Sep 30th 2009
By Lynn Freer, EA, Spidell Publishing, Inc.
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It sounds like a tabloid article: A wealthy, older, newly single person suddenly receives a lot of attention from an attractive, much younger, much poorer member of the opposite sex. Suddenly it’s true love, a whirlwind wedding, and a new stepparent who looks like a sibling to the adult children from the older spouse’s first marriage.
It’s just an amusing tale until the wealthy older person is your client and it’s estate-planning time. When your client remarries someone with little or no assets, a qualified terminable interest property (QTIP) trust may be the way to make sure that, in the event of the older spouse’s death, the new spouse is not thrown out on the street and the children from the first marriage have their inheritances protected.
The QTIP (IRC §2056(b)(7)) is also an effective means of protecting a surviving spouse who is unable to handle the finances or has no business skill, or for marriages where both spouses have assets that they want to control after the death of a spouse.
Generally, a QTIP trust has the following characteristics:
- The decedent’s spouse must be entitled to all income from the property for life. The income must be distributed at least annually.
- The decedent’s spouse may also receive principal from the trust as necessary for his or her medical care, maintenance and support.
- When determining whether principal is paid to the surviving spouse, the trustee considers all other income known to be available to the surviving spouse.
- The decedent controls the disposition of the remaining trust principal upon the death of the surviving spouse.
- Property allocated to the QTIP trust qualifies for the unlimited marital deduction. The decedent’s executor must make the QTIP election on the estate tax return (IRS Form 706).
- The value of the QTIP trust remaining at the death of the surviving spouse is included in his or her estate for tax purposes.
The will and trust may also provide for a disclaimer trust. If so, the surviving spouse can disclaim any of the assets at the death of the first spouse and those assets will go into the disclaimer trust, which may still provide for income and principal payments to the surviving spouse, though the assets in the disclaimer trust will be included in the decedent’s (first spouse’s) estate rather than the surviving spouse’s estate.
EXAMPLE: Jane is a widow with an estate of $2 million. Jane falls in love with her gardener, Jeff, and presents him as her new husband when she comes for her tax appointment. Jane is blissfully happy and doesn’t understand why her son Bill (a 35-year-old-engineer) doesn’t like Jeff. Jeff is also very happy and he has no intention of disinheriting Bill. He just wants to be taken care of if Jane dies because he has given up his gardening business to travel with her and make her happy.
If Jane establishes a QTIP trust, at her death, Jeff will receive the income from her estate for his lifetime (and principal if the trustee deems proper) and whatever is remaining at his death will pass to Bill.
EXAMPLE: Bill and Betty Boop were married at age 60. Each was previously married and has one child. When they married, each had an estate of $2 million. They want to use the QTIP trust so that the survivor still has an income stream after the first spouse’s death but each of their own children will receive the $2 million. Assuming Bill dies in 2004, the estate tax exemption is $1.5 million. If a QTIP is established, Bill’s estate will escape tax because of the $1.5 million AEA exemption and a $500,000 marital deduction.
When Betty dies, the $500,000 will be included in her estate. However, if Bill dies in 2006, the property could be disclaimed. That will force all the property to be included in Bill’s estate. Because the AEA is $2 million in 2006, the entire estate will escape tax at Bill’s death and if the trust is properly drafted, Betty will still receive the income during her lifetime.