Estate Planning Blog Articles

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What Is a QTIP Trust?

A Qualified Terminable Interest Property Trust, or QTIP, is a trust allowing the person who makes the trust (the grantor) to provide for a surviving spouse while maintaining control of how the trust’s assets are distributed once the surviving spouse passes, as explained in the article “QTIP Trusts” from Investopedia.

QTIPs are irrevocable trusts, commonly used by people who have children from prior marriages. The QTIP allows the grantor to take care of their spouse and ensure assets in the trust are eventually passed to beneficiaries of their own choosing. Beneficiaries could be the grantor’s offspring from a prior marriage, grandchildren, other family members or friends.

In addition to providing the surviving spouse with income, the QTIP also limits applicable estate and gift taxes. The property within the QTIP trust provides income to the surviving spouse and qualifies as a marital deduction, meaning the value of the trust is not taxable after the death of the first spouse. Rather, the property in the QTIP trust will be included in the estate of the surviving spouse and subject to estate taxes depending on the value of their own assets and the estate tax exemption in effect at the time of death.

The QTIP can also assert control over how assets are handled when the surviving spouse dies, as the spouse never assumes the power of appointment over the principal. This is especially important when there is more than one marriage and children from more than one family. This prevents those assets from being transferred to the living spouse’s new spouse if they should re-marry.

A minimum of one trustee must be appointed to manage the trust, although there may be multiple trustees named. The trustee is responsible for controlling the trust and has full authority over assets under management. The surviving spouse, a financial institution, an estate planning attorney or other family member or friend may serve as a trustee.

The surviving spouse named in a QTIP trust usually receives income from the trust based on the trust’s income, similar to stock dividends. Payments may only be made from the principal if the grantor allows it when the trust was created, so it must be created to suit the couple’s needs.

Payments are made to the spouse as long as they live. Upon their death, the payments end, and they are not transferable to another person. The assets in the trust then become the property of the listed beneficiaries.

The marital trust is similar to the QTIP, but the is a difference in how the assets are controlled. A QTIP allows the grantor to dictate how assets within the trust are distributed and requires at least annual distributions. A marital trust allows the surviving spouse to dictate how assets are distributed, regular distributions are not required, and new beneficiaries can be added. The marital trust is more flexible and, accordingly, more common in first marriages and not in blended families.

Your estate planning attorney will explain further how else these two trusts are different and which one is best for your situation. There are other ways to create trusts to control how assets are distributed, how taxes are minimized and to set conditions on benefits. Each person’s situation is different, and there are trusts and strategies to meet almost every need imaginable.

Reference: Investopedia (Aug. 14, 2022) “QTIP Trusts”

Pay Attention to Income Tax when Creating Estate Plans

While estate taxes may only be of concern for mega-rich Americans now, in a relatively short time, the federal exemption rate is scheduled to drop precipitously. Estate planning underway now should include consideration of income tax issues, especially basis, according to a recent article titled “Be Mindful of Income Tax in Estate Planning, Particularly Basis” from National Law Journal.

Because of these upcoming changes, plans and trusts put into effect under current law may no longer efficiently work for income tax and tax basis issues.

Planning to avoid taxes has become less critical in recent years, when the federal estate tax exemption is $10 million per taxpayer indexed to inflation. However, the new tax laws have changed the focus from estate tax planning to coming tax planning and more specifically, to “basis” planning. Ignore this at your peril—or your heirs may inherit a tax disaster.

“Basis” is an oft-misunderstood concept used to determine the amount of taxable income resulting when an asset is sold. The amount of taxable income realized is equal to the difference between the value you received at the sale of the asset minus your basis in the asset.

There are three key rules for how basis is determined:

Purchased assets: the buyer’s basis is the investment in the asset—the amount paid at the time of purchase. Here’s where the term “cost basis” comes from

Gifts: The recipient’s basis in the gift property is generally equal to the donor’s basis in the property. The giver’s basis is viewed as carrying over to the recipient. This is where the term “carry over basis” comes from, when referring to the basis of an asset received by gift.

Inherited Assets: The basis in inherited property is usually set to the fair market value of the asset on the date of the decedent’s death. Any gains or losses after this date are not realized. The heir could conceivably sell the asset immediately and not pay income taxes on the sale.

The adjustment to basis for inherited assets is usually called “stepped up basis.”

Basis planning requires you to review each asset on its own, to consider the expected future appreciation of the asset and anticipated timeline for disposing the asset. Tax rates imposed on income realized when an asset is sold vary based on the type of asset. There is an easy one-size-fits-all rule when it comes to basis planning.

Estate planning requires adjustments over time, especially in light of tax law changes. Speak with your estate planning attorney, if your estate plan was created more than five years ago. Many of those strategies and tools may or may not work in light of the current and near-future tax environment.

Reference: National Law Review (July 22, 2022) “Be Mindful of Income Tax in Estate Planning, Particularly Basis”

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