Q-TIP Trusts and Portability: The upside of Rev. Proc. 2016-49

Q-TIP Trusts and Portability: The upside of Rev. Proc. 2016-49

Back in 2001, the IRS issued Rev. Proc. 2001-38, an important procedural announcement concerning Q-TIP elections treated as a nullity.  That Revenue Procedure, as explained below, was modified and superseded by Rev. Proc. 2016-49, effective September 27, 2016.  The specifics:

Under the federal estate tax, there is allowed what is called the “marital deduction” (a dollar for dollar deduction under IRC Section 2056) for property passing to a surviving spouse either outright or in certain types of trusts (which I will generically refer to as a “marital trust”). One particular type of marital trust, called a Qualified Terminable Interest Property Trust (“Q-TIP Trust”) basically requires that all of the net income of the trust be payable to the surviving spouse for life, and that the spouse be the sole beneficiary of the trust during his or her lifetime.  Further, it is required that an election be made on Schedule M of the federal estate tax return of the decedent spouse’s estate to qualify that trust, or the desired portion thereof, for the marital deduction.  Upon the surviving spouse’s death the trust would be included in his or her gross estate under IRC Section 2044. 

In Rev Proc 2001-38 the IRS addressed whether there could be relief for a surviving spouse when a Q-TIP election was made for a trust on the deceased spouse’s federal estate tax return, when owing to the size of the decedent’s taxable estate, and the available credit amount, no federal estate tax would be imposed on the deceased spouse’s estate regardless of whether or not a Q-TIP election was made.  In ruling that the QTIP election would be treated as a nullity, the IRS reasoned, under logic which seemed appropriate at the time, that no-one would make an unnecessary election to qualify for the marital deduction in the first spouse’s estate and cause the trust to be included in the surviving spouse’s estate, if a marital deduction was not needed to reduce the federal estate tax to $0.00. 

Fast forward to 2016. The federal exclusion amount is $5,450,000.00 and let’s say that under the decedent’s Will, his or her estate of the same size is all left in a trust for the surviving spouse who is entitled for life to all of the net income from the trust and so much of the principal as determined necessary for the spouse’s health, maintenance, support, and education.  If the executor filed a federal estate tax return, and made a QTIP election and a portability election, the executor could chose to pass on to the surviving spouse the deceased spouse’s unused exclusion amount under IRC Section 2010(c). So the executor would like to make a QTIP election for the entire trust to qualify for the marital deduction (all $5,450,000.00) so that all of the decedent’s unused $5,450,000.00 exclusion amount could be passed on to the surviving spouse, who would then have the decedent’s unused exclusion amount ($5,450,000) as well as his or her own exclusion amount ($5,450,000.00 in 2016).  And by making a Q-TIP election for the trust, that would cause the trust to be included in the surviving spouse’s gross estate at his or her death.  And that means that the assets in the trust, under current law, would receive a step up in basis equal to their value on the date of the surviving spouse’s death.  On the other hand, if Rev. Proc. 2001-38 applied and rendered the Q-TIP election in the first spouse’s estate a nullity because no portion of the trust needed to be elected to qualify for a marital deduction in order to reduce the first decedent’s federal estate tax to $0.00, then there would be no unused exclusion amount to pass on to the surviving spouse, and there would be no trust included in the surviving spouse’s estate upon his or her subsequent death. Therefore, and accordingly, the trust assets would not get a basis adjustment on the surviving spouse’s subsequent death.  Thus, the question in Rev. Proc. 2016-49 basically involved whether an executor can file an estate tax return in order to make a portability election and also make an otherwise unnecessary federal estate tax Q-TIP marital deduction election.  The bottom line answer is that yes it can be done for federal estate, gift, and generation-skipping transfer tax purposes. That is, more particularly:

Rev. Proc. 2001-38 provides a procedure by which the IRS will disregard and treat as a nullity for federal estate, gift, and generation-skipping transfer tax purposes a Q-TIP election made in cases where the election was not necessary to reduce the estate tax liability to zero.  Thus, we had a case come into the office where, in the estate of the first spouse to die, an improper QTIP election had been made on the deceased spouse’s federal estate tax return, even though no such election was needed in order to reduce the federal estate tax for the deceased spouse's estate to $0.00.  As a result, the trust in question would have been included in the surviving spouse’s estate when the survivor later died. By asserting the applicability of Rev. Proc. 2001-38, however, we were able to exclude the trust from the surviving spouse’s estate, and thereby save a significant amount of federal estate taxes which would otherwise have been due and owing on the survivor's death. 

Rev. Proc 2016-49 takes into account what happens if the executor of the first estate not only makes what would otherwise appear to be an unnecessary QTIP election, but also makes a portability election under IRS Section 2010(c).  Recall that under Rev. Proc. 2001-38 the QTIP election would be a nullity. However, under Rev. Proc. 2016-49, the procedure treats as void certain QTIP elections, while treating as valid certain others. More particularly:

Pursuant to Section 3.01, Rev. Proc. 2016-49 treats as void QTIP elections made in cases where all of the following requirements are satisfied:

(1)  The estate’s federal estate tax liability was zero, regardless of the QTIP election, based on values as finally determined for federal estate tax purposes, thus making the QTIP election unnecessary to  reduce the federal estate tax liability;

(2)  The executor of the estate neither made nor was considered to have made the portability election as provided in Section 2010(c)(5)(A) and the regulations thereunder; and

(3)  The requirements of Section 4.02 of the revenue procedure are satisfied.

Pursuant to Section 3.02, Rev. Proc. 2016-49, however, does not treat as void QTIP elections made to treat property as QTIP in cases where:

(1)  A partial QTIP election was required with respect to a trust to reduce the estate tax liability and the executor made the election with respect to more trust property than was necessary to reduce the estate tax liability to zero;

(2)  A QTIP election was stated in terms of a formula designed to reduce the estate tax to zero. See for example Section 20.2056(b)-(7)(h), Examples 7 and 8;

(3)  The QTIP election was a protective election under Section 20.2056 (b)-7(c);

(4)  The executor of the estate made a portability election in accordance with Section 2010(c)(5)(A) and the regulations thereunder, even if the decedent’s DSUE amount was zero based on values as finally determined for federal estate tax purposes; or

(5)  The requirements of Section 4.02 of the Revenue Procedure (2016-49) are not satisfied.

To be noted, QTIP elections for which relief has been granted under the procedures of Rev. Proc. 2001-38 are not within the scope of Rev. Proc. 2016-49.

In the case of a QTIP election within the scope of Section 3.01 of Rev. Proc. 2016-49, the IRS will disregard the QTIP election and treat it as null and void for purposes of IRC Sections 2044(a), 2056(b)(7), 2519(a), and 2652. The property for which the QTIP election is disregarded under the Rev. Proc. will not be includible in the gross estate of the surviving spouse under Section 2044, and the spouse will not be treated as making a gift under Section 2519 if the spouse disposes of part or all of the income interest with respect to the property. Finally, the surviving spouse will not be treated as the transferor of the property for generation-skipping transfer tax purposes under Section 2652(a). Conversely, if the QTIP election is valid, then the opposite shall apply. That is the property will be includible in the gross estate of the surviving spouse under Section 2044, and the spouse will be treated as making a gift under Section 2519 if the spouse disposes of part or all of the income interest with respect to the property, and the surviving spouse will be treated as the transferor of the property for generation-skipping transfer tax purposes under Section 2652(a) (unless as to GST, a reverse QTIP election is made under Section 2652(a)(3)).

Section 4.02 of Rev Proc 2016-49 sets out the procedural requirements for relief to treat a QTIP election as void.

Thus, an executor could in an appropriate estate administration file a federal estate tax return for the first spouse to die, making a QTIP election for marital deduction purposes and a portability election for DSUE purposes. 

Finally it should be noted that there is renewed interest amongst estate planners in utilizing general power of appointment trusts as an alternative way to cause inclusion of the marital trust in the surviving spouse’s estate, preserve unused exclusion for portability purposes, and get a step up in basis of the trust assets on the surviving spouse’s death.  With the New Jersey Estate Tax scheduled for repeal on January 1, 2018, the use of general power of appointment trusts may gain more traction in marital deduction estate planning as a basis adjustment mechanism where a trust is desired. 

Should you wish to discuss the impact of Rev. Proc. 2016-49 upon an estate you may be administering, or the import of the procedure on your estate planning, please do not hesitate to call me at the office, (908) 359-8000, or to send me an email at bmblaw@ymail.com.

October 12, 2016                                                        Barry M. Benson, Esq.