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| THE LIFETIME QTIP TRUST |
| One of the first things I advise
my clients is the importance of each spouse owning at least $2,000,000 of
assets in his or her own name. This is because you never know which spouse
will be the first to die, and if a spouse with less than $2,000,000 dies
first, that spouse has wasted part of his or her $2,000,000 federal applicable
exclusion amount. Example: John and Mary have a total combined estate of $3,000,000, with John owning virtually all of the property other than $50,000 in Mary’s name and their jointly owned $300,000 residence. Mary dies, with a taxable estate of only $200,000 (one-half the house value + her $50,000). Under her Will, the first $2,000,000 of her assets passes into a credit shelter or Family Trust, designed to be excluded from John’s estate upon his later death. However, because the house was jointly owned, it passes automatically to John, so only $50,000 gets funded into the Family Trust. There are no federal or state death taxes due on Mary’s death. On John’s death one year later, his estate consists of $2,950,000: only the $50,000 in the Family Trust is excluded from his taxable estate. Result: His estate owes federal and state estate taxes of almost $460,000. Could this have been prevented? Yes. John and Mary should equally divide their estates as follows: John transfers $1,325,000 to Mary, adding to her own $50,000, and leaving the house in joint names. This gives each of them $1,375,000 in assets (other than the house). Then, on Mary’s death, her $1,375,000 can be funded into the Family Trust (her 50% interest in the house passes automatically to John, which is better for income tax purposes). On John’s death, his $1,675,000 estate passes tax free to their children. Amount saved: almost $460,000! The same result applies no matter which of them is the first to die. What if John is reluctant to give his wife an outright gift of $1,325,000? He may be in a second marriage and wants to be sure that after her death, his assets pass to his children and not to her side of the family, or he may be worried that she may remarry after his death and either predecease her new husband or get divorced from him, in either case exposing his assets to claims of the new husband. In all of these cases, there is no guarantee that John’s children will ever see any of his money. Another reason for concern may be that Mary was never good at handling money or may be a soft touch for swindlers and other smooth talkers. Is there any other way he can get money to her but still control its ultimate disposition? The lifetime QTIP trust The lifetime QTIP trust permits the wealthier spouse to give the other spouse assets to fund the $2,000,000 credit shelter or Family Trust yet still keep control. Based on the IRS’s recently issued final QTIP Regulations, John can have his cake and eat it, too, by use of a lifetime QTIP trust. Here’s how it works: John creates a separate irrevocable trust, today, that pays all of the income at least annually to Mary. The trust may, but need not, make payments of principal available to Mary. Finally, no person (including Mary) can have the power to appoint any part of the property to anyone other than Mary during her lifetime. Those are the only requirements. John then transfers $1,325,000 worth of property to this trust. Because it is a gift of a terminable interest (Mary’s right to income terminates at her death), it would not ordinarily qualify for the marital deduction, and John would be making a taxable gift. However, if a QTIP election is made on a timely filed federal gift tax return for the year of the transfer to the trust, the marital deduction will apply to the gift and no gift tax consequences will result upon his transfer of assets to the trust. If John dies before Mary If John dies before Mary, no part of the QTIP trust will be includible in his taxable estate. His 50% interest in their jointly owned residence will pass outright to Mary, but the balance of his estate ($1,325,000) will pass tax free into his Family Trust, which will not be includible in Mary’s estate at her later death. If Mary dies before John If Mary dies before John, the full amount of the QTIP trust assets will be includible in Mary’s taxable estate, be sheltered by her own $2,000,000 exemption, and either continue in trust for the benefit of John’s children or be distributed outright to them, according to the trust terms as determined by John initially. Since no part of these assets is taxable in John’s estate, and his own estate is under $2,000,000, this gives them the zero estate tax result discussed above. Finally, because the assets are in trust, they are shielded from claims of Mary’s creditors, will not be subject to a new husband’s statutory share of her estate if she predeceases him or if they divorce, professional asset management can be arranged by appointing a corporate trustee, and the assets will be out of Mary’s probate estate and available for her if she becomes unable to care for herself. Retained Interests of John “Well”, says John, “This sounds great, but if Mary dies before I do, much as I love my kids, I’d like to be able to access the QTIP trust property for my own benefit, so long as I’m alive, yet still keep it out of my taxable estate. Is there a way I can do this?” Keeping a Second Life Estate The answer is Yes. The trust can state that if John survives Mary, the income can be payable to John for the rest of his life. Prior to the issuance of the final IRS QTIP Regulations, there was some question whether this arrangement would be characterized as a retained income interest by John, causing the entire amount of the trust property to be includible in John’s taxable estate if he died before Mary. This has now been resolved as stated above. And based on these same Regulations, the retention of John’s secondary income interest will not cause automatic inclusion of the property in John’s taxable estate even if he dies after Mary. After Mary’s Death However, once Mary dies, the trust property will be includible in Mary’s taxable estate. If her executor makes a QTIP election for the trust, it will qualify for the marital deduction in Mary’s estate and be taxed in John’s estate. This actually is good, because it allows for some fine tuning based on who dies first and the amount of each spouse’s assets. Of course, if the terms of the trust state that after Mary’s death, the trust is for the benefit of John and the children, it cannot qualify as QTIP in Mary’s estate and will not be taxed in John’s estate; in effect, this would allow Mary to fund a Family Trust with John’s assets, sheltering up to $2,000,000. Note that in order to qualify the transfer to the trust for the marital deduction, (i) John should not retain a power to appoint any of the property, even if the power is exercisable only after Mary’s death, and (ii) the trust should not permit Mary’s interest to terminate if she and John get divorced. |
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Boulder ElderLaw
Law Office of K. Gabriel Heiser 4845 Pearl East Circle, Suite 101 Boulder, CO 80301 Ph:(303) 447-6855 fax: (888) 301-9466 
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