New Rule Allows Deferral of State Death Tax
By Robert J. Saalfeld
SAALFELD GRIGGS PC
The new Oregon inheritance tax, passed by the 2003 Legislature, can trigger a state death tax at the death of the first spouse to die. Under recent administrative rules issued by the Oregon Department of Revenue, in appropriate cases the Oregon inheritance tax can be deferred until the death of the surviving spouse by making a special election. The election is called a state qualified terminable interest property (“QTIP”) election. The state QTIP election is available only if the decedent’s Will or Living Trust is drafted to accommodate the election.
Let’s take an example. Winifred dies in 2004 with an estate of $1,500,000. She is survived by her husband Harvey. Winifred’s plan provided for a “Bypass” Trust for Harvey for life, funded with her full unused federal exclusion ($1,500,000 in 2004). The Trust provides that all income shall be distributed to Harvey, together with discretionary principal, and otherwise qualifies as a QTIP Trust. The personal representative files a federal death tax return without claiming a QTIP election. The Bypass Trust uses the full $1,500,000 exemption for federal death tax at Winifred’s death. But with respect to Oregon, the personal representative files a State of Oregon inheritance tax return and makes a state QTIP election for $650,000 of the Bypass Trust (the difference between the $1,500,000 federal exclusion and the $850,000 Oregon exclusion). This avoids triggering a state death tax of $64,400 on the $650,000 upon Winifred’s death. The $650,000 is included in Harvey’s estate for Oregon inheritance tax purposes, but not for federal.
It is important to note, however, that if the Bypass Trust had been drafted to allow sprinkling distributions to Harvey and the children, then the state QTIP election would not have been available.
A very flexible estate plan that uses the state QTIP is called the “Clayton QTIP”. With this plan, the personal representative can wait until after the death of the first spouse to die to decide how much to place in the Bypass Trust. You don’t have to put the full federal exclusion in the Bypass Trust if it is not necessary to save death taxes. This flexibility is important because the assets the children inherit from the Bypass Trust at the surviving spouse’s death do not receive a step up in income tax basis. If you put too much in the Bypass Trust, the kids can have more income tax when they sell the assets after the surviving spouse’s death.
We can use our same example to illustrate the Clayton QTIP. Winifred dies in 2004 and her $1,500,000 passes to a QTIP Trust for Harvey for life. The personal representative determines that instead of placing the full $1,500,000 into the Bypass Trust, only $1,000,000 of Winifred’s assets should go to the Bypass Trust in order for there to be no death tax on the combined estates at Harvey’s death. The personal representative makes a partial federal QTIP election on the federal death tax return to qualify only $500,000 as a QTIP (meaning this amount has no death tax at Winifred’s death because of the marital deduction). The $1,000,000 balance funds the Bypass Trust and has no federal death tax at Winifred’s or Harvey’s death. To avoid triggering state death tax at Winifred’s death on the excess over the $850,000 state exclusion, the personal representative makes a state QTIP election for $150,000 of the Bypass Trust ($1,000,000 minus $850,000 state exclusion). The state QTIP portion is free of federal death tax but now includable in Harvey’s estate for state death tax purposes.
In summary, Oregon allows decedents to avoid triggering the new state death tax at the death of the first spouse to die by using a state QTIP election. Existing plans should be reviewed to see if they qualify for the state QTIP election if this is necessary to avoid an unwanted state death tax at the first death. Plans should also be reviewed to ensure that there is flexibility not only to save death taxes, but also to achieve income tax savings for the beneficiaries after the death of both spouses.
If you would like more information regarding this new rule or estate planning in general, please contact our office.