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.
If the QTIP election is voided, the assets will not be included in the surviving spouse’s estate (instead, they will likely be included in the estate of the first-to-die spouse), the surviving spouse will not be treated as though he or she made a gift upon disposition of the property and will not be treated as a transferor of the property for GST tax purposes.
On the other hand, a QTIP election will be treated as valid where: (1) a partial QTIP election was necessary to reduce the estate tax liability, but the executor made the QTIP election with respect to more property than was necessary to reduce the tax to zero; (2) the QTIP election was set forth in a formula designed to reduce the estate tax liability to zero; (3) the QTIP election was considered a protective election under the treasury regulations; (4) the executor made a portability election, even if the deceased spouse’s unused exemption (DSUE) amount was zero; or (5) the necessary procedural requirements were not satisfied.
A surviving spouse may wish to maintain a QTIP election even where it was not necessary to reduce estate tax on his or her late spouse’s estate to zero for many reasons. For example, some may worry that the currently high estate tax exemption will be reduced in the future, and may hope that “saving” the deceased spouse’s exemption will preserve it. Other clients may know that they have substantial assets and will need the deceased spouse’s exemption to reduce their own future estate tax liability.
For clients with substantial assets, the ability to preserve a QTIP election even where it was not necessary to reduce estate tax to zero can provide a valuable planning tool for the future—and the newly released IRS guidance has provided the certainty that clients need in order to engage these strategies.
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Originally published on Tax Facts Online, the premier resource providing practical, actionable and affordable coverage of the taxation of insurance, employee benefits, small business and individuals.
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