This post is about a trust that works well for protecting your nest egg, both for asset protection purposes and for helping reduce your estate tax exposure. This nest egg being your longer-term assets you do not expect to use for your daily living expenses. My view is the sweet spot for this QTIP trust is for clients with $1.0 million or more of longer-term assets.
You can be the trustee of this QTIP trust and thereafter can continue investing the trust assets in the same manner as you wish (e.g., you can buy and sell investments, use an investment manager, pick and choose the investments, use any number of different financial institutions, etc.).
The trust is an inter-vivos QTIP trust. It is designed so that no separate trust income tax return is required (all income, losses, deductions, etc., are reportable on your personal tax return Form 1040). The trust is also designed so that your transfer of the assets into the trust is not a present gift, called an incomplete gift for tax purposes. Thus, no gift tax return filing is required.
There are three key reasons for using this QTIP trust. One, the QTIP trust provides an excellent level of asset protection. Two, the trust provisions can be designed so that property in the trust is available to absorb the benefit of the first-to-die spouse’s estate tax exemption amount, in addition to the surviving spouse’s exemption when the surviving spouse dies regardless of the ordering of the spouses’ deaths. Three, the QTIP trust is designed so that all income, losses, deductions are reportable on the married couple’s joint personal income tax return, without the QTIP trust having to file a separate trust income tax return.
As to the estate tax benefit, by using both spouses’ estate exemptions each spouse does not have to try and anticipate which one will die first, thus eliminating typical worry about whether the first-to-die spouse will own enough property to use his or her estate exemption. This is because the QTIP trust property will be treated as owned by whichever spouse dies first for use of that first-to-die spouse’s own estate exemption. In addition, any excess value of the QTIP trust assets exceeding the first spouse’s exemption can apply against the surviving spouse’s own exemption when the second spouse dies. The QTIP trust helps ensure use of both spouses’ exemptions.
Now, here are more details about this QTIP trust:
Inter-vivos means this trust is created and funded during life as opposed to a testamentary trust funded at death; QTIP is an acronym from the tax law for qualified terminable interest property.
Typically, the spouse with the greater portion of assets creates and funds this QTIP trust. The other spouse is the sole beneficiary of the QTIP trust for lifetime. If the beneficiary spouse dies first, the donor spouse (who funded the trust) thereafter becomes the beneficiary of the trust for life. Ultimately, this QTIP trust after both spouses’ deaths is for their children (or for any other reminder beneficiaries under the specific design of the trust).
What if this married couple later gets divorced? This is a question married clients often raise when considering this QTIP trust.
This divorce concern can be addressed under the written provisions of the QTIP trust by giving the beneficiary spouse a limited power to appoint the property back to the donor spouse in the event of a divorce. An example of a divorce agreement with an inter-vivos QTIP trust was addressed in an earlier IRS private letter ruling 200413011 (December 3, 2003).
As with many trust techniques, the trust and tax laws are complex in terms of properly formulating and writing the QTIP trust document; but, the benefits I describe above are very effective and relatively straightforward. For readers who wish to delve more into the technical complexity of how the QTIP trust operates, the above IRS letter ruling 200413011 touches on the majority of the technical factors. Here is a copy of the IRS ruling. I warn you. This IRS letter ruling is for a limited audience. Generally, for pointy-headed tax lawyers and CPAs who deal with these types of trusts.