Qualified Terminable Interest Trusts (QTIP or A-B-C Trust)
It used to be that the only way a married person could avoid the estate tax was to leave all of his or her assets that exceeded the amount of the estate tax exemption to the surviving spouse. This all changed over twenty-five years ago, in 1981. Transfers between spouses are now exempt from the estate tax as long as the surviving spouse is a citizen of the United States.
A Qualified Terminable Interest Trust
The 1981 law permits the spouse who dies with the option to place the amount exceeding the exemption amount in a Qualified Terminable Interest Trust, commonly called a "QTIP Trust." This is a special, irrevocable trust for the surviving spouse's benefit, and the trust must continue throughout that surviving spouse's life. The surviving spouse, also, is required to receive all income generated by the trust from such sources as net rental income, pidends, and interest, but any capital gains realized through the sale of assets held in the trust may be kept in the trust, which would then be responsible for the tax.
The surviving spouse may receive payments from the trust, but until he or she dies, no one else is eligible. The surviving spouse may raid the principal amount of any of the trust's assets for his or her health, support, education, or maintenance as long as the trust documents do not specifically prohibit such withdrawals. Legally, the only requirement is that only the surviving spouse will receive all the trust's income.
When the surviving spouse dies, the trust's assets pass in accordance with the first spouse's designation. The surviving spouse has no control over how the assets are distributed. Estate taxes are paid from the trust on its assets when the surviving spouse dies, which saves those who receive the trust's proceeds from any tax liability.
Qualified Terminable Interest Trust Requirements
Included in the requirements for a Qualified Terminable Interest Trust are the following:
1. When the estate tax return is filed, the trust's executor or tax preparer must make an election that the special trust be treated as a qualified terminable interest trust.
2. All income from the trust must be paid only to the surviving spouse for the remainder of his or her life.
3. As long as the surviving spouse lives, no other person may receive any payments from the trust.
The Point is Control, not the Estate Tax
For most couples with a living trust, the first spouse who dies leaves the maximum allowable amount exempt from the estate tax, in an irrevocable trust. Amounts above this amount can either be left to the surviving spouse, placed in a revocable trust that can be controlled by the surviving spouse, or placed in a qualified terminable interest trust. All of these possibilities shield the assets from taxation when the first spouse dies. When the surviving spouse dies, however, the taxes on the assets are due.
The sole issue here is control of the assets. Most couples who have been married for a long time and who don't have children from any prior marriages usually arrange for the assets of the first spouse who dies to be left outright to the surviving spouse or placed in the surviving spouse's revocable trust. If the first to die has children from an earlier marriage or a large quantity of separate property, the point becomes one of control and a qualified terminable interest trust may be a solution.
A qualified terminable interest trust creates two irrevocable trusts upon the death of the first spouse instead of just one. This creates additional complications, but is a way to insure the surviving spouse does not change the disposition of the assets.
If there is a large amount of separately held property, children from a former marriage, or if there is a strong desire to insure that the assets go to certain relatives, charities, or other institutions, a qualified terminable interest trust may be warranted. It allows the spouse full control over his or her assets and if such control is paramount, a qualified terminable interest trust may be desirable.