Marital Deduction Trusts: What is a QTIP?

On the estate planning side of my business, something I see with some regularity when I first meet with a married couple who already have a trust in place is that they may not understand what exactly happens after the first of them dies.  For instance, they may not realize their trust splits into multiple trusts at that time, one of which restricts the use and enjoyment of the funds in that trust for the surviving spouse.  Sometimes this is a done for good reason.  Sometimes this is done because that was the template on the lawyer’s computer.  The latter can be a dangerous situation.

One reason to split a trust after the first death, at least historically, had to do with tax savings.  This “A/B split” was designed to take advantage of the federal estate tax exemption at the time of both deaths.  Now, with the portability of the first spouse’s exemption, the A/B split is falling into disuse.  That being said, the law could change in the future, so you still need to plan around the contingencies.  But, this post is not about the A/B split.  This is about the other common split: the one between the Survivor’s Trust and the Marital Deduction Trust (also known as a QTIP Trust).

The purpose of the Marital Deduction Trust split is not really tax-driven, although it does affect estate taxes.  The purpose generally is the desire to exercise some dead hand control over your property after you pass.  By way of background, the federal estate tax laws allow your surviving spouse to pay zero dollars ($0) in estate taxes for anything you transfer to him/her outright at the time of your death.  This is the Marital Deduction.  The surviving spouse’s estate will probably have to pay estate taxes on this amount of the time of his/her death, but at least at the time of the first death, estate taxes are avoided/deferred.  To make the Marital Deduction work, however, the surviving spouse has to receive a non-terminable interest in the property.

In non-lawyer speak, that means the surviving spouse has to own the assets/property outright and can do whatever they want with it.  That includes bequeath it to the pool boy or girl.  If, however, you want your spouse to get this Marital Deduction, but you want to make sure that your property still goes to who you say it should after the surviving spouse dies, then the Marital Deduction Trust comes into play.  It takes advantage of a narrow allowance in estate tax law for claiming the deduction while still restricting the ownership of the assets.  For all assets in the Marital Deduction Trust, the surviving spouse cannot change who it goes to; the trust is irrevocable.  The surviving spouse can enjoy the income and some of the principle for his/her lifetime, but can’t transfer it to someone else.  In other words, the surviving spouse’s interest in the assets is no longer “terminable.”  That is where QTIP comes from: Qualified Terminable Interest Property Trust.

If this is something you want as a part of your estate plan, that is great.  But the problem comes if you did not want this as part of your estate and you find out you have a mandatory QTIP split only after the death of your spouse.  On top of the grief of losing a loved one, now you learn that half your stuff will be tied up for the rest of your life.  If that was not by intentional design on your and your spouse’s part, that can be a huge inconvenience, to say the least.

Whenever I draft or review a trust, I make sure to explain to clients the exact consequences of their plan and ensure that it reflects their wishes.  If you would like assistance in reviewing your estate plan or drafting one, please contact our law firm.  We serve clients all over the Northern California area from Modoc County to Yuba County.

2011 Changes to Estate and Gift Taxes: What Does This Mean For Your Will and Trust?

It seems the laws regarding how the IRS will treat your estate keep changing.  Last year, as you may have heard or read, was a “good year to die” because there was no estate tax.  To be more accurate, the estate tax still existed, it was just that the “exemption amount” was unlimited.  The estate tax, as the name suggests, is the tax the IRS applies to transfers on death.  The exemption amount is the amount someone may transfer after death without paying any estate taxes.  An unlimited exemption amount means you could transfer everything; a 1 Million Dollar exemption amount means you could transfer only the first 1 Million tax-free.

Because the unlimited exemption amount was set to expire at the end of 2010, we were all scratching our heads to see what would happen for 2011.  If no new laws were passed, the exemption amount would have reverted back to 1 Million Dollars.  In December of 2010, President Obama signed the 2010 Tax Relief Act.   Because of the changes, certain provisions in your current estate plan might be outdated, or worse, detrimental to your wishes.

The following are highlights of the changes in the Tax Relief Act:

(1) Unified exemptions.  The law unifies the estate tax exemption (discussed above) with the lifetime gift tax exemption.  Currently, you may gift $13,000 per person per year without incurring any gift tax penalties.  If you gift more than this amount, you are allowed a lifetime gift tax exemption amount.  If you use up your lifetime gift tax exemption, you are also using up your estate tax exemption.  For example, if you gift 1 Million Dollars to one person over the $13,000, you have also decreased your estate tax exemption amount by 1 Million Dollars.

(2) Higher exemption.  The estate tax and lifetime gift tax exemption for 2011 and 2012 is increased from $1 million to $5 million.

(3) Portability.  For the first time, a surviving spouse may take the deceased spouses exemption amount, shelve it, and then use it at his or her own death.  In other words, the exemption amount from the first spouse to die is portable to the second spouse.  Before, the spouses would have to plan ahead with a “bypass trust” to ensure that they could take advantage of two exemptions.  The problem was that the surviving spouse was required to use the first exemption at the time of the deceased spouse’s death via the bypass trust.  Furthermore, bypass trusts have tight restrictions on what the surviving spouse can do with the assets inside the bypass trust.  At least for now, spouses have some flexibility in taking the deceased spouse’s exemption amount to be used later.  What this means is that it is possible to transfer 10 Million Dollars tax free.  Some commentators have indicated that this signals the death-knell of the bypass trust.  Such suggestions might be a little premature as Congress could change the law later to dissallow portability.  What this means for you is that you need an estate plan that has the flexibility of allowing you to use the portability if it exists, but to also use a bypass trust if it does not exist.

The new developments with regard to estate and gift taxes make it imperative that you have your current estate plan reviewed.  Our law firm can assist you in making any necessary changes to ensure that your estate plan has the flexibility that is required to adapt to not only the current laws, but any foreseeable changes that may occur.  Please contact our office today!

Estate Planning Basics: Wills and Trusts

Designing an effective estate plan is a very personalized process.  Many of the tools attorneys will use to help you transfer your assets on to your children and heirs have been around for centuries, but the way in which they are arranged can be different for every person or family.  You have probably already heard of and have some familiarity with Wills and Trust.  What follows below is a very basic sketch of these common estate planning tools.

Wills:

A will is a document that has no legal effect until you die.  For that reason, snooty lawyers refer to them as “Testamentary Instruments.”  Wills have been the traditional way in which property is transferred at death.  Increasingly, wills have taken a back seat to revocable living trust as the primary estate planning tool.  One of the reasons for this is that, at least in California, if you have more than $100,000 worth of assets pass via your will, your whole estate becomes “probated.”

Probate is a court-supervised administration of your estate.  This is generally disfavored because it takes a long time, costs more money, and can expose your assets to general public knowledge.  Alternatively, planning through a trust can be quicker and less expensive to administer at death, and is far more private.

This is not to say wills are not necessary.  Many estate planners use what is called a “pour over” will in conjunction with a revocable living trust.  What this means that is although a large portion of your estate is held in the trust; there will always be some assets and accounts you keep outside of the trust.  For instance, it would be too cumbersome to have your personal checking account be held in trust.  That is where the pour over will comes into play.  When you die, all of those miscellaneous assets outside of the trust get poured into the trust to be administered.

Trusts:

A trust is essentially an agreement whereby one person agrees to hold and own property for the benefit of another person.  It is a splitting of the ownership and enjoyment in an asset.  There are three major players in a trust: 1) a Settlor or Grantor; 2) a Trustee; and 3) a Beneficiary.  A Settlor or Grantor is the person who creates the trust, and who funds the assets into it.  The Trustee is the person who owns the assets in the name of the trust, and administers those assets for the benefit of the Beneficiaries.  Although these are legally distinct “offices”, the same person can be all three.

This is commonly the situation with a revocable living trust for a family.  Mom and Pop are the Settlors, who administer the trust during their lifetime as Trustees, for their own benefit as Beneficiaries.  The roles change when one or both of the parents die, but the principals remain the same.

There are many different varieties of trusts that perform a myriad of different functions.  One of the most widely-used trusts is a Revocable Living Trust.  Such trusts are “Living” because they are established by the Settlors during their lifetime, and not at death via a will (this is called a “Testamentary Trust”).  Such trusts are “Revocable” because, unsurprisingly, they can be fully revoked and cancelled by the Settlors (prior to death, at least…zombies cannot revoke trusts).

Revocable living trusts are popular because they can help avoid probate.  Any assets put into such trusts are not valued for probate purposes.  So if you have less than $100,000 outside the trust, even if you have millions inside, your estate can avoid probate.  Living trusts are also desirable for tax-planning.  If drafted properly, they can help you take full advantage of estate tax exemptions (especially if you are married).

All of these benefits of wills and trusts come with a serious element of danger, however.  If drafted incorrectly, or if improperly funded or administered, your estate can become exposed to significant tax liabilities.  Worse still, an improperly drafted estate plan that fails to anticipate contingencies can cause serious family turmoil.

Our law offices represent clients in Chico and Redding and the surrounding Northern California communities for their estate planning and asset protection needs.  If you have any questions or would like a consult, please contact our law firm at 530-345-2212 or info@ajstewartlaw.com.