The Clayton QTIP is one of our favorite estate planning structures. It allows for the re-direction of assets while still being able to qualify for the marital deduction. In the right situation, it can be a home run.
In this article, we will discuss the mechanics of the Clayton QTIP and review some of the pros and cons. Let’s get started.
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The Clayton QTIP provides a disclaimer option. For example, a husband can leave all his assets to his wife outright. They can also be left in a QTIP trust with a provision in his will that if she disclaims, then the disclaimed assets will pass directly to a credit shelter trust (also called the “bypass” trust).
If structured correctly, if his net worth increases or the estate tax exemption decreases (so that a bypass trust makes sense), his widow can create it after he passes away. This approach is easier for the client to comprehend, and there is no complex gift formula. This allows the surviving spouse to take additional actions to reduce taxes if it is required.
The final result is essentially the same under a disclaimer plan or a Clayton QTIP plan. The property that otherwise would have been passed for the spouse’s benefit (and qualified for the estate tax marital deduction and included in the surviving spouse’s taxable estate at death) now passes instead to a bypass trust that avoids estate taxation under both spouses’ estates.
Clayton QTIP Structure
How can this possible re-allocation of assets work while still allowing the QTIP to qualify for the marital deduction?
For the marital deduction to work, no one can have the power to direct property away from the spouse. But that was the issue in the Clayton case, in which the concept was approved. The marital deduction is available for the QTIP as long as the election is made. This is true even if the document provides for non-QTIP property to pass to the bypass trust.
The QTIP must be elected. The trustee must make an election at the death of a spouse. The trustee is typically the surviving spouse. The trust assets are then allocated between a Marital Trust and a Survivor’s Trust.
The assets of the spouse who passed away are allocated based on the surviving spouse’s election to treat these assets as QTIP property. As such, these assets will remain in the surviving spouse’s estate. This eliminates capital gains tax that could have been due at the surviving spouse’s death from the deceased spouse’s assets.
The main difference between a Clayton QTIP and a standard split trust is that the surviving spouse will elect the first death. This must be provided in the trust document and allow the deceased spouse’s assets to be allocated as a QTIP Trust. The end result is that the trust assets will be included in the surviving spouse’s estate for estate tax purposes.
Examining the Pros & Cons
- The children of the deceased spouse cannot be disinherited due to the irrevocability of the trust.
- There is a full step-up in the basis of all assets at the date of the first death. In addition, there is another full step-up in the basis of all assets at the second death. This eliminates the capital gains tax at the second death that could have been due.
- The surviving spouse is protected from attempts to defraud or complications with a new spouse.
- If the election is not made, then a typical A/B or A/B/C split Trust is typically used.
- The surviving spouse will have minimal power of appointment over the trust assets.
- Your estate planning attorney must complete specific administrative tasks upon the death of the first spouse.
- You must file an estate tax return. In addition, the surviving spouse must elect portability in the estate tax return.
A word about the Marital Deduction
The marital deduction is rather straightforward. It allows for the value of property to pass from the decedent to the decedent’s surviving spouse. This is the unlimited marital deduction. This deduction applies to gifts that are made outright from the decedent to his or her spouse, as well as to certain interests that can be placed in trust for the benefit of the spouse during the spouse’s lifetime.
As long as the spouse is a U.S. citizen and the interest qualifies as a deductible interest, the marital deduction is an unlimited deduction against the estate tax for federal purposes. The idea behind the unlimited marital deduction is that the interest received by the surviving spouse will be subsequently included in the spouse’s estate at the spouse’s subsequent death unless spent by the spouse during his or her lifetime.
However, the maximum use of the unlimited marital Deduction is not always appropriate. Property which passes outright to the surviving spouse—for example, as survivingjoint tenant or as named beneficiary under an insurance policy or pension plan—qualifies for the marital deduction.
In addition, there are three types of trusts which qualify for the marital deduction, although only two are used with frequency. These trusts which qualify for the marital deduction are the QTIP Trust, the General Power of Appointment Trust, and the Estate Trust.
As you can see, there are many advantages of the the Clayton QTIP. It should be no surprise why we like the trust so much. In the right situation, the trust is able to re-allocate assets and still get the marital deduction. It can be a win-win.