How to Obtain a Marital Deduction for Property Not Left Outright to a Spouse via the QTIP Trust

It is currently possible to obtain a marital deduction for property that is not left outright to a spouse. In fact it is possible to specify that the principal of a client’s estate must pass to his children or some selected party other than the surviving spouse and still obtain the marital deduction. The vehicle for such planning is called a QTIP trust, a trust that holds qualifying terminable interest property. Through a QTIP trust, a client can provide income for life to a spouse but at that spouse’s death the client can be sure it will pass to the person or persons he has selected.

There is a cost to this flexibility and tax deferral; whatever assets remain in the QTIP trust at the surviving spouse’s death must be included in the surviving spouse’s estate just as if the surviving spouse had transferred the property. The problem is (aside from the obvious estate tax and liquidity problem) that this same fiction applies for GST tax purposes. The surviving spouse is treated as if she was the transferor of property, which was really transferred by her husband. This might cause a portion or all of her husband’s GST tax exemption to be wasted.

With a reverse QTIP election, the first spouse to die (David) will be treated as the transferor of both trusts and therefore his GST tax exemption can be allocated to both trusts. The surviving spouse could not use her exemption against the GST tax since she was not the transferor (because of the reverse QTIP election).

Perhaps a better course of action to fully utilize both spouse’s GST tax exemptions would be to split the QTIP trust into two trusts, one by formula equal to the amount of the GST tax exemption left after funding the CEBT and the other equal to the remaining estate. The predeceased spouse’s estate would make a reverse QTIP election and wipe out the GST tax in the first trust. The surviving spouse could then apply her exemption to this second trust since she would be treated as its creator. In this way, all trusts have been fully sheltered from GST tax. This splitting of trusts for the purpose of making a reverse QTIP election must be made before the due date of the estate tax return of the first spouse to die.

Reproduced with permission.  Copyright The National Underwriter Co. Division of ALM

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