In the first two parts of this topic, we covered the attempt to unify trust law throughout the United States and Virginia’s brief new amendment to its version of the Uniform Trust Code. Now, to close the loop, we conclude by giving further detail to two important types of marital deduction trusts briefly mentioned in the last post.
Yeah, what is this “qualified terminable interest property” and “power of appointment” I keep hearing so much about?
These refer to two ways one spouse can give property to another spouse within a Marital Deduction Trust without giving the recipient complete control. U.S. tax law says if a trust contains property with qualified terminable interest property or a power of appointment, the recipient spouse will have just enough control, “present interest”, or “strings” to claim the trust in his or her own estate.
Couples of all levels of wealth go to this trouble to protect the trust assets as well as the individuals involved, as we will briefly discuss below.
The Internal Revenue Code defines both terms in the same section (26 U.S.C. § 2056(b)(5) & (7)), and both have these following similar characteristics:
- The property is passed from a decedent spouse to the survivor.
- The surviving spouse has a lifetime right to the property’s income, payable annually or more frequently.
- No one (such as the trustee) can appoint any interest in the property to anyone other than the surviving spouse.
They also differ in the following ways:
A trust holding “qualified terminable interest property” (affectionately known as a “QTIP Trust”) has the additional requirement that the decedent’s executor must specifically elect QTIP status for any such trust property. Additionally, the decedent spouse “chooses” to whom the trust property is ultimately distributed in the trust – the survivor cannot change this choice. Finally, the survivor can be given the right to access the principal, but only if it is for “ascertainable” purposes (most commonly “health, education, welfare or support”).
The QTIP Trust is very effective since the decedent spouse can prevent the survivor from giving any of the trust assets to anyone else (such as a new spouse, creditors, the poolboy, etc.). The QTIP Trust also protects the couple’s children, in that they will receive the remaining interest in the trust after the surviving spouse dies.
Power of Appointment Trust
On the other hand, a “power of appointment” gives the survivor this choice. As opposed to the QTIP Trust, the survivor does have the lifetime right, but not the obligation, to decide how the property should be distributed. The survivor may also make this choice at death in his or her will. However, if this trust is not drafted carefully, there is a danger that the IRS will deem that not enough “present interests” or “strings” has been given away. If this happens, the intended gift will fail and not qualify for the marital deduction, thereby resulting in many thousands of dollars in extra estate taxes.
The Power of Appointment Trust is perhaps less popular for this reason, and because of the survivor’s ability to assign trust assets anywhere (including away from the original family unit). However, they are still in regular use mainly because many couples do not want to impose too many limits on the survivor.
Wow, this new law has it all! Intrigue, history, conflict, uniformity vs. uniqueness, individual Davids vs. creditor Goliaths, no “free lunches”, Crummey Powers, cotton swabs, epistemology, truth, clarity… Thank you so much for this enlightening lesson!
My pleasure! But remember, even though you now have this newfound wisdom, there’s many a slip ‘twixt the cup and the lip!
Forget about it.
- Limited Powers of Appointment: Simple but Effective (dedononestateplanning.typepad.com)
- Tax Relief Act of 2010 – Part 3 – Temporary $5 Million Estate Tax Exemption (tennesseeestateplanninglaw.com)
- What is a QTIP Trust? (willsandwealth.wordpress.com)