Taxation & Estate Planning

DIVISION OF TRUST MINIMIZES SECTION 2519 DAMAGE

By Charles Rubin

Section 2519 serves as a backstop to the marital deduction provisions of the Internal Revenue Code. When property passes into a QTIP trust for the benefit of a spouse, the transferor spouse (or the estate of the transferor spouse) avoids gift or estate taxes by electing the gift or estate tax marital deduction. While this avoids a current gift or estate tax, at the death of the surviving spouse the remaining assets are included in the gross estate of that spouse and thus may be subject to estate tax at that time.

To prevent surviving spouses from gifting away their interests in QTIP trusts during lifetime so as to avoid the estate tax on the trust assets at death, Section 2519 creates a taxable gift equal to the value of a QTIP trust when the spouse-beneficiary disposes of all or a part of his or her income interest (less, the value of any retained income interest of that spouse-beneficiary). Effectively, any distribution from a QTIP trust to persons other than the spouse-beneficiary will trigger this taxable gift. This taxable gift occurs, for example, if a QTIP trust is commuted, paying the value of the income interest to the spouse-beneficiary and the remaining assets out to the remaindermen.

Oftentimes, in the settlement of trust litigation, the parties desire to pay some of the assets of a QTIP trust out to one or more remaindermen. Normally, if even $1 is paid out to a remaindermen, a full taxable gift based on the value of the trust (less, the value of the spouse's retained income interest) is triggered.

A recent private letter ruling provides a method for avoiding the application of Section 2519 on the entire trust, when only a partial distribution is occurring to the parties. In the ruling, the IRS ruled that Section 2519 will apply to only one QTIP trust that is commuted, when prior to the commutation, the QTIP trust is divided into 5 different QTIP trusts. More particularly, the IRS ruled that the 4 QTIP trusts that were not commuted were not subject to Section 2519, thus substantially limiting the effect of the Section to the one QTIP trust that was commuted after the division.

Private Letter Ruling 200844010, 10/31/2008

Full post as published by Rubin on Tax on November 05, 2008 (boomark / email).