Much has changed in the estate-planning world since the American Taxpayer Relief Act of 2012 ushered in a new era of permanence with respect to estate tax rates, the federal exemption and portability of the exemption between spouses.
Despite this, in some areas uncertainty has persisted over whether clients were permitted to take advantage of spousal planning techniques involving qualified terminable interest property (QTIP) now that portability has been made permanent—until now.
Newly released guidance has provided certainty with respect to a powerful new planning strategy that can be used by wealthy clients in order to maximize the amount of a deceased spouse’s federal estate tax exemption that may be “ported” to the surviving spouse—if certain specific requirements are satisfied.
What’s in a QTIP Election?
Often in estate planning, one spouse will direct that his or her property will be placed in a trust for the benefit of a surviving spouse—meaning that the surviving spouse is entitled to income from the trust, but not to the trust principal itself (which may be passed to children or other heirs after the second spouse’s death).
While these trusts may be valuable planning tools, generally these assets would not qualify for the marital deduction because they are “terminable interests,” meaning that the surviving spouse’s interest In the property will eventually terminate.
By making an election to treat the assets as QTIP, however, those assets can be excluded from the first-to-die spouse’s estate. QTIP is property that (1) passes from the decedent, (2) in which the surviving spouse has a qualifying interest for life and (3) as to which the executor makes an irrevocable election to have the marital deduction apply on a federal estate tax return.
A qualifying interest for life exists if the surviving spouse is entitled to all the income for life, and no person has the power to transfer that interest during the surviving spouse’s lifetime.
While a QTIP election will remove the property from the first-to-die spouse’s estate, it can have estate, gift and generation skipping transfer (GST) tax consequences for the surviving spouse. As a result, the IRS developed rules providing that any QTIP election would be treated as void if it was not necessary to reduce the first-to-die spouse’s estate tax liability to zero.
However, this treatment was developed before portability was made permanent. In some cases, it has been determined that a surviving spouse might benefit from a QTIP election because it would preserve a greater portion of the deceased spouse’s exemption for the future, regardless of the election’s impact on current estate tax liability—leading the IRS to release guidance in the form of Revenue Procedure 2016-49.
The Revenue Procedure 2016-49 QTIP Guidance
Revenue Procedure 2016-49 essentially provides that a QTIP election will not be voided merely because it was unnecessary to reduce estate tax liability to zero. Pursuant to the new guidance, a QTIP election will be voided only if (1) the estate’s federal estate tax liability was zero, regardless of the QTIP election, (2) the executor neither made, nor was considered to have made a portability election and (3) certain procedural requirements outlined in the revenue procedure have been satisfied.