Taxation & Estate Planning

The QTIP, Part 1

By Joel A. Schoenmeyer

I'd like to spend a few posts talking about QTIPs. No, I'm not talking about the cotton swabs you aren't supposed to stick in your ear but do. Nor am I talking about the rapper from A Tribe Called Quest who is best known for his guest spot on Deee-Lite's single "Groove Is In The Heart." Rather, I'm talking about Qualified Terminable Interest Property.

To talk about QTIPs in this last sense, we need to talk about how the estate tax works. I'll try to be brief, and simplify (maybe over-simplify). The idea of the estate tax is, roughly, as follows:

1. There's no estate tax on property left to a surviving spouse.

2. There's no estate tax on property left to charity.

3. There's no estate tax on property left to anyone else, unless its value exceeds what we'll call the "exemption amount." (Currently it's $3.5 million.)

In most cases involving married couples, the goal is to defer the payment of estate tax until the death of the surviving spouse. This can be done in a couple of ways. One way is by setting up (at the death of the first spouse to die) two trusts:

A Family Trust or Exemption Amount Trust, holding property equal in value to the exemption amount. This trust will NEVER be subject to estate tax.

A Marital Trust, holding the rest of the property of the first to die. This trust will be subject to estate tax in the estate of the surviving spouse.

If you draft the main trust document correctly, you create a situation where no estate tax will be due when the first spouse dies, no matter how much property the first spouse to die owns, and no matter what the exemption amount at the time of death. For instance: if the exemption amount is $3 million and I die with $100 million, then the Family Trust gets $3 million (no estate tax, ever) and the Marital Trust gets the remaining $97 million (no estate tax now, but subject to estate tax in the surviving spouse's estate).

Alternatively, you can just create one trust (let's call it the "Family Trust"), but then -- once you determine the exemption amount and the value of the property of the first to die -- you make what's known as a "QTIP election." That is, you elect to treat part of the trust (the part over and above the exemption amount) as "qualified terminable interest property," for which you receive a marital deduction. So, again, no estate tax due at the death of the first to die.

One cite: "qualified terminable interest property" is defined in IRC Section 2056(b)(7).

Next time: what's an Illinois QTIP election?

Full post as published by Death and Taxes Blog on October 26, 2009 (boomark / email).