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What is the QTIP election?
The QTIP election is a powerful post-mortem estate planning tool that can help your estate take advantage of the unlimited marital deduction and the applicable exclusion amount (the amount that can be sheltered from federal gift tax and estate tax by the unified credit). The QTIP election qualifies property, which may be in a trust, as QTIP property, which is given special tax treatment. A full or partial election can be made. The QTIP election is made by your personal representative on your estate tax return (Form 706).
This is an irrevocable election. The effect of this election is that the value of the property qualifying as QTIP property must be included in your surviving spouse’s taxable estate.
What are the advantages of the QTIP election?
Takes advantage of the unlimited marital deduction
The unlimited marital deduction allows you to pass an unlimited amount of property to your spouse free of estate tax. The catch is that you must pass the property in a way that does not break the terminable interest rule. A terminable interest is an interest in the spouse that might fail, expire, or terminate upon the occurrence of an event, condition, or contingency. The terminable interest rule applies to disallow a marital deduction for property transferred to your spouse where: (1) you pass a terminable interest to your spouse, and (2) upon the possible failure of your spouse’s interest, the property would pass to a third party pursuant to an interest you created in the property (or might pass to a third party under a power of appointment you retained).
Michael’s will provides that a trust be set up and funded with $250,000. The terms of the trust provide that the income from the trust be distributed to Michael’s spouse, Liz, each year. The terms of the trust further provide that upon Liz’s death, the principal of the trust be distributed to Michael’s son, Alan. Because Liz’s interest in the trust terminates upon her death and the remaining interest in the property passes to another party, unless a valid QTIP election is made, the trust does not qualify for the unlimited marital deduction and will be included in Michael’s estate for estate tax purposes.
One way around the terminable interest rule is to qualify the property as QTIP (qualified terminable interest property) property. That means that you can do as Michael does in the previous example as long as you elect QTIP treatment for the property and agree to include the property in your surviving spouse’s estate for estate tax purposes.
You own shares of stock valued at $500,000 and held in your name. You are concerned that if you leave the stock to your spouse, your spouse will sell it and use the money for other purposes. You want the stock to continue to grow and benefit your children.
You transfer the stock into a trust. The terms of the trust direct that your spouse receive the annual income for life and that the principal be distributed to your children upon your spouse’s death. Upon your death, your executor elects QTIP treatment for the trust. The trust assets are now fully deductible from your estate for estate tax purposes. The trust assets must be included in the surviving spouse’s estate for estate tax purposes.
You direct how the principal will ultimately be distributed
With restrictions, you decide who will get the property after the death of your spouse. This is advantageous if you do not want your spouse to direct where the property goes. However, during the life of the surviving spouse, only the surviving spouse may be a beneficiary of the income or principal.
Designed to take full advantage of the basic (applicable) exclusion amount
The QTIP trust was designed for one narrow purpose; to permit a wealthy spouse to leave property for the benefit of a less-well-off surviving spouse without consuming the deceased spouse’s full gift and estate tax basic (applicable) exclusion amount (see the example below).
Dick and Martha are married. Say that Dick died in 2009. Dick’s will pours over property valued at $7 million to a trust, the income of which is payable to Martha for life, and the principal of which is to be distributed to their children upon Martha’s death. Martha owns no property. The applicable exclusion amount in 2009 is $3.5 million. Dick’s estate uses all of his applicable exclusion amount and pays estate taxes on $3.5 million (assume no other variables). Say that Martha died later in 2009. Martha has no estate, so no estate taxes are owed.
Now, let’s see what happens when Dick’s executor makes a partial QTIP election. Dick’s executor elects QTIP treatment for $3.5 million, which passes to Martha tax free under the unlimited marital deduction. Dick’s estate pays no estate taxes and uses all of his applicable exclusion amount (assume no other variables). Martha dies later in 2009. Martha’s estate is valued at $3.5 million, owes no estate taxes, and uses all of her applicable exclusion amount.
Because Dick’s executor made the QTIP election, each spouse uses all of the applicable exclusion amount, and they save estate taxes on $3.5 million.
Because the basic exclusion amount is $13,610,000 (in 2024, $12,920,000 in 2023), and the fact that for 2011 and later years the exclusion is portable (i.e., the estate of a deceased spouse can transfer any unused exclusion amount to his or her surviving spouse), the QTIP trust may seem less attractive, except for extremely large estates with a very high disparity in net worth between the spouses.
However, the QTIP trust remains a viable planning option for other reasons, such as individual state estate taxes with smaller exemption amounts.
What are the requirements?
Surviving spouse must be entitled to all income for life
To qualify for the QTIP election, the surviving spouse must be entitled to receive all the income from the trust, payable at least annually, for life.
Two common pitfalls you need to be aware of are trust provisions that allow the trustee to accumulate income, or retain non-income-producing property. In these cases, as long as your spouse has the right to override the trustee at least once a year to withdraw income from the trust and require the trustee to sell non-income-producing property, the trust property will qualify.
Income interests granted for a term of years or a terminable life estate (i.e., one that terminates upon the occurrence of some event such as remarriage) do not qualify.
QTIP property must be included in surviving spouse’s taxable estate
The property that qualifies for QTIP treatment under the QTIP election must be included in your surviving spouse’s estate for estate tax purposes.
No power of appointment can be granted
The property will not qualify for the unlimited marital deduction if anyone (your surviving spouse or any third party) has any power to appoint the property to any third person during the surviving spouse’s lifetime. However, it will not disqualify the property from QTIP treatment if someone has the power to appoint the property remaining after your spouse’s death.
How is the election made?
The election is made by checking the appropriate block on the estate tax return (Form 706 United States Estate and Generation-Skipping Transfer Tax Return).
Can an election be made for contingent QTIPs?
Yes. A contingent QTIP is one under which your personal representative’s action of making or not making the QTIP election determines whether, and the extent to which, your spouse will even receive an income interest. This allows your personal representative to keep the principal out of your spouse’s estate and keep income from your spouse, as well. A traditional QTIP only keeps the principal out of your spouse’s estate. A contingent QTIP gives your personal representative the ability to take into account changed circumstances up to the time for making the election in deciding how to best minimize the combined estate taxes.