Qualified Terminable Interest Property (QTIP) Trust

*-1 by J.K. Califf is licensed under CC 2.0. *

The federal estate tax provides an exemption for property left to a surviving spouse. This exemption is generally referred to as the marital deduction. In order for property to qualify for the marital deduction, the surviving spouse may not receive a terminable interest in it, that is, the spouse must receive the property outright. Property in which a surviving spouse receives a partial or temporary interest generally does not qualify.

One exception to this general rule is qualified terminable interest property. Under Section 2056 of the Internal Revenue Code, a lifetime income interest in property may take advantage of the marital deduction. By placing this property into a qualified terminable interest property trust, or QTIP trust, a decedent’s estate can take advantage of the marital deduction while preserving the property for distribution to future heirs upon the death of the spouse.

This method of estate planning is often desirable for large estates where the decedent had children from a previous marriage. This planning tool allows the surviving spouse to enjoy the income from the trust while preserving the underlying assets for decedent’s surviving children. A QTIP trust protects against the possibility of the decedent’s property’s eventually going to a future spouse of the surviving spouse or to heirs other than the decedent’s own children.

Qualifying as a QTIP Trust

To qualify as a qualified terminable interest property trust, the trust and its underlying property must meet the following requirements:

1. The surviving spouse and only the surviving spouse must be entitled to all the income from the property.
2. Income from the property must be payable at least annually for the lifetime of the surviving spouse.
3. No one including the surviving spouse can have a power of appointment to appoint any part of the property to anyone other than the surviving spouse.
4. The executor of the decedent’s estate must make an irrevocable election to treat the underlying property as qualified terminable interest property.
5. If the property is not producing income, the spouse must have the power to make the trustee replace it with income-producing property.

An Example

Suppose for example that you are a widower with an estate valued at $10 million. You have remarried and want to provide for your spouse after your death, but you also want your children from your first marriage eventually to receive the underlying property.

Your new wife also has adult children of her own, and you want to ensure that your children’s inheritance is preserved and does not eventually end up in the hands of your wife’s children. So, you decide to put a portion of your estate into a QTIP trust, naming your wife as the life beneficiary and your children as the final beneficiaries.

After your death, your surviving wife will receive the income from the trust for the rest of her life, but she will not be able to access the underlying assets. Then, upon her death, your children will receive the property in the trust.

Tax Deferment

It is important to realize that a QTIP trust does not eliminate the estate taxes due on the underlying assets. It simply defers them until the surviving spouse’s death. At the death of your surviving spouse, the assets held in the trust will be included in your spouse’s estate for purposes of determining any estate tax due.

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See Also:

The Federal Estate Tax

Qualified Personal Residence Trust (QPRT)