How to Set Up a QTIP Trust [Step by Step]

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Paul Sundin, CPA

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By now, you probably understand how QTIP trusts work and the best situations to use them. But you may not know how to set up a QTIP trust.

These trusts (commonly referred to as qualified terminal interest property trusts) are used in a few specific situations. In the proper case, they can be a home run.

In this post, we will talk about how to set up a QTIP trust. We will also address a few tips and tricks along the way. So let’s dive in.

The Basics of the QTIP Trust

QTIPs are generally set up for married couples. Each spouse can set up a QTIP trust and leave assets to each other. But upon the death of the first spouse, the survivor gets a life and state in the assets of the QTIP trust. This refers to that the surviving spouse is allowed to receive any income from the QTIP assets. This is typically rental income for real estate and could be dividends or interest on other investments.

The surviving ex-spouse is named the life beneficiary. However, the surviving spouse does not have full ownership of these assets and cannot dispose of them or gift them away.

Taxes written on hanging tags

Upon the second spouse’s death, the assets will subsequently go to the final beneficiary named in the trust document. This is usually children from a spouse’s prior marriage.

When a QTIP trust is set up, you have to name the trustee along with the final beneficiaries. You will generally name your spouse as the trustee. Tax and legal professionals can also serve as the trustee but only relevant when the trust adds significant assets.

You need to establish and communicate to the children from the prior marriage that they will ultimately inherit these trust assets. This can often result in some headaches and tension for the children. But make sure you create and communicate the plan document as clearly as possible.

A spouse does not have to be concerned that if a subsequent amount spouse remarries, it will be left to this new spouse. In addition, if you leave these assets to the spouse without a QTIP. The children may worry that they do not receive subsequent spousal assets.

The children from the prior marriage should certainly communicate with the surviving spouse and assist in managing the QTIP assets. They may even help direct the trust investments to maximize the production of income for the spouse.

QTIP Taxation

The QTIP trust will not illuminate all estate tax. But it will postpone it until the death or passing away of the second spouse.

When you set up a QTIP, NOAA state tax is due on the assets designated into the trust at your death. The assets will qualify for the unlimited marital deduction, which will allow the property to pass to the surviving spouse free of estate tax. This is one significant advantage.

But you could only get the estate tax advantages of the QTIP if the surviving spouse is a US citizen. The unlimited marital deduction is critical to the QTIP trust taxation. It does not apply to non-citizens.

If your spouse is a non-citizen, you should consider a QDOT or qualified domestic trust. This might be a better asset protection structure.

Once the second spouse passes away, the estate tax would be due on all of that property, including anything retained in the QTIP trust. But remember, you still have access to the estate tax exemption.

As you are probably aware, most estates will not owe any federal estate tax. But it would help if you certainly considered any estate tax at the state level.

How to Set Up a QTIP Trust

The QTIP trust is actually made via an election. The nice part about a QTIP trust is that there is some flexibility for the surviving spouse.

Establishing a QTIP

  1. Name the Executor

    The decision to set up a QTIP usually resides with the executor. This could be the surviving spouse. The executor makes a QTIP election on the estate tax return filed when the first spouse passes away.

  2. Review Upon Death of First Spouse

    When the first spouse passes away, the financial situation of the family and even the estate tax laws allow the survivor some flexibility when implementing or electing for the QTIP.

  3. Make QTIP Election

    It is the election itself that creates the QTIP trust. The executor would list on a schedule or attachment to the estate tax return on Form 706 the assets going into the QTIP trust itself. The executor may elect to put all or just some of the deceased spouse’s assets into the QTIP trust.

  4. Review a Prtial Election

    If only a portion of the assets goes into the QTIP, this would be called a partial QTIP election. But remember that this election is irrevocable. As such, the executor should engage legal and tax professionals to get advice before making any QTIP election.

  5. File Estate Tax Return (Form 706)

    Also, realize that a QTIP requires an ongoing tax return filing. While it’s not one of the more complex tax returns, it should still be careful consideration when transferring assets into a QTIP.

Final Thoughts

Setting up a QTIP trust requires careful consideration. The trust must be carefully structured to avoid running into IRS issues.

Even though you could possibly include the trust document and draft it yourself, it is not recommended. Many QTIP trust attorneys will carefully set up these trusts and help you review your situation.

A QTIP trust is not for anybody. Make sure you review your situation with a qualified tax attorney and decide if a trust makes sense for you.

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Estate CPA

Gilbert, AZ