MARITAL DEDUCTION TRUSTS

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1 One Commerce Plaza Albany, New York P F

2 QTIPS

3 Unlimited Marital Deduction IRC 2056(a) Estate taxes are not imposed on any assets passing to a surviving spouse who is a U.S. citizen. Tax on property going to the spouse is deferred until her death.

4 Terminable Interest IRC 2056(b)(1) No marital deduction is allowed if the spouse receives a terminable interest.

5 Terminable Interest Interest in property that ends due to: Passage of time; Occurrence of future event; or Failure of an event to occur.

6 QUALIFIED Terminable Interest QTIP Trust exception to disqualification of terminable interest from marital deduction: qualifies for MD by giving the spouse SUBSTANTIAL AND ASCERTAINABLE RIGHTS.

7 QTIP Trust ONLY THE SPOUSE CAN BE THE BENEFICIARY OF THE TRUST DURING HER LIFETIME! No one (not even spouse) has the power to appoint property to anyone other than spouse while she is alive.

8 QTIP Trust: (continued) Under IRC 2056(b)(7) - Spouse is entitled to all income at least once/yr; and Executor of the deceased spouse s estate makes irrevocable election on estate tax return.

9 Right To Income The spouse has the right to demand that the non-income producing property be converted into income-producing property. This provision trumps the one allowing the trustee to retain unproductive assets.

10 PLR The decedent left stock in closely held business to a QTIP. The Trustee was required to sell securities only if the decedent s son, the manager of the company, directed the sale and its conditions. The IRS ruled that the portion of the QTIP trust funded with company stock did not qualify for the marital deduction because only the manager of the company, and not the spouse nor the trustee, was empowered to convert the nonincome producing company stock to income-producing property.

11 Potential Benefits Providing creditor and predator protection. Protection against having the assets diverted to a new spouse. Providing for the first spouse s children or other chosen beneficiaries.

12 Potential Disadvantages May create conflict between the spouse and remainder beneficiaries (often, children from prior marriage). The spouse would prefer investment strategies that maximize income while the children will wish to increase the principal. Additional conflicts if QTIP allows for discretionary principal distributions to the spouse.

13 QTIPs and Elective Share The elective share can be satisfied only with an outright disposition, not a QTIP. Exercise of elective share may convert nontaxable estate into a taxable one. When assisting with QTIP plan, advise the client to obtain a waiver of the elective share from the spouse.

14 TAXING QTIPS

15 Estate Tax Placing funds in a QTIP trust does not eliminate estate tax forever. The QTIP is eventually taxed in the estate of the beneficiary spouse, along with her own estate if, together, they add up to more than the spouse s exemption. QTIP trust pays the additional estate tax that is generated because of its inclusion in the estate of the surviving spouse.

16 Example Professor Minerva McGonagall marries Professor Severus Snape. She dies leaving $3mm in a QTIP trust, with income to her beloved husband, Severus, and remainder to Harry Potter.

17 Example (continued) Snape dies later and the QTIP is worth $3mm. Snape s own estate is valued at $4mm and he leaves it to the Malfoys. His Executor, Draco, must file Form 706, reporting an estate of $7mm.

18 Example (continued) If surviving spouse s estate alone would not be taxable and QTIP trust puts it over the exemption amount, the entire estate tax is allocated to the QTIP trust.

19 QTIP ELECTION

20 Making QTIP Election If the QTIP trust is established during lifetime, the grantor makes an election on her federal gift tax return. If the QTIP trust is created at death, the Executor must make an election on the estate tax return. The Executor can choose all, a portion or none of the assets in a QTIP to qualify for a marital deduction.

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22 Making QTIP Election (continued) Listing QTIP trust on Schedule M creates a presumption of the QTIP election. The election is irrevocable. If failed to make one, can t file an amended return to make the election unless the amended return is filed on or before the due date for filing the original Form 706.

23 State QTIP Election N.Y only QTIP election is allowed if no federal return is required to be filed. If federal return is filed, NY and federal QTIP elections must be consistent.

24 QDOTS

25 QDOTs Non-citizen spouse is not entitled to a marital deduction because he may take it outside the U.S. To avoid estate tax on the death of the 1 st spouse two options: U.S citizenship or QDOT trust.

26 QDOT Requirements 1. Qualifying income interest for life. 2. Administered under the laws of a US state. 3. At least 1 trustee must be a US citizen. 4. Irrevocable election must be made on Form No distribution other than income may be made w/out the US trustee withholding estate tax. [hardship exception]

27 QDOT Requirements (continued) If a QDOT is large (DOD value of over $2mm), it must meet one of the following additional requirements: 1. At least 1 US trustee is a bank; 2. US trustee furnish a bond in favor of IRS in the amount of 65% of the FMV of trust assets; or 3. US Trustee must furnish an irrevocable letter of credit issued by a bank, in an amount of 65% of FMV of trust assets.

28 REVERSE QTIPS Maximizing GST Tax Exemption

29 Reverse QTIP Generation-Skipping Transfer (GST) tax exemption not portable; use it or lose it. Giving it to spouse or her QTIP trust makes her the transferor to skip persons (e.g., remainder beneficiaries). IRS allows the Executor to REVERSE the transfer of a QTIP in order to qualify it for the decedent s GST tax exemption.

30 Reverse QTIP (continued) Election to treat the decedent as transferor of a QTIP trust for Generation Skipping Transfer tax purposes, even though the trust will be included in the gross estate of the surviving spouse for regular estate tax purposes.

31 Reverse QTIP Election Cannot Be Partial The Trustee can split the QTIP trust. One QTIP trust can hold the exact amount of the unused GST tax exemption ('the reverse QTIP trust') and a second QTIP trust takes the balance of the QTIP bequest.

32 CLAYTON QTIPS

33 Estate of Clayton v. Commissioner of Internal Revenue, 976 F.2d 1486 (1st Cir. 1992) In the event my executors fail or refuse to make the QTIP election, with respect to my QTIPable trust, the property with respect to which such election was not made shall pass to another trust under my Will with spouse AND kids as beneficiaries.

34 Clayton QTIP The testamentary document is drafted to distribute the portion which is not qualified for the MD (unelected QTIP) to a new trust with different terms (e.g., nonspousal beneficiaries); funding a CST. Useful alternative to formula and disclaimer planning.

35 Lucy Kats Whiteman Osterman & Hanna LLP