QTIP Trusts: Qualified Terminable Interest Property

A Qualified Terminable Interest Property (QTIP) trust is a powerful estate planning tool that allows property to qualify for the unlimited marital deduction while still giving the deceased spouse control over the ultimate disposition of the property. QTIP trusts are particularly valuable for blended families, allowing a spouse to provide for a surviving spouse while ensuring children from a prior marriage ultimately receive the assets.

The Seven Requirements for QTIP Treatment

For property to qualify as QTIP under IRC Section 2056(b)(7), ALL of the following requirements must be met:

1. Property Must Pass from Decedent

The property must pass from the decedent to the surviving spouse. This includes property passing under the will, by intestacy, or by operation of law.

2. Spouse Must Receive ALL Income for Life

The surviving spouse must be entitled to ALL of the income from the QTIP property for life. This is a mandatory, non-negotiable requirement:

• Income cannot be subject to any contingencies
• Income cannot terminate upon remarriage
• Income must be the spouse's absolute right

3. Income Must Be Paid at Least Annually

Income must be payable at least annually. The trust cannot accumulate income without paying it to the surviving spouse. Quarterly or monthly payments are acceptable, but annual payment is the minimum frequency.

4. Spouse Must Be Able to Compel Conversion of Non-Income-Producing Property

If the QTIP trust holds non-income-producing or unproductive property, the surviving spouse must have the power to compel the trustee to:

• Convert it to income-producing property, OR
• Sell it and reinvest the proceeds in productive assets

This requirement ensures the surviving spouse actually receives income, not just a theoretical right to it.

5. No Person May Appoint Property to Anyone Other Than Spouse During Spouse's Lifetime

During the surviving spouse's lifetime, no person (including the spouse) can have a power to appoint any part of the property to anyone other than the surviving spouse. This requirement:

• Prevents property from leaving the trust before the spouse's death
• Ensures the spouse's life interest is protected
• Does NOT prevent the trustee from distributing principal to the spouse for the spouse's benefit

6. Property Must Be Included in Spouse's Gross Estate

At the surviving spouse's death, the QTIP property is included in the surviving spouse's gross estate under IRC Section 2044. This is the trade-off for the marital deduction--the property is not eliminated from estate taxation, merely deferred.

7. Executor Must Make a QTIP Election on Form 706

The QTIP election is made on the decedent's federal estate tax return (Form 706). Important timing rules:

• The election must be made on a timely filed return (including extensions)
• The due date is 9 months after death, plus 6-month extension if requested
• This gives the executor up to 15 months to decide whether to make the QTIP election
• The election is irrevocable once made
• Partial elections are permitted (executor can elect QTIP treatment for a portion of qualifying property)

Strategic Uses of QTIP Trusts

Blended Families

QTIP trusts are ideal when the deceased spouse wants to:

• Provide income to the current spouse for life
• Ensure children from a prior marriage receive the principal at the surviving spouse's death
• Prevent the surviving spouse from disinheriting the deceased spouse's children

Example: Robert has two children from his first marriage. He marries Susan, who has her own children. Robert creates a QTIP trust providing Susan with all income for life. At Susan's death, the remaining principal passes to Robert's two children, regardless of Susan's wishes or any new will she might create.

Maintaining Control Over Ultimate Distribution

Unlike an outright transfer or a general power of appointment trust, QTIP property passes according to the deceased spouse's wishes, not the surviving spouse's:

• The deceased spouse determines who receives the remainder
• The surviving spouse cannot redirect assets to new beneficiaries
• Protection against surviving spouse's remarriage to someone who might influence asset distribution

Postmortem Flexibility

The QTIP election provides significant postmortem planning flexibility:

• Executor can assess estate size and tax laws at death
• Partial QTIP elections allow optimization
• Executor can balance marital deduction with use of the deceased spouse's exemption

State Estate Tax Planning

Many states with estate taxes do not recognize portability. QTIP trusts can be structured to:

• Maximize federal marital deduction
• Minimize state estate tax at first death
• Coordinate federal and state estate tax planning

Comparison: QTIP vs. Other Marital Trusts

Inter Vivos QTIP Trusts

While QTIP trusts are typically testamentary (created at death), an inter vivos (lifetime) QTIP trust can be created:

Requirements for Lifetime QTIP

• Same income requirements as testamentary QTIP
• Surviving spouse must be a U.S. citizen (unlike testamentary QTIP, which can use QDOT)
• Gift tax marital deduction election required on Form 709
• Assets included in surviving spouse's estate under Section 2044

Benefits of Inter Vivos QTIP

• Begin providing for spouse during grantor's lifetime
• Asset protection planning
• Medicaid planning (in some circumstances)
• Income splitting between spouses

Tax Consequences of QTIP Trusts

At First Spouse's Death

• Full QTIP election: 100% marital deduction, no estate tax
• Partial QTIP election: Marital deduction on elected portion, exemption used on remainder
• No gift tax (already taxed or exempt via marital deduction)

During Surviving Spouse's Lifetime

• Income distributed to surviving spouse is taxable income to the spouse
• Trust is a "simple trust" for income tax purposes (required to distribute all income)
• Surviving spouse reports income on personal Form 1040

At Surviving Spouse's Death

• Full value of QTIP property included in surviving spouse's gross estate (IRC Section 2044)
• Surviving spouse's estate can recover estate tax from remainder beneficiaries (unless waived)
• Property passes per deceased spouse's directions (not surviving spouse's will)
• Beneficiaries receive a step-up in basis to fair market value at second death

Common QTIP Planning Mistakes

1. Income Accumulation

Drafting language that allows or requires income accumulation disqualifies the trust from QTIP treatment.

2. Remarriage Provisions

Including a provision that terminates income upon the surviving spouse's remarriage will disqualify the trust.

3. Discretionary Income

Making income payments discretionary (even with a liberal standard) fails the "all income" requirement.

4. Missing Conversion Power

Failing to include the power to compel conversion of non-productive property can disqualify the trust.

5. Third-Party Appointment Power

Giving anyone (even the trustee) a power to distribute principal to someone other than the surviving spouse during the spouse's lifetime disqualifies the trust.