QTIP Trust Requirements: The #1 Way to Structure [Illustration]

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Paul Sundin, CPA

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The unlimited marital deduction represents a critical tool to defer or avoid estate taxes for a married couple. Property that passes to a surviving spouse using the marital deduction avoids taxation on the first spouse’s death but becomes part of the surviving spouse’s taxable estate.

By combining the use of the applicable exclusion amount with the marital deduction, the first spouse’s estate will pay no estate tax, and any potential estate tax will be deferred until the surviving spouse’s death.

Marital Deduction

The marital deduction is available for property which is left:

  1. Outright to the surviving spouse.
  2. In trust for the surviving spouse, if the surviving spouse has the unrestricted right to withdraw any property during their lifetime.
  3. In trust for the surviving spouse, if the trust meets the requirements for a qualified terminable interest property (“QTIP”) trust.

For a specific trust to qualify as a QTIP trust, the surviving spouse must be entitled to receive all of the trust’s income at least annually. During the spouse’s lifetime, no one other than the surviving spouse can receive any trust principal. A proper election must also be made on the first spouse’s estate tax return.

Control Issues

The QTIP trust allows the first spouse to control the ultimate disposition of the QTIP trust property while retaining the benefit of deferring estate taxes until the surviving spouse’s death by the unlimited marital deduction. QTIP trusts are commonly used in mixed families with children from a prior marriage or when an individual is concerned that their spouse may not protect or manage the inherited property.

While it is not a requirement of a QTIP trust that the surviving spouse has access to the trust’s principal, most QTIP trusts allow distributions from the principal to provide for the surviving spouse’s health, support, and maintenance if needed. The surviving spouse can be granted a right to withdraw a certain amount or percentage of the trust principal from time to time.

A QTIP trust allows an individual to qualify their property for a marital deduction to defer or avoid estate taxes, and at the same time, retain control over the ultimate disposition of the QTIP trust property.

Spousal Powers

The QTIP Trust may provide the surviving spouse with a limited power of appointment on death. This is not a necessary feature. The popularity of the QTIP Trust derives from the fact that upon the death of the surviving spouse, the property may be distributed to the original decedent’s descendants or other beneficiaries named by the original decedent (and the first of two parents to die).

That is, a QTIP Trust may be structured so that the surviving spouse (the beneficiary of the QTIP Trust) has no authority to govern the disposition of the remaining QTIP Trust estate on the subsequent death of the surviving spouse. This feature makes it very popular, especially in the case where there are children of a first marriage, and the QTIP is created for the spouse in a subsequent marriage.

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Estate CPA

Gilbert, AZ