Marital Deduction and QTIP Trust
The marital deduction allows property to be transferred (either during life or at death) between spouses, without triggering either the federal estate tax or the federal gift tax. For a transfer between spouses to qualify for the marital deduction, certain requirements must be met. For example, the spouses must be legally married, as defined under state law, and the surviving or donee spouse must be a U.S. citizen. In addition, property left (or given) to the spouse cannot be a "terminable interest" if it is to qualify for the marital deduction. A "terminable interest" is an interest in property that can expire due to the passage of time or the occurrence or nonoccurrence of an event. However, tax law does allow certain types of "terminable interests" to qualify for the marital deduction.
Qualified terminable interest property (QTIP) is property in a decedent's estate that, even though a terminable interest, can still qualify for the estate and gift tax marital deduction. The term also includes property given to a spouse during life that qualifies for the gift tax marital deduction, even though it is subject to similar restrictions. For a terminable interest to qualify for the marital deduction, it must:
- Meet the legal criteria of a "qualified" terminable interest (either a lifetime income interest or an income interest in a charitable remainder trust); and
- Be elected to qualify as a QTIP trust by an executor.
Here's how a QTIP trust works:
- The first spouse to die directs by will that certain property be placed in a QTIP trust. The executor must elect whether to qualify the property for the marital deduction in the deceased spouse's estate.
- All of the income from the trust must be paid to the surviving spouse no less frequently than annually for his or her life. (No person may have the power to appoint any part of the property to anyone other than the surviving spouse.)
- The trust principal passes to beneficiaries designated by the first spouse after the death of the surviving spouse.
- The surviving spouse has the right to force conversion of nonproductive property into productive property.
A QTIP is taxed in the same manner as a normal transfer between spouses. At the first spouse's death, the marital deduction may be claimed (even though the transfer is a terminable interest). At the second spouse's death, the transfer will be taxed (even though the spouse has no ownership or interest over the property).
There are several reasons why individuals use QTIP's, including:
- Flexibility in estate planning-Since the final decisions regarding whether to qualify the QTIP property for the marital deduction is delayed until after the estate owner's death, the current circumstances of the surviving spouse and other beneficiaries may be taken into account.
- Income for life to a surviving spouse-The surviving spouse can be assured of receiving all of the income from the QTIP property for his or her entire lifetime.
- Placing restrictions and still claiming the marital deduction-The estate owner can restrict the ultimate disposition of the QTIP property without sacrificing the marital deduction.
Other reasons why individuals use QTIP's, include:
- ">Failing to leave property outright to a surviving spouse-Sometimes it is inappropriate to leave property outright to a surviving spouse, perhaps because the spouse is aged, infirm or not sophisticated in financial affairs or property management. The QTIP trust allows property to be managed for the spouse's benefit without these burdens.
- Second marriage situation-The first spouse to die can be assured that the property will pass eventually to his or her children or other heirs, rather than to the surviving spouse's children from a prior marriage, while still providing lifetime financial security to the surviving spouse.
- Eases remarriage fears-If property is left outright to a surviving spouse who later remarries, the property could wind up in the hands of the new spouse. The QTIP trust provides for a surviving spouse, but retains control over the ultimate disposition of the property.