The QTIP Provision In A Living Trust

On this mornings conference call we briefly discussed the QTIP trust. This topic is important but detailed enough that it deserves more study than a telephone conference call can provide. So I have decided to detail it here this morning for you to study. For clarity I will use the material from Henry W. Abts III, author of “The Living Trust”, a book I highly recommend. Mr. Abts put the QTIP quite succinctly in his book...and I quote. 

“The A-B-C Trust is used for a married couple whose estate exceeds $10 million in 2012 and reducing to $2 million in January of 2013 (two federal estate tax equivalent exemptions). this form of Trust is used to provide the right to forgo any estate taxes upon the first to die, regardless of the size of the estate. Of the decedent’s portion of the estate, $5 million will flow down into the decedents B Trust, and the excess will flow into the C Trust, in order to prevent estate taxation upon the death of the first spouse.

the C Trust is also known as a Q-Tip Trust. “Q-Tip” stands for Qualified Terminal Interest Property, which means that, to qualify for this right, the surviving spuse must have two rights:

 1. Right to Income-The surviving spouse must have a right to all of the income, a right that must be granted for the the life of the surviving spouse. The income right may not be terminated, for example, in only ten years or during the life of the surviving spouse. For the Trust to qualify, the surviving spouse must not be given the right to use the principal. In other words, the asset is preserved for the heirs, but the spouse may use any income derived from the asset (such as rental income from an apartment).

 2. Right to Change Beneficiaries-In addition, the surviving spouse may be given a testamentary right to change the beneficiaries of Trust C, which means that, during the remaining life of surviving spouse, he or she may change the beneficiaries of Trust C.

Occasionally, a situation arises where, for example, a couple have married, each spouse has children by a previous marriage, and both spouses have accumulated substantial estates prior to their new marriage. If one spouse (for example, the husband) desired that a large share of his estate pass directly to his children upon his death, his assets would not qualify for inclusion in the Q-Tip Trust, since the surviving spouse would not have the right to income from these assets. Therefore, the husband’s excess assets would be subject to federal estate taxes upon his death. 

The husband may pass the assets directly from the B Trust to his heirs without those assets being subject to further federal estate taxation, leaving his excess assets in the C Trust for the use of his surviving spouse.

The C Trust is expandable. The surviving spouse may pass any amount in excess of $5 million (in 2012) to the C Trust (whether the amount is $150,000, $1.5 million, or $15 million) and thereby defer any assessment of estate taxes until the death of the surviving spouse.

The amount of tax saved will increase for larger estates, but the principle is the same. However, generally speaking, dollars in hand today are more valuable than money saved tomorrow. 

Following a seminar some time ago, a young man came up to me and rather pompously announced that he knew about the Q-Tip Trust and knew that it was better to pay the decedent’s estate tax up front. My response to the young man was that, if the surviving spouse knows he or she will die within only a few months of the decedent spouse, then paying tax on the decedent’ share of the estate may have merit. However, as a practical matter, the intent of most people is to preserve as much of the estate as possible for the survivor. After settling hundreds of estates, I have found only this one estate where it as appropriate to recommend paying taxes on the decedent’s estate following the death of the decedent, rather than waiting until the death of the surviving spouse. the Q-Tip Trust is an ideal estate-planning tool and a protection for the surviving spouse.”

Until Next Time....