse, then assets
may be includible in the gross estate of the original donor under Code § 2036 if
the IRS successfully asserts there was an understanding or pre-existing
arrangement regarding the trustee’s exercise of discretion in favor of the original
donor spouse.
Based upon most clients’ objective of obtaining the anticipated tax and asset
protection results, the author prefers the Inter Vivos QTIP Trust Jurisdictions, or
use of a combination of an inter vivos QTIP trust created by one spouse and a
credit shelter trust created by another spouse where the QTIP assets will revert to
the initial donor upon the death of the initial donee spouse and the assets of the
credit shelter trust pass to children (and not in trust for the initial donor spouse)
upon the death of the donee spouse. Life insurance could be purchased on the life
of the donee spouse of the credit shelter trust to replace assets that will pass to
children upon the death of the donee spouse beneficiary of the credit shelter trust.
E.
Benefits of Superchargingsm39 an Inter Vivos QTIP Trust
A number of articles have been written about the use of “supercharging” to
achieve enhanced growth of assets in a credit shelter trust for the benefit of the
surviving spouse. 40 The term refers to a credit shelter trust that is taxed to the trust
beneficiary as a grantor trust whether or not distributions are made from the trust.
Upon creation of an inter vivos QTIP trust, the trust is created as a grantor trust
with respect to the donor spouse (assuming the donee spouse is a beneficiary with
respect to both trust income and principal). 41 Following the donee spouse’s death,
the assets in the inter vivos QTIP trust are includible in the donee spouse’s gross
estate. 42 Estate tax is avoided to the extent of the donee spouse’s remaining
38
FLA. STAT. § 736.0505(3)(a).
Gans, Blattmachr & Zeydel, supra, note 14.
40
Gans, Blattmachr & Zeydel, supra, note 14; Diana S.C. Zeydel, Cutting Edge Estate Planning Techniques: What
Have I Learned From My Colleagues?, NAEPC J. OF EST. & TAX PLAN. at 29 (2012), available at
http://www.naepc.org/journal/issue13c.pdf; Mitchell M. Gans, Jonathan G. Blattmachr & Diana S.C. Zeydel,
Supercharged Credit Shelter Trustsm: A Super Idea for Married Couples Especially in Light of the 2010 Tax Act,
ALA. TR. CO. NEWSL. (May 2011), available at http://www.alaskatrust.com/assets/files/newsletters/Newsletter2011-05.pdf.
41
Gans, Blattmachr & Zeydel, supra, note 14 at 55. See I.R.C. §§ 676, 677, 2523(i).
42
I.R.C. § 2044.
39
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unified credit amount. The inter vivos QTIP trust can be drafted to either: (i)
provide that if the donor spouse survives the original donee spouse, assets are held
in trust for the original donor spouse; or (ii) provide the original donee spouse
with a special power of appointment in favor of the original donor spouse and
lineal descendants. Even if the credit shelter trust created upon the death of the
original donee spouse is drafted to permit distributions to the donor spouse, upon
the death of the original donee spouse, it will not be includible in his or her gross
estate. 43
For income tax purposes, the trust created for the original donor spouse upon the
death of the original donee spouse can continue to be treated as the donor
spouse’s grantor trust after the donee spouse’s death, provided the trustee has
discretion to make distributions of income and principal to the donor spouse.44
The trust’s taxable income will continue to be attributed to the donor spouse
under the grantor trust rules by reason of the donor spouse's discretionary interest
in trust income and principal. 45 The donor spouse is viewed as remaining the
grantor of the trust for income tax purposes, and his or her payment of the tax on
the trust’s income does not constitute a taxable gift. 46 Assuming the trustee
accumulates the income of the credit shelter trust or distributes it to the
descendants (as long as they are also discretionary beneficiaries of the credit
shelter trust), the donor spouse is required to pay the income tax and is not treated
as making a taxable gift when he or she does so, hence why the credit shelter trust
is “supercharged.” 47
When the asset protection and “supercharged” gift tax benefits of inter vivos
QTIP trust planning are combined, the technique is one that is worthy of
consideration for those with a combined family estate from $5 million to $50
million or more.
F.
States Where Dennis and Debbie Could Create an Inter Vivos QTIP Trust Plan
Without Concern of Relation Back or Self-Settled Trust Issues.
There are tradeoffs that a client must consider to obtain greater certainty as to tax
and asset protection results. Inter Vivos QTIP Trust Jurisdictions provide
certainty that the anticipated asset protection results will be effectuated because
these statutes explicitly provide that assets reverting to the initial donor as a result
of the death of the initial donee are considered to have been contributed by the
donor’s spouse and not the donor. Under such statutes, if the inter vivos QTIP
trust is properly drafted — and assuming the initial transfer to the trust was not a
fraudulent conveyance — it is clear that the assets of the inter vivos QTIP trust
43
See Treas. Reg. § 25.2523(f)-1(f), Ex. 11 (explaining that assets held in an inter vivos QTIP trust for the benefit of
the donor after the death of his or her spouse will not be includible in the donor’s taxable estate under Code §§ 2036
or 2038).
44
Gans, Blattmachr & Zeydel, supra, note 14 at 55.
45
I.R.C. §§ 676, 677.
46
See Treas. Reg. § 1.671-2(e)(5).
47
See Gans, Blattmachr & Zeydel, supra, note 14.
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described in the example above will be considered as if contributed to the trust by
Debbie (the initial trust beneficiary) and not Dennis (the initial donor) and
therefore, will not be subject to Dennis’ creditors upon the death of Debbie. As
long as the assets in the trust created by Dennis are not subject to the creditors of
Dennis when such assets revert to Dennis, such assets should not be includible in
the taxable estate of Dennis. 48 Thus using the inter vivos QTIP plan, $0 of assets
will be subject to creditors’ claims while both spouses are married and living, and
$0 of assets should be subject to creditors upon death of first spouse or divorce. 49
Similar results may be available, using the fifteen states that have self-settled
asset protection trust legislation, but only the Inter Vivos QTIP Trust Jurisdictions
assure favorable results. 50
G.
Issues Requiring Analysis When Implementing an Inter Vivos QTIP Trust Plan.
1.
Net Worth — Clients will appreciate the certainty of tax and asset
protection results of creating an inter vivos QTIP trusts in Inter Vivos
QTIP Trust Jurisdictions. However, for wealthier clients, creating an inter
vivos credit shelter trust for a spouse could provide significant estate tax
benefits because the assets held in an inter vivos credit shelter trust
(including appreciation) will not be subject to tax upon the death of the
donee spouse, whereas the inter vivos QTIP trust assets are subject to
estate tax upon the death of the donee spouse based upon date of death
values. If the inter vivos QTIP trust assets, when combined with the other
assets of the donee spouse, exceed the available estate tax exemption for
the year of death, additional estate taxes will be incurred. Wealthier clients
may be willing to each create trusts for their children with their $5.34
million gifting exemption (or such lesser amount based upon prior taxable
gifts). Alternatively, couples with children who are not willing to lose the
ability to benefit from $10.68 million of gifts may consider the creation of
one inter vivos credit shelter trust that could benefit the donee spouse
during his or her lifetime (at the discretion of the trustee) and allow for
invasions for children and grandchildren, and one inter vivos QTIP trust.
The credit shelter trust assets can pass to children or grandchildren upon
the death of the donee spouse. The donee spouse of the credit shelter trust
could create an inter vivos QTIP trust for the other spouse, thereby
reserving a remainder interest in trust in an Inter Vivos QTIP Trust
Jurisdiction. Both spouses will benefit from at least $5 million held in trust
until they both have passed away (i.e., the QTIP assets will benefit the
donee spouse during the lifetime of the donee spouse and then pass, in
48
See Treas. Reg. § 25.2523(f)-1(d); Howard M. Zaritsky, Tax Planning for Family Wealth Transfers: Analysis
With Forms ¶ 6.03[3][a], 6-12 (Thompson Reuters/WG/L, 4th ed. 2002 & Supp. Aug. 2011).
49
The tax is similar to the CPA Tax Savings plan with the exception of the assets subject to creditors. Dennis’ Gross
Estate ($8.16 million, $5.34 million of brokerage assets and $2.82 million in equity from homestead) – Applicable
Exclusion Amount ($5.34 million) = Dennis’ Taxable Estate ($2.82 million) Dennis’ Estate Tax is $1.128 million
($2.82 million x 40 percent). See Exhibit C.
50
See Kroch et al., supra note 34; Gans, Blattmachr & Zeydel, supra, note 14.
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trust, to the initial donor of the inter vivos QTIP trust for the lifetime of
such donor).
2.
Jurisdiction — The trust should be created in an Inter Vivos QTIP Trust
Jurisdiction or possibly in a state that recognizes self-settled asset
protection trusts assuming the structure complies with the self-settled asset
protection trust statutes.
3.
Reciprocal Trusts — If both spouses create an inter vivos QTIP trust, there
is a possibility that the IRS could take the position that they were
reciprocal. 51 Avoidance of reciprocal trust attacks may be accomplished
by allowing a considerable amount of time lapse between the creation of
the husband’s inter vivos QTIP trust and the wife’s inter vivos QTIP trust,
and by having different dispositive provisions in the trusts, for example:
providing for different trustees, different beneficiaries upon the death of
the donee spouse, a special power in favor of certain beneficiaries in each
trust, or not providing a special power upon the death of the donee spouse
at all in one of the trusts. 52 Arizona, Kentucky, North Carolina and Texas
have addressed the reciprocal trust dilemma by enacting Arizona Revised
Statutes § 14-10505(E)(4), Kentucky Revised Statutes Annotated §
381.180(8)(a)(3), North Carolina General Statutes § 36C-5-505(c)(3) and
Texas Property Code § 112.035(g)(3)(A) that, in conjunction with §§ 1410505(E), 381.180(8), 36C-5-505(c) and 112.035(g), attempts to provide
protection from a reciprocal trust attack when spouses create irrevocable
trusts for one another. 53 Planners need to review the reciprocal trust issues
carefully if they intend to create similar irrevocable trusts for both a
husband and a wife, and state laws such as Arizona, Kentucky, North
Carolina and Texas should be reviewed to see whether other states should
consider similar enactments.
4.
Divorce — The donor of an inter vivos QTIP trust typically understands
that under the grantor trust rules provided in Code Sections 671 and 677(a)
he or she will be taxed on all trust income. However, the donor may be
surprised that for the reasons discussed below, grantor trust status may
continue with respect to undistributed capital gains post-divorce during the
remaining lifetime of the donee spouse. In such event the donor spouse
will be subject to income taxes, post-divorce, on capital gains retained in
the inter vivos QTIP trust during the remaining lifetime of the former
spouse. Numerous articles and presentations have extolled the many
benefits of inter vivos QTIP trusts including asset protection, creation of
estate tax discounts and “Superchargingsm.” 54 However, donors and their
51
For a thorough analysis of reciprocal trusts, see Gans, Blattmachr & Zeydel, supra, note 14.
Id.
53
ARIZ. REV. STAT. § 14-10505(E); KY. REV STAT ANN § 381.180(8); N.C. GEN STAT. § 36C-5-505(c); TEX. PROP.
CODE § 112.035(g).
52
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advisors may not focus on the fact that the donor of an inter vivos QTIP
trust may have continuing obligations to pay income taxes on trust capital
gains post-divorce, notwithstanding that the donor may have no right to
trust distributions or access to trust assets to pay such taxes.
a.
Code Section 682 Provides Limited Relief Post-Divorce
Code Section 682 provides that upon divorce, the donee spouse
pays tax on distributed income from a trust that otherwise was a
grantor trust taxed to the initial donor spouse. However, Code
Section 682 apparently does not apply to shift income tax on
accumulated capital gains from the trust donor to the donee spouse
or the trust itself post-divorce. The law is not perfectly clear as to
whether the donor will be taxed on post-divorce capital gains in all
events, but it is clear that if the trust assets revert to the donor upon
the death of the donee spouse under the terms of the initial inter
vivos QTIP trust, the donor spouse will have to pay the income
taxes on undistributed capital gains post-divorce during the
lifetime of the donee spouse.
b.
Flying Under the Radar
There are only limited articles that address the post-divorce income
tax consequences to the donor of an inter vivos QTIP trust. 55 Those
who have discussed the topic agree that the law is not clear as to
whether the donor may have continued exposure to pay income tax
on undistributed capital gains. 56
54
See Barry A. Nelson, Lester Law & Richard S. Franklin, Seeking and Finding New Silver Patterns in a Changed
Estate Planning Environment: Creative Inter Vivos QTIP Planning, Address at the ABA Section of Real Property,
Trust and Estate Law Spring Symposia (May 2, 2014) (and accompanying materials); Jonathan G. Blattmachr,
Mitchell M. Gans & Diana S.C. Zeydel, Supercharged Credit Shelter Trustsm versus Portability, 28 PROB. & PROP.
10 (Mar./Apr. 2014).
55
See Carlyn S. McCaffrey, Restructuring and Dissolving Trusts in the Context of Divorce, 12 (2014); Robert T.
Danforth & Howard M. Zaritsky, Grantor Trusts: Income Taxation Under Subpart E, 819 T.M. EST. GIFTS & TR. at
A-60 (2010); Donna G. Barwick, Divorce: Right up There With Death and Taxes, Estate Planning Techniques in the
Context of Divorce, Address at the 29th Annual Heckerling Institute on Estate Planning (Jan. 1995), in 29th Annual
Heckerling Institute on Estate Planning (Matthew Bender, Pub., 1995).
56
Danforth & Zarisky, supra note 55 at A-60-A-61, states:
“The effect of the spousal attribution rules of § 672(e)… on the spousal income requirement of §
677(a) is unclear. Regs. § 1.677(a)-1(b)(2) states that § 677(a) applies only to distributions or
accumulations made “during the period of the marriage.” Thus, if the grantor and the spouse
divorce, the grantor ceases to be taxable as the trust’s owner under § 677(a) for income
distributions or accumulations that benefit the former spouse, and the trust will be taxed either
under § 682 or § 71… On the other hand, §672(e) treats the grantor as holding any power or
interest his or her spouse holds, based on the marital relationship when the power or interest is
created… without regard to any subsequent dissolution. The IRS apparently views § 682 as
dispositive on this issue. Regs. § 1.1361-1(k)(1), Ex. 10 (ii), states that where the grantor is the
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Attorneys and other advisors should be aware of the continuing
income tax obligations during divorce negotiations and the
potential continuing income tax burden on the inter vivos QTIP
trust donor should be considered as a part of marriage settlement
agreements. Possibly the issue could be addressed in the form of a
postnuptial agreement executed prior to creation of the inter vivos
QTIP trust, but clients are often reluctant to do so. To avoid a
surprise in the event of divorce where the donor spouse becomes
taxed on undistributed trust capital gains, the issues described
herein should be considered in advance of execution of the inter
vivos QTIP trust. Planning options described below should be
considered.
c.
QTIP Qualifications Versus Divorce Consequences
Some inter vivos QTIP trusts provide that in the event of divorce,
the donee beneficiary no longer is entitled to discretionary
principal distributions from the inter vivos QTIP trust. However,
to qualify for the gift tax marital deduction, the inter vivos QTIP
trust income must continue to be paid to the donee spouse for the
lifetime of the donee spouse even after divorce, and no
distributions can be made to anyone other than the donee spouse. 57
As a result, even if the parties recognize the income tax exposure
to the donor spouse post-divorce, there is no ability to provide for a
tax reimbursement clause in the inter vivos QTIP trust in favor of
the donor spouse, without disqualifying such trust from the gift tax
marital deduction.
Code Section 2523(f)(3) applies the
testamentary definition of a qualifying income interest for life for
an inter vivos QTIP trust by reference to Code Section
2056(b)(7)(B)(ii). The donee spouse has a qualifying income
deemed owner of an inter vivos qualified terminable interest property (QTIP) trust, if the couple
divorces, the grantor ceases to own the trust under § 677, because of the application of § 682.“
It should be noted that Treas. Reg. § 1.1361-1(k)(1), Ex. 10 (ii) referenced by Danforth and Zaritsky assumes the
inter vivos QTIP trust provides the beneficiary spouse with all trust income and corpus distributions. Whether such
Regulation would have a different result if corpus distributions terminate upon divorce is also uncertain.
Barwick, supra note 55, states:
“IRC Section 682 provides that the income a husband or wife receives from a trust will be
included in his or her gross income and excluded from the income of the other spouse, where they
are divorced or separated. It is designed primarily to override the operation of the grantor trust
rules where they would otherwise apply to trusts set up for this purpose (for example, where the
transferor spouse retains a reversion that would result in grantor trust treatment under IRC Section
673), and to achieve the same tax results as trusts generally... Because of the lack of a clear
definition of "income" for Section 682, there are still uncertainties about its operation. It may be
advisable to… provide for a tax reimbursement mechanism in the event the results turn out not to
be as anticipated by the parties.”
57
I.R.C. § 2523(f)(1)(B) & 2056(b)(7)(B).
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interest for life if: (i) the donee spouse is entitled to all the
income 58 from the property; and (ii) no person has a power to
appoint any part of the property to any person other than the
surviving spouse. The donee spouse’s right to income must begin
immediately upon establishing the inter vivos QTIP trust and must
continue for the donee spouse’s life. 59 A term of years or a life
estate subject to termination upon the occurrence of a specified
event (e.g., divorce) will not satisfy the qualifying income interest
for life requirement. 60
d.
The Potential Income Tax Surprise for the Donor Spouse PostDivorce
Typically in the event of a divorce, the donor spouse has lost a
portion of marital assets, may have obligations to pay alimony and
child support, will no longer have indirect access to the inter vivos
QTIP trust income that is payable annually to the donee spouse,
and yet may be required to pay capital gains taxes on sales of the
assets of the inter vivos QTIP trust where the sales proceeds either
are not or may not be distributed to the donee spouse. Possible
planning techniques to reduce the unanticipated tax liability for
capital gains to the donor spouse post-divorce include:
Donor Retains Remainder Interest if Donee Spouse
i.
Predeceases Donor. Inter vivos QTIP trusts can provide excellent
asset protection in states that have adopted self-settled asset
protection legislation or in Inter Vivos QTIP Trust Jurisdictions.61
Although there are significant asset protection benefits for those in
jurisdictions with either self-settled asset protection or in Inter
Vivos QTIP Trust Jurisdictions where the donor reserves the right
to trust assets upon the death of the donee spouse, Code Sections
677(a) and 672(e) result in the donor being subject to income taxes
post-divorce on undistributed capital gains. The donor spouse may
be willing to assume such a risk or may take advantage of planning
to minimize the potential income taxes on such capital gains by,
for example, providing the donor spouse with a power to substitute
assets of equal value and thereby control the character of assets in
the inter vivos QTIP trust so they are unlikely to significantly
appreciate or if they do, to acquire the appreciated assets by
substituting other assets without appreciation in the trust. If the
donor spouse has liquidity to pay potential capital gains taxes, the
58
The term “income” means fiduciary accounting income or “trust income,” and not taxable income. See Treas.
Reg. § 25.2523(f)-1(c)(2).
59
Treas. Reg. §25.2523(f)-1(c)(2).
60
Treas. Regs. §§ 25.2523(f)-1(c), 25.2523(e)-1(f).
61
See discussion in paragraphs C. and D. of Section II, infra.
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donor spouse may be willing to do so if the donor and/or the
donor’s children are the residuary beneficiaries of the inter vivos
QTIP trust.
ii.
Donor does not Retain an Interest in the Inter Vivos
QTIP Trust but, the Donor’s Spouse is Provided a
Testamentary Special Power of Appointment (“SPA”) in Favor
of the Donor or Donor’s Lineal Descendants. If the donor is not
designated as a remainder beneficiary under the terms of the inter
vivos QTIP trust upon the death of the donee spouse but the donee
spouse has a special power of appointment in favor of the donor
spouse or the donor’s lineal descendants, would the donor still be
subject to tax on undistributed capital gains post-divorce under
Code Section 677(a), whether or not the power of appointment is
in fact exercised in favor of the donor? This issue appears less
clear than where the inter vivos QTIP trust provides a reversion
back to the donor if the donee spouse predeceases the donor, but it
would appear that the IRS could take the position that grantor trust
status continues with respect to undistributed capital gains postdivorce. Code Section 672(e) states that the determination as to
grantor trust status is made if the person holding the power or
interest was the spouse of the donor at the time of creation of
such power or interest [emphasis added]. Although
Code
Section 682 addresses the issue for distributed income,
undistributed income may continue to be taxed to the donor
spouse. 62
iii.
Terminate Trust Post-Divorce. If upon divorce the assets
of the inter vivos QTIP trust are distributed outright to the donee
spouse, then the donor spouse is relieved of any obligation to pay
income tax on accumulated capital gains under the grantor trust
provisions. However, in order to be sure that trust assets pass to
the donor’s lineal descendants, termination of the trust may be an
unacceptable alternative. Furthermore, if the inter vivos QTIP
trust was initially created as part of an asset protection plan,
outright distributions to the donee spouse are unlikely to be an
acceptable alternative.
iv.
Require Reimbursement of Income Taxes Payable by
Donor from Other Assets of Donee Spouse. Although the inter
vivos QTIP trust cannot permit distributions to anyone other than
the donee spouse during the life of the donee spouse, a marital
settlement agreement can obligate the donee spouse to reimburse
the donor spouse for income taxes paid on accumulated capital
62
See Footnotes 55 & 56, infra.
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gains or enable the donor spouse to setoff alimony or other
payments otherwise due to the donee spouse by the income taxes
payable on accumulated capital gains. This option is especially
fair where the donor spouse has no retained interest should Code
Sections 677(a) and 672(e) result in grantor trust treatment
subjecting the donor spouse to tax without any rights to trust
remainder upon death of the donee spouse. The obligation of the
donee spouse to reimburse the inter vivos QTIP trust donor may be
difficult to secure and it is possible that alimony payments owed
by the donor spouse to the donee spouse could be less than the
amount of income taxes payable by the donor spouse, such that a
portion of the reimbursement to the donor spouse is unsecured.
v.
Creation of Nonreciprocal Inter Vivos QTIP Trusts. If
non reciprocal inter vivos QTIP trusts are created by husband and
wife, then each inter vivos QTIP trust can authorize discretionary
distributions of trust principal to the donee spouse of an amount in
excess of trust income to reimburse the donee spouse for any
income tax obligations post-divorce resulting from grantor trust
status of such trust (i.e., the inter vivos QTIP trust created by
husband for wife would provide that in addition to trust income
that must be distributed annually to wife, wife would be entitled to
a distribution from trust principal post-divorce to reimburse wife
for any income taxes payable by wife on any trusts created by wife
for husband that are determined to be grantor trusts). As long as
there are sufficient assets in both inter vivos QTIP trusts, this
approach may provide the security against an unanticipated
diminishment of the donor’s estate so that the consequences of
grantor trust status, post-divorce, will not be burdensome to the
donor spouse. However the provisions may enhance an IRS
position that the trusts are in fact reciprocal trusts.
III.
Conclusion.
While many questions exist, there is no question that clients should be advised of the
benefits of restructuring their assets to maximize asset protection and use of the currently
available applicable exclusion amount. Inter vivos QTIP trust planning in an Inter Vivos
QTIP Trust Jurisdiction is one alternative that should be considered.
* * *
These materials are intended to assist readers as a learning aid but do not constitute legal advice and, given their purpose, may
omit discussion of exceptions, qualifications, or other relevant information that may affect their utility in any planning situation.
Diligent effort was made to insure the accuracy of these materials, but Nelson & Nelson, P.A. assumes no responsibility for any
reader's reliance on them and encourages all readers to verify all items by reviewing all original sources before applying them.
The reader should consider all tax and other consequences of any planning technique discussed. Anyone reviewing these
materials must independently confirm the accuracy of these materials and whether any cases or ruling have been superseded. An
attorney in the state of domicile of any potential debtor should be engaged for any individual planning.
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EXHIBITS
SEEKING AND FINDING NEW SILVER PATTERNS
IN A CHANGED ESTATE PLANNING ENVIRONMENT:
CREATIVE INTER VIVOS QTIP PLANNING
Barry A. Nelson, Esq.
estatetaxlawyers.com
NELSON& NELSON, P.A.
2775 Sunny Isles Boulevard, Suite 118
North Miami Beach, Florida 33160
305.932.2000 T
305.932.6585 F
103
EXHIBIT A
Debbie and Dennis - Tenancy by the Entireties Plan
Barry A. Nelson
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EXHIBIT B
Debbie and Dennis - CPA’s Tax Savings Plan
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EXHIBIT C
Debbie and Dennis - Inter Vivos QTIP
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EXHIBIT D
Debbie and Dennis - Comparison of Benefits of Inter Vivos QTIP
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EXHIBIT E
States with Similar Inter Vivos QTIP Trust Legislation
(as of May 2014)
State
Statute
Arizona
Ariz. Rev. Stat. § 14-10505(E)
Delaware
Del. Code Ann. Tit. 12 § 3536(c)(2)
Florida
Fla. Stat. § 736.0505(3)
Kentucky
Ky. Rev. Stat. Ann. § 381.180(8)(a)
Maryland
Md. Est. & Tr. Code Ann. § 14-116(a)(1)-(2)
Michigan
Mich. Comp. Laws § 700.7506(4)
North Carolina
N.C. Gen Stat. § 36C-5-505(c)
Oregon
Or. Rev. Stat. § 130.315(4)
South Carolina
S.C. Code Ann. § 62-7-505(b)(2)
Texas
Tex. Prop. Code § 112.035(g)
Virginia
Va. Code Ann. § 64.2-747(B)(2)
Wyoming
Wyo. Stat. Ann. § 4-10-506(e)
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EXHIBIT F
New §736.0505(3) Assures Tax/Asset Protection of Inter Vivos QTIP Trusts
The Florida Bar Journal, December 2010
By Barry A. Nelson and Richard R. Gans
LINK TO WEB ARTICLE
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EXHIBIT G
Protecting Trusts From Claims of Alimony or Child Support
Trusts & Estates Magazine, March 2014
By Barry A. Nelson
Article originally published in the March 2014 issue of Trusts & Estates.
For more information, go to trustsandestates.com.
LINK TO WEB ARTICLE
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Creative Estate Planning Strategies
for using Lifetime QTIPs
Richard S. Franklin
Lester B. Law
Barry A. Nelson
McArthur Franklin PLLC
Abbot Downing
Nelson & Nelson, P.A.
1101 Seventeenth Street NW, Suite 820
305 Fifth Avenue South, Suite 204
2775 Sunny Isles Boulevard, Suite 118
Washington, DC 20036
Naples, Florida 34102
North Miami Beach, Florida 33160
202.857.3434 (phone)
239.263.4663 (phone)
305.932.2000 (phone)
rfranklin@mcarthurlaw.com
lester.law@abbotdowning.com
barry@estatetaxlawyers.com
ABA/RPTE Webinar on Inter Vivos QTIP Planning
April 7, 2015
120
Example 1
Funding Testamentary use of Donee Spouse’s Applicable Exclusion Amount
Lifetime QTIP Trust
Donor
Spouse
(irrevocable “grantor” trust)
Donor Spouse
gives up to $5.43
million of Assets to
Lifetime QTIP Trust
Upon Donee
Spouse's death,
the balance to
Descendants
Trusts
Division among
Descendants Trusts
(separate trusts for descendants)
121
Copyright 2015 Richard S. Franklin. All Right Reserved.
Example 2
Funding Lifetime use of Donee Spouse’s Applicable Exclusion Amount
Lifetime QTIP Trust
Donor
Spouse
(irrevocable “grantor” trust)
Donor Spouse
gives up to $5.43
million of Assets to
Lifetime QTIP Trust
During life, Donee
Spouse releases
his interest in the
trust;
descendants
trusts are funded
Division among
Descendants Trusts
(separate trusts for descendants)
122
Copyright 2015 Richard S. Franklin. All Right Reserved.
Example 3
Lifetime use of Donor Spouse’s Applicable Exclusion Amount with Gift of
Hard to Value Assets (partial QTIP)
Donor
Spouse
Donor Spouse
makes gift of hard
to value assets to
Lifetime QTIP Trust
Lifetime QTIP Trust
(irrevocable “grantor” trust)
QTIP portion
non-QTIP
portion
Upon Donee
Spouse’s death,
the balances of
QTIP and nonQTIP trusts pass
to the “Grantor”
Bypass Trust
“Grantor” Bypass
Trust/Continuing
QTIP Trust – For Donor
Spouse, if the Donor Spouse survives
the Donee Spouse (backend interest)
123
Copyright 2015 Richard S. Franklin. All Right Reserved.
Donor Spouse
makes a formula
QTIP election so
that the remaining
amount of her
applicable exclusion
does not get
QTIP-ped
Example 4
Lifetime use of Donor Spouse’s Applicable Exclusion Amount with Gift of
Hard to Value Assets (disclaimer)
Donor
Spouse
Donor Spouse
makes gift of hard
to value assets to
Lifetime QTIP Trust
Disclaimer: Donee Spouse executes a formula
disclaimer of the amount that can pass free of tax
using the Donor’s applicable exclusion amount.
Under the terms of the marital trust, the disclaimed
amount passes to the Family Trust. The remainder
remains in the Lifetime QTIP Trust
Upon Donee Spouse’s
death, the balance to
“Grantor” Bypass Trust
124
Copyright 2015 Richard S. Franklin. All Right Reserved.
(irrevocable “grantor” trust)
Upon Donee Spouse’s
death, the balance to
“Grantor” Bypass Trust
Family Trust
-- For Descendants (and
potentially Donee Spouse);
Receives applicable exclusion
amount
Lifetime QTIP Trust
“Grantor” Bypass
Trust/Continuing
QTIP Trust – For Donor
Spouse, if the Donor Spouse survives
the Donee Spouse (backend interest)
Using Lifetime QTIP with Loan to Irrevocable Defective Grantor Trust
(IDGT) to finance Purchase from Donor Spouse
Example 5
Lifetime QTIP Trust
Cash
Donor
Spouse
(irrevocable “grantor” trust)
Step #1 -- Donor
Spouse gives $3
million of cash to
Lifetime QTIP Trust
Cash
Step #3 – Donor
sells $3 million
FLP interest to
IDGT for $3
million of cash
Cash
Promissory
Note
FLP Int.
Step #2 –
Lifetime QTIP
loans $3 million
of cash to IDGT
Irrevocable
Defective Grantor
Trusts
125
Copyright 2015 Richard S. Franklin. All Right Reserved.
Example 6
Using Lifetime QTIP with Sale to Irrevocable Defective Grantor Trust (IDGT)
Lifetime QTIP Trust
66% of Stock
Donor
Spouse
(irrevocable “grantor” trust)
Step #1 -- Donor
Spouse gives 66%
of Waddles, Inc.
stock to Lifetime
QTIP Trust
Promissory
Note
33% of Stock
Step #2 –
Lifetime QTIP
sells 33% of
Waddles, Inc.
stock to IDGT
Irrevocable
Defective Grantor
Trusts
126
Copyright 2015 Richard S. Franklin. All Right Reserved.
Use of Lifetime QTIP to Facilitate Fractional Interest
Discounts in Art (a la Elkins)
Donor Spouse
owns 4
Paintings
worth approx.
$10 Million
Step #1: Donor
Spouse gives an
undivided 25% interest
in 4 Paintings
(assuming a 40%
discount, the gift is
$1.500,000)
Irrev. GST Family
Trust
-- For Donee Spouse and
Descendants (Donee Spouse
is primary beneficiary)
Upon Donee Spouse’s death,
the balance to Descendants
Trusts
Step #2: Donor
Spouse gives an
undivided 75% interest
in 4 Paintings
Step #3: Donor
Spouse makes formula
fractional QTIP
election on timely filed
gift tax return. The
formula is designed to
limit the taxable gift to
the appraised values
of the 25% and a
percentage interest
equal to his remaining
gift exclusion amount.
Any excess value is
subject to QTIP
election
Division among
Descendants Trusts
(separate trusts for
descendants)
127
Copyright 2015 Richard S. Franklin. All Right Reserved.
Example 7
Lifetime QTIP Trust
(irrevocable “grantor” trust)
Donee Spouse is only beneficiary
during her lifetime
Upon Donee Spouse’s death
or earlier release of her
interests in the QTIP, the
balance to “Grantor” Bypass
Trust
“Grantor” Bypass
Trust/Continuing
QTIP Trust – For Donor
Spouse, if the Donor Spouse survives
Donee Spouse, or if Donee Spouse releases
her interests in the QTIP Trust
Upon the last of Donor Spouse’s
and Donee Spouse’s deaths, the
balance to Descendants Trusts
Grantor Bypass Trust
Example 8
Lifetime QTIP Trust
Donor
Spouse
(irrevocable “grantor” trust)
Upon Donee Spouse's death,
non-QTIP assets, plus
balance of Donee Spouse's
applicable exclusion amount
to Grantor Bypass Trust
Grantor Bypass
Trust
-- For Donor Spouse
and Descendants
Upon Donee Spouse’s
death, the balance to
Descendants Trusts
Upon Donee
Spouse's death, the
balance to Second
Marital Trust
Second Marital
Trust -- For Donor
Spouse
Division among
Descendants Trusts
(separate trusts for
descendants)
128
Copyright 2015 Richard S. Franklin. All Right Reserved.
Section 682
(a) Inclusion in gross income of wife. There shall be included in the gross income of a
wife who is divorced or legally separated under a decree of divorce or of separate
maintenance . . . the amount of the income of any trust which such wife is entitled to
receive and which, except for this section, would be includible in the gross income of
her husband, and such amount shall not, despite any other provision of this subtitle,
be includible in the gross income of such husband. This subsection shall not apply to
that part of any such income of the trust which the terms of the decree, written
separation agreement, or trust instrument fix, in terms of an amount of money or a
portion of such income, as a sum which is payable for the support of minor children of
such husband. In case such income is less than the amount specified in the decree,
agreement, or instrument, for the purpose of applying the preceding sentence, such
income, to the extent of such sum payable for such support, shall be considered a
payment for such support.
(b) Wife considered a beneficiary. For purposes of computing the taxable income of the
estate or trust and the taxable income of a wife to whom subsection (a) applies, such
wife shall be considered as the beneficiary specified in this part.
(c) Cross reference. For definitions of “husband” and “wife”, as used in this section, see
section 7701 (a)(17).
129
Barry A. Nelson
barry@estatetaxlawyers.com
HOMESTEAD
TBE PROTECTION
130
EXHIBIT A
TENANCY BY THE ENTIRETIES PLAN
DEBBIE & DENNIS
Debbie
Dennis
T by E
Upon Debbie’s Death
House – Protected Homestead
$ 2.82 M
Brokerage
$10.68 M
TOTAL
$13.5 M
Debbie’s Gross Estate Assuming She
Dies First
$6.75 M
MARITAL DEDUCTION
$6.75 M
Debbie’s Taxable Estate
$0
Debbie’s Tax
$0
131
EXHIBIT A
TENANCY BY THE ENTIRETIES PLAN
DEBBIE & DENNIS
Debbie
Dennis
T by E
UPON DENNIS’ DEATH
Dennis’ Gross Estate
$13.5 M
Less Applicable Exclusion
Amount (assuming portability)
($10.68 M)
Dennis’ Taxable Estate
$2.82 M
Dennis’ Tax
$1.128 M
Assets subject to creditors while both married and living
$0
Assets subject to creditors upon death of 1st spouse or divorce $10.68 M
132
EXHIBIT B
CPA’S TAX SAVINGS PLAN
DEBBIE & DENNIS
Debbie’s
Revocable Trust
Dennis’
Revocable Trust
Upon Debbie’s Death
House – Protected Homestead
T by E
$2.82M
Brokerage
$5.34 M
$5.34 M
TOTAL
$5.34 M
$5.34 M
Debbie’s Gross Estate Assuming
She Dies First
$6.75 M
Debbie’s Share of Homestead to
Dennis Outright
($1.41 M)
MARITAL DEDUCTION
$1.41 M
Debbie’s Taxable Estate
$5.34 M
Less Applicable Exclusion Amount
($5.34 M)
Debbie’s Tax
$0
133
$2.82 M
EXHIBIT B
CPA’S TAX SAVINGS PLAN
DEBBIE & DENNIS
Debbie’s
Revocable Trust
UPON DENNIS’ DEATH
Dennis’ Gross Estate
$8.16 M
Less Applicable Exclusion
Amount
($5.34 M)
Dennis’ Taxable Estate
$2.82 M
Dennis’ Tax
$1.128 M
Savings Compared to
Tenancy by the Entireties
$0
Dennis’
Revocable Trust
T by E
Homestead
$2.82 M
Brokerage Assets $5.34 M
Assets subject to creditors while both married and living
$10.68 M
Assets subject to creditors upon death of 1st spouse or divorce
Assuming assets pass into spendthrift trust for surviving spouse upon death of
1st spouse
$5.34 M
134
EXHIBIT C
INTER VIVOS QTIP
DEBBIE & DENNIS
Debbie’s QTIP Dennis’ QTIP
Upon Debbie’s Death
House – Protected Homestead
T by E
$2.82 M
Brokerage
$5.34 M
$5.34 M
TOTAL
$5.34 M
$5.34 M
Debbie’s Gross Estate
Assuming She Dies First
$6.75 M
Debbie’s Share of Homestead
to Dennis’ Marital Deduction
($1.41 M)
MARITAL DEDUCTION
$ 1.41 M
Debbie’s Taxable Estate
$ 5.34 M
Less Applicable Exclusion Amount
($5.34 M)
Debbie’s Tax
$0
135
$2.82 M
EXHIBIT C
INTER VIVOS QTIP
DEBBIE & DENNIS
Debbie’s QTIP
Dennis’ QTIP
T by E
UPON DENNIS’ DEATH
Homestead
$2.82 M
QTIP Trust from Debbie
$5.34 M
Dennis’ Gross Estate
$8.16 M
Less Applicable Exclusion Amount
($5.34 M)
Dennis’ Taxable Estate
$2.82 M
Dennis’ Tax
$1.128 M
Assets subject to creditors while both married and living
$0
Assets subject to creditors upon death of first spouse or divorce
$0 M
136
EXHIBIT D
COMPARISON OF BENEFITS OF INTER VIVOS QTIP
Tenancy by the
Entirety Plan
Technique
T by E
Securities Protected
While Both Living
$10.68 M
Securities Protected
Upon Death of 1st
Spouse
$0
Tax Plan
Benefits of QTIP
Plan
Tax Savings Plan
Funded
Inter Vivos QTIP
$0
$10.68 M
$5.34 M
$10.68 M
$1.128 M
$1.128 M
Tax Paid Upon Death
of Spouse
(assuming portability) $1.128 M
137
EXHIBIT E
 States with
Similar Inter
Vivos QTIP Trust
Legislation
(as of May 2014)
State
Statute
Arizona
Ariz. Rev. Stat. § 14-10505(E)
Delaware
Del. Code Ann. Tit. 12 § 3536(c)(2)
Florida
Fla. Stat. § 736.0505(3)
Kentucky
Ky. Rev. Stat. Ann. § 381.180(8)(a)
Maryland
Md. Est. & Tr. Code Ann. § 14-116(a)(1)-(2)
Michigan
Mich. Comp. Laws § 700.7506(4)
North Carolina
N.C. Gen Stat. § 36C-5-505(c)
Oregon
Or. Rev. Stat. § 130.315(4)
South Carolina
S.C. Code Ann. § 62-7-505(b)(2)
Texas
Tex. Prop. Code § 112.035(g)
Virginia
Va. Code Ann. § 64.2-747(B)(2)
Wyoming
Wyo. Stat. Ann. § 4-10-506(e)
138