The QTIP Trust: The Swiss Army Knife of Estate Planning
By Robert J. Saalfeld
SAALFELD GRIGGS PC
Have you ever seen the TV show Survivor Man? The hero always pulls something out of his backpack that has multiple uses to save him. A Qualified Terminable Interest Property (“QTIP”) trust is similar because it can be used to avoid many pitfalls in estate planning. For this reason it has been called the Swiss Army Knife of estate planning. Consider the following situations which you may encounter in estate planning, and how the QTIP trust can be the device to help.
PROTECTS CHILDREN’S INHERITANCE AGAINST SECOND SPOUSE
Let’s say John and Sally have had a long marriage with several children. Unfortunately Sally dies and John is alone. Several years later John meets Gloria at a church social and they marry. Over time, as John buys new assets, he titles them jointly with survivorship with Gloria. John also eventually changes his will to pass all of his assets to Gloria. If he dies before Gloria, John believes that at Gloria’s later death she will bequeath the assets she received from John to John’s children.
John then dies before Gloria. Gloria receives the joint assets by survivorship and John’s other assets by his will.
Several years later Gloria becomes very dependent on her children. At the urging of her children, Gloria changes her estate plan to will her entire estate to her children. John’s children receive none of the assets that he and his first wife Sally worked years to build up.
If instead John had passed his assets to a QTIP trust for Gloria’s life, then Gloria could have received distributions from the QTIP trust during her life, but at Gloria’s death the amount in the QTIP trust would have passed to John’s children and not to Gloria’s own children. The QTIP trust is thus a useful device to protect against a second spouse’s family winding up with assets that are meant to pass to your children.
ALLOWS FLEXIBILITY TO REDUCE DEATH AND INCOME TAXES
A common way for married couples to save death tax is to provide in a will or living trust that at the first death the decedent spouse’s assets (up to the federal death tax exclusion) passes to a bypass-type trust for the surviving spouse for life. The amount in the bypass trust passes free of death tax upon the decedent spouse’s death, as well as at the surviving spouse’s death. In this way, each spouse’s death tax exclusion is used, instead of only one, and death taxes are saved for the children.
Now that the federal death tax exclusion is $3.5 million and the Oregon death tax exclusion $1 million, there can be several problems with this approach. First, in estates of less than $2 million, you may not need all of the decedent’s assets to go to the bypass trust to avoid death tax at the second death. You only need to put enough in the bypass trust so that the surviving spouse’s estate is less than the $1 million Oregon death tax exclusion. If you put more than you need in the bypass trust, you can cause more income tax for the children. This is because the assets put in the bypass trust, while typically receiving a step up in income tax basis at the first death, do not receive adjustment or another step up in income tax basis at the surviving spouse’s death. The assets included in the surviving spouse’s estate typically do receive a basis step up at the survivor’s death. The trick therefore is to not over fund the bypass trust so that more assets can receive a basis step up at the survivor’s death to potentially lessen income tax for the children when they sell assets.
In larger estates the problem with the mandatory bypass plan is that if you put more than the $1 million state exclusion in a “sprinkle” type bypass trust (i.e., one that distributes income and principal to the surviving spouse and/or children), you have to obtain the children’s consent to a special Oregon marital property election so as to not trigger Oregon death tax at the first death. A more modern and flexible plan is to use a QTIP trust for the surviving spouse. With a QTIP trust you have the flexibility to divide the trust at the first death into appropriate sections based on the size of the estate and the amount of the federal and state exclusions at that time. You avoid triggering Oregon death tax at the first death, you do not need the children’s consent to any special Oregon election, and you can maximize the amount of assets that will receive the stepped-up income tax basis upon the surviving spouse’s death that potentially saves income taxes for the children.
The surviving spouse can be the trustee of the QTIP trust, and receive distributions of income and also principal for health, education, maintenance and support.
PRESERVES VALUATION DISCOUNTS
Assume Steve and Sarah each own 40% of a closely held corporation. Steve dies and he passes his 40% to Sarah. At Sarah’s death, the full 80% is in her estate for death tax purposes. If instead Steve passed his 40% to a QTIP trust for Sarah, then Steve’s 40% and Sarah’s 40% could be valued separately as minority interests and preserve possible valuation discounts that reduce the estate values for death tax purposes.
In summary, if you want help navigating through the perils that can pop up in the estate planning environment, you should consider the flexibility and advantages of the QTIP trust. If you would like more information on this article or your estate plan in general, please contact a member of our Estate Planning Practice Group.