Voiding of QTIP Election May Save Gift Taxes…
Instead of an outright distribution to a surviving spouse, estate planners often advise that assets be distributed to a qualified terminal interest property (“QTIP”) trust for the benefit of the surviving spouse. This planning occurs often in a second or third marriage. Upon the predeceasing spouse’s death, their estate receives a 100% marital deduction for assets place in the QTIP trust. At the surviving spouse’s death, the assets can then be distributed to the decedent’s children (the surviving spouse’s stepchildren); however, any assets remaining in the QTIP trust will be subject to estate tax in the surviving spouse’s estate.
Assume Bob and Mary are in their 3 or 4th marriage and Bob has children from a prior marriage. Bob wants Mary to have the benefit of his assets prior to his death but wants his children to receive the assets after Mary’s death. He can create a QTIP trust which requires all income to Mary but, at her death, the assets will be distributed to Bob’s children. This QTIP trust will qualify for the marital deduction, assuming an election is properly made on the federal estate tax return. At Mary’s subsequent death, the value of the QTIP trust will be included in Mary’s estate. If, however, Mary gives ANY portion of the QTIP trust away during her lifetime, then the ENTIRE value of the trust (less the value of her income interest) will be subject to a gift tax.
A recent ruling illustrates how such a QTIP election can be “undone”.
In Private Letter Ruling (“PLR”) 20165004, a decedent, with a surviving spouse and 2 children from a prior marriage, created a qualifying QTIP trust. The QTIP trust ALSO qualified for the marital deduction because the spouse held a general power of appointment (“GPOA”) over the trust. The trustee of the trust made a valid QTIP election on the federal estate tax return and allocated the decedent’s generation skipping transfer tax (“GSTT”) exemption to the trust.
After the decedent’s death, the trustee, the surviving spouse and the decedent’s children entered into a settlement agreement to terminate the QTIP marital trust. The state court approved the settlement agreement and the parties applied for the PLR to determine the tax consequences.
First, they asked that, because the trust not only qualified for a marital deduction because the trust was a valid QTIP trust but ALSO qualified for the marital deduction because the trust was a valid GPOA trust, whether they could “void” the QTIP election, thereby also avoiding gift taxes on the total value of the QTIP trust resulting from the termination of the QTIP trust.
Second, they wanted to confirm that, because the spouse released her GPOA, that any gift tax resulting from the release of the GPOA would be based only upon the difference of the fair market value of the gift less any consideration she received (instead of the value of the total trust as required under the QTIP rules).
Third, they requested a ruling that the surviving spouse would not be considered the transferor for purposes of the generation skipping transfer tax (“GSTT”) and that the allocation of the decedent’s GSTT exemption was valid.
The IRS determined that under Revenue Procedure 2001-38, the QTIP election could be voided as it was not necessary to reduce the estate tax to zero and the election did not need to be made for the marital deduction to be otherwise valid. The GPOA made the trust otherwise qualify for the marital deduction.
Second, the IRS determined that the release of the spouse’s GPOA would be subject to gift tax upon the excess of the fair market value of the trust assets over the consideration received would be a gift.
Finally, because the spouse released her GPOA which was subject to gift tax, she was considered the transferor for GSTT purposes and the original allocation of the decedent’s exemption was negated.
ADVICE: A good advisor reviewed the law and determined that a QTIP election could be “voided” if unnecessary. The result was not so good as to the GST issue. Disclaimers are another technique that will help “fix” certain mistakes. If you have adverse tax consequences after a death, then hire competent counsel to determine whether there is a way to fix the adverse tax consequences. BUT be sure that one fix does not create another adverse GST consequence.
WORD OF THE WEEK: A general power of appointment (“GPOA”) is defined under Section 2041 of the Internal Revenue Code (the “Code”) for estate tax purposes and Section 2514 of the Code for gift tax purposes as a right to appoint assets to yourself, your creditors, your estate, or your estate’s creditors. Generally, if you have a GPOA at your death, all of the assets over which you have that GPOA are included in your estate for estate tax purposes. Until recently, an individual did NOT want to have a GPOA because those assets over which he or she had a GPOA would be included in their estate to calculate estate taxes. Now a GPOA may be utilized to include assets in non taxable estates to increase the basis in such estate assets.
GENEROSITY IS A KEY TO HAPPINESS …REACH OUT AND HELP SOMEONE TODAY! 😎