Estate Planning with QTIP Trusts

This article on QTIP trusts discusses the Mellinger case in which, interestingly, the wife, after her husband’s death, removed her shares of stock in the same company that her husband had owned shares in. The purpose was to avoid the two holdings being lumped together for valuation purposes to the advantage of the IRS. This is another reason for couples to use separate revocable trusts so that it is clear with the IRS that we are talking about two separate holdings – both for purposes of exemption, and for valuation purposes where that is important.

Recent legal developments, including a change in position by the IRS, may create new opportunities to use Qualified Terminable Interest Property (QTIP) trusts in estate planning.

Several recent court opinions, including the Tax Court's decision in Estate of Mellinger, have approved significant estate tax valuation discounts for property owned partly by one spouse and partly by a QTIP trust established by the other spouse.

How QTIPs Work

The marital deduction generally allows one spouse to transfer an unlimited amount of assets to the other spouse free of estate and gift taxes, either during life or at death. But transferring all your assets to your spouse may not be the best way to achieve your estate planning goals. Perhaps you wish to preserve certain assets for children from a previous marriage, for example. The QTIP trust provides a vehicle for achieving your goals while still making the most of the marital deduction.

Contributions to a properly structured QTIP trust qualify for the marital deduction but allow the donor to specify the ultimate disposition of the assets. The QTIP trust is established pursuant to the donor's will. The surviving spouse receives a "qualifying income interest" in the property for life, and the donor's estate elects to claim a marital deduction for the property. A qualifying income interest means the surviving spouse is entitled to all of the property’s income, payable at least annually, with no person having power to appoint the property to anyone other than the surviving spouse.

When the second spouse dies, the value of the QTIP assets is included in the second spouse's gross estate and "treated as property passing from the decedent."

Some estate planners have used QTIP trusts to achieve significant estate tax savings. By dividing the ownership of assets between the surviving spouse and a QTIP trust, the property should qualify for valuation discounts for fractional interests, even if the entire property ultimately ends up in the hands of a single heir.

IRS Position

The IRS has taken the position that interests held by the QTIP and the surviving spouse merge upon the surviving spouse's death, resulting in 100% ownership by the estate and eliminating any fractional-interest discounts.

In recent years, a number of courts have rejected the IRS position. These courts argued that although the QTIP assets were treated as passing through the surviving spouse's estate for tax purposes, the surviving spouse had no control over the disposition of the property, which was determined by the terms of the QTIP trust. Fractional-interest discounts, therefore, were appropriate.

IRS Acquiesces

In Estate of Mellinger, a husband and wife owned almost five million shares of stock, held in a revocable inter vivos family trust. When the husband died, he left his 50% interest in a QTIP trust. The wife removed her shares and contributed them to another revocable trust.

The IRS claimed that when the wife died, the shares in the QTIP and revocable trusts merged for valuation purposes and, therefore, weren’t entitled to fractional-interest discounts. In fact, because the combined shares constituted a controlling interest, the IRS contended a premium should be applied.

The Tax Court rejected the argument that the wife should be treated as the owner of the QTIP property, noting that “nothing in the statute indicates that Congress intended that result or that QTIP assets should be aggregated with other property in the estate for valuation purposes." The court emphasized "at no time did decedent possess, control, or have any power of disposition" over the QTIP shares.

The IRS recently announced its acquiescence in the result of Estate of Mellinger. Although acquiescence in a court decision has no precedential value, it does indicate a change in the IRS’s litigation position on this issue and provides a degree of comfort to those considering using QTIP trusts in their estate plans.