Estate Planning: Cue the QTIP Trust

For affluent individuals, estate planning remains a concern—especially those who have been married more than once. Reason: Assuming you pass away first, you will probably want to benefit both your surviving spouse and the children of your first marriage. This can be tricky in light of the current $2 million estate-tax exemption. In this situation, a qualified terminable interest property (QTIP) trust may meet your needs.

How it works: The trust pays out income to your surviving spouse while he or she is alive. Upon your spouse’s death, the assets go to the beneficiaries you have selected. Best of all, there is no estate-tax bill when you pass away. Your surviving spouse’s subsequent transfer to your children may be sheltered by the estate-tax exemption.

Under the current unlimited marital deduction, any property that is transferred from one spouse to another is completely free of estate and gift tax. In other words, if you leave property to your spouse when you pass away, there is no tax whatsoever. However, the marital deduction generally is not allowed for property passing to a spouse for his or her life and then to someone other than the surviving spouse.

Fortunately, there is an exception for property transferred to a QTIP trust. If certain requirements are met and a timely election is made, the value of the property qualifies for the marital deduction. Subsequently, the remaining assets are included in the taxable estate of the surviving spouse.

How does a family qualify for the QTIP exception? The surviving spouse must have a “qualifying income interest for life.” In general, the following conditions must be met:

*The spouse must be entitled to all the income from the property for life or all the income from a specific portion of the property.

*The income is payable annually or at more frequent intervals.

*QTIP treatment must be affirmatively elected by the executor on the estate-tax return.

*No one, including the surviving spouse, has the power to transfer any part of the property to another person while the surviving spouse is still alive.

There are, however, a couple of key exceptions to these rules. First, a spouse still may maintain the right to dispose of an income interest. Second, the transfer of a remainder interest is not prohibited as long as the spouse’s income interest is not affected by the transfer.

Although a QTIP trust is commonly used in second and third marriages, it can serve other purposes. For instance, you might be concerned that your surviving spouse will squander his or her inheritance. In that case, a QTIP trust may be appropriate.

The election to qualify for the QTIP exception is made by the executor of the estate of the first spouse to die. Once the election is made, it is irrevocable.

Word of advice: This sophisticated technique, as well as other estate-planning concepts, should be discussed with a professional adviser. It should be coordinated with other aspects of your estate plan.

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