Qualified Terminable Interest Property (QTIP) Trust

A Qualified Terminable Interest Property (QTIP) Trust is a type of Trust that allows a surviving spouse to postpone estate taxes. A QTIP Trust allows the surviving spouse to make use of the Trust property tax-free. Taxes are deferred until the surviving spouse dies and the final Trust beneficiaries receive the Trust property.

The Trust is designed so that all assets in the Trust qualify for the unlimited marital deduction, as would outright gifts to a spouse. Thus, the Trust avoids estate taxes upon the death of the first spouse. The real advantage of the Trust is the ability to have an independent Trustee control and manage the assets for your surviving spouse, and the ability to determine the contingent beneficiaries, who are usually the children. Additionally, the QTIP Trust gives you both the opportunity to ensure that your children inherit their wealth while at the same time providing for the financial security of your surviving spouse.

Does a QTIP Qualify for the Marital Deduction?

Since 1982, an unlimited marital deduction for gifts and bequests to spouses has existed. These transfers are tax free and the tax consequences are postponed until the surviving spouse gifts or sells the property, or dies.

Prior to the creation of the QTIP exception, assets had to be left outright to the surviving spouse in order to qualify for the marital deduction. In other words, the surviving spouse had to be given the assets to use as he or she pleased. The QTIP, however, can qualify for the marital deduction if both of the following conditions are met:

• Your surviving spouse is entitled to all the annual income from the Trust for life
• The principal can’t be used by anyone but your surviving spouse as long as he or she lives.

What Does a Trustee of a QTIP Do?

The Trustee of the QTIP typically manages the investments of the Trust and distributes the income to your surviving spouse. Additionally, the Trustee can allow your surviving spouse to take out principal to meet certain needs. These include:

• Support in reasonable comfort
• Maintenance
• Education
• Health, medical, dental, hospital and nursing expenses

Unlike the Living Trust, the QTIP typically isn’t created until you die. Then the QTIP becomes part of your spouse’s taxable estate, and is taxed accordingly when the surviving spouse dies. After the survivor’s death, these assets then pass on to the beneficiaries you previously designated.

Using the QTIP for Family Conflicts

Family conflicts are not only seen in remarriages. The interest of your spouse may be at odds with those of your own children. In these cases, the QTIP minimizes conflict by giving your spouse a qualifying life interest while leaving the principal to children of the marriage.

As a general rule, your spouse will be in favor of the QTIP election. With a QTIP election, the unlimited marital deduction will allow the property to pass to him/her tax free. Your spouse will benefit from the income-earning potential of the entire property unreduced by taxes.

On the other hand, your children may not be as happy with the QTIP election. Even though no taxes are due upon your death, the full value of the remainder interest at the time of your spouse’s death must be included in his/her estate. Since the Trust value has the potential to appreciate during your spouse’s remaining life, your children may end up with increased taxes. Additionally, your children will have to pay the QTIP tax based on your spouse’s highest marginal rate.

Using the QTIP to Keep Your Spouse from Being Vulnerable

When you die, your spouse is left in an extremely vulnerable position. It is not just that your spouse no longer has you around to provide love, support, guidance and companionship. Your spouse may also, for the first time, have more assets at his/her disposal than ever before. This puts your spouse in the position to make bad decisions.

This is one reason why QTIP Trusts are created to hold qualifying property. Simply stated, creditors cannot get something from your spouse that your spouse does not have. Your spouse does not have the unlimited right to the principal. The QTIP provision, then, can protect your spouse against his/her own bad judgment.

Using the QTIP to Keep Sickness from Eating Away Your Estate

With the costs of medical care rising in recent years at a rate much greater than consumer prices, a long convalescence is one of the most frightening prospects and expensive situations anyone can face. In terms of estate planning, the costs of extended medical care can destroy the best-laid plans that you may make.

Let’s assume that you and your spouse are happily married with no prior divorces, and have wonderful children. You decide to leave your spouse with full control of all the assets, perhaps as an outright bequest or maybe in a Trust for which your spouse has a general power of appointment.

When you die, your spouse inherits everything free of estate taxation as a result of the unlimited marital deduction. Then your spouse gets sick and uses up the current income stream of the estate or Trust to cover the medical bills. Once that is used up, your spouse is forced to consume principal. It is certainly not your spouse’s intent, yet he/she is eating into your children’s future inheritance.

Because your spouse has access to all of the estate, he/she will not qualify for Supplemental Security Income (SSI) or Medicaid until the estate is nearly gone. A QTIP could have provided some relief.

If properly drafted, a QTIP would result in having only your spouse’s income interest in the QTIP included in the determination of financial need, and he/she may be able to qualify for government assistance. Your spouse would get the medical care needed and the remainder interest would be left intact.

This type of planning is not without risk. While it works in the current environment of federal and state regulation, this environment could change in response to the need for reform in Medicaid and other assistance programs.

Using the QTIP for Generation Skipping Transfers

A gift and estate plan will typically involve at least some transfers of property that will “skip generations,” going, for example, from you to your grandchildren or great-grandchildren. Since 1987, decedents have at their disposal a $5.49 million exemption from taxation on Generation Skipping Transfers (GST). The planner, then, has two means of significantly reducing estate tax liability: the applicable exclusion amount (that now is equivalent to a $5.49 million exemption) and the GST tax exemption amount. The trick is to get the most from both.

The GST exemption enables each taxpayer to shield $5.49 million of generation skipping transfers from the GST tax. Both you and your spouse get your own $5.49 million exemption, but it is not transferable. Therefore, whatever amount of GST exemption has not been used at your death is lost forever. The GST / QTIP election permits the deceased spouse’s estate to ignore a QTIP election that was made for estate tax purposes and to treat the deceased spouse as the transferor of such property for purposes of allocating that spouse’s GST exemption.

There are other alternatives to the QTIP that will give you and your spouse the control and financial security you both seek. The QTIP is an outstanding planning tool that allows multiple options. In fact, its flexibility extends to full, partial, or no election at all. That’s why a visit to your estate planning attorney may be the best way to ensure the proper use of a QTIP.