Overview of QTIP Trust

By Michael S. Whalen and Edmond R. Davis

Reproduced from commentary in Lawgic's California Wills & Trusts

QTIP Trust

I.R.C. §2056 provides for an unlimited marital deduction for property passing outright to the surviving spouse or passing in trust to a "qualified terminable interest property trust," commonly referred to as a QTIP trust. Under a QTIP trust, all of the income must be payable at least annually to the surviving spouse during his or her lifetime. All the net income must be paid to the surviving spouse and cannot be sprinkled to other beneficiaries.

I.R.C. §2056(b)(7)(B)(ii) provides that the spouse has a qualifying income interest for life if:

"(I) the surviving spouse is entitled to all the income from the property, payable annually or at more frequent intervals, or has a usufruct interest for life in the property, and

(II) no person has a power to appoint any part of the property to any person other than surviving spouse.

Subclause (II) shall not apply to a power exercisable only at or after the death of the surviving spouse. To the extent provided in regulations, an annuity shall be treated in a manner similar to an income interest in property (regardless of whether the property from which the annuity is payable can be separately identified)."

The QTIP trust is used where the objective is to obtain the marital deduction in the estate of the first spouse to die, yet limit the surviving spouse's right to the property. Such a trust can also be used to defer the decision to claim the maximum marital deduction. Only through the executor's election can the deduction be claimed. If the surviving spouse dies prior to the filing of the federal estate tax return for the deceased spouse, the executor likely would not elect to take the maximum marital deduction but would attempt to equalize the two estates or take advantage of the credit for tax of previously taxed property under §2013.

The surviving spouse has no ability to make gifts to family members directly from the QTIP trust--except by transferring all or a portion of the life income interest. But, the spouse may use distributions from the trust, including income, discretionary distributions, and distributions made under a power granted to the surviving spouse, to make gifts after receiving the property. I.R.C. §2056(b)(7).

In Priv. Ltr. Rul. 9717005, the Service determined that the husband's interest in a marital trust did not qualify for QTIP treatment because, under the regulations, the husband was not entitled to all of the income from the trust. Although the husband was to receive all of the net income annually (and could direct the trustee to convert any non-income-producing property to income-producing property, but not "real property used for the production of timber"), the Service concluded that the trust was funded substantially with unproductive property and that the husband could not compel the trustee to convert the trust assets to productive property. The marital trust was funded with the deceased wife's one-third interest in a trust created by her mother which was funded with timberland, and which was being held and managed to pay the tax and interest due under a §6166 installment payment of estate tax applicable to the mother's estate.