9020 / Can a qualified terminable interest property (QTIP) trust be useful in reducing the estate tax burden in a family business' succession plan?

Yes. In the context of a family-owned business owned by one spouse, a qualified terminable interest property trust is a tool that may be used in reducing the estate tax burden upon the death of the first-to-die spouse if the business interests would otherwise be included in the taxable estate. Essentially, this strategy is used to remove a portion of the first-to-die spouse’s interests from his or her estate so that the value of that estate is reduced to below the applicable estate tax exemption amount ($12.06 million in 2022, $12.92 million in 2023, $13.61 million in 2024 and $13.99 million in 2025).

A qualified terminable interest property trust is a trust containing “qualified terminable interest property” (QTIP), which is property (1) which passes from the decedent, (2) in which the surviving spouse has a “qualifying income interest for life,” and (3) as to which the executor makes an irrevocable election on the federal estate tax return to have the marital deduction apply.

The surviving spouse has a “qualifying income interest for life” if (1) the surviving spouse is entitled to all the income from the property, payable annually or at more frequent intervals, and (2) no person has a power to appoint any part of the property to any person other than the surviving spouse unless the power is exercisable only at or after the death of the surviving spouse.¹ Apparently, the last requirement is violated even if it is the surviving spouse who is given the lifetime power to appoint to someone other than the surviving spouse.²

An executor can elect under IRC Section 2056(b)(7) to treat an individual retirement account and a trust as QTIP if the trustee is the named beneficiary of decedent’s IRA and the surviving spouse can compel the trustee to withdraw from the IRA an amount equal to all the income earned on the IRA assets at least annually and to distribute that amount to the spouse. No person can have a power to appoint any part of the trust property to any person other than the spouse.³

Importantly, this strategy allows the spouse who actually controlled the business to direct how the principal (the actual business shares) will be disposed of after the death of the surviving spouse. However, if the QTIP trust is funded with a minority interest in the business, and the estate contains a controlling interest, it is possible that a control premium and minority discount (see Q 9034) may impact the valuation of the shares for estate tax purposes. In this case, the shares that form the controlling interest may be given a higher value than anticipated (and the shares included in the QTIP trust may be given a lower value than anticipated), thus increasing the estate value while correspondingly decreasing the value of the martial deduction that will result from the use of the QTIP strategy.

As a result, the business owner should consider the impact of the control premium and minority discount valuation issues, and either (1) transfer additional assets from the estate to the QTIP trust in order to reduce the value of the estate to below the exemption level or (2) ensure that sufficient shares are transferred into the QTIP trust so that the estate will not be deemed to hold a controlling interest in the business.

See Q 9021 for a discussion of the implications of using a QTIP trust to transfer small business interests in the context of a buy-sell agreement.