Chapter 17. Inter Vivos Marital Dispositions

• Author: Jerold I. Horn
• Pages: 536-563

17

Inter Vivos Marital Dispositions

Inter vivos, marital-deduction dispositions in trust are an alternative to

outright gifts. They can permit the use of the nonportable exemptions that a

less pecunious spouse otherwise could not use if he or she were to die first.

Dispositions in trust permit the donor to control the management and the

ultimate disposition of the property.

The primary inquiry is the extent to which inter vivos, marital-

deduction dispositions in trust can, and cannot, include flexibility. The

issues appear primarily in two contexts. The first relates to the extent to

which the donor can control the trust estate during and after the life of the

donee without disqualifying the gift for the marital deduction. The second

relates to the extent to which the donor can benefit from and control the

property after the death of the donee without including the property in the

gross estate of the donor.

I. QUALIFICATION FOR MARITAL DEDUCTION: ABILITY

OF DONOR TO CONTROL DURING LIFE AND AFTER

DEATH OF DONEE

The marital deduction is a sine qua non of the use of interspousal transfers

to enable a less pecunious spouse to use his or her transfer tax exemptions

even if he or she dies first. However, the donor who during life creates a

trust that is to qualify for the marital deduction because of the general

power of the donee spouse to appoint or because of a QTIP election cannot

retain any ability to establish or alter beneficial enjoyment, regardless of

whether the power is exercisable during the life or only upon or after the

death of the donee. An “ability to establish or alter beneficial enjoyment”

was a “power” as defined in Code Section 2613(d) of the generation-

skipping tax before the Tax Reform Act of 1986. The concept is used here

as a short-hand description of the type of ability that a donor cannot retain

in a trust if the trust is to qualify for the marital deduction for gift tax

purposes. The problem that a power presents for the marital deduction is not

an issue in the case of marital arrangements that a property owner creates at

the time of his or her death. Similarly, it is not an issue in the case of an

outright gift to a spouse during the life of the donor.

Some argue that the conclusion stated in the preceding paragraph does

not apply if the donor creates the power but, rather, applies only if the donor

receives the power from a third party. See Jonathan G. Blattmachr, Diana

Zeydel & Mitchell Gans, The World’s Greatest Gift Tax Mystery, Solved,

115 TAX NOTES 243 (Apr. 16, 2007); Richard Covey & Dan Hastings, IRC

Sec. 2523(f) Lifetime Qualified Terminable Interest (QTIP) Trusts and

Permissible Principal Interests of Donor Spouse, PRACTICAL DRAFTING, Apr.

2007, at 8881–88. This writer finds the argument inconclusive and counsels

the conservative course for planning purposes.

A person who owns property in fee simple absolute can create a power

with respect to the property and can transfer the property and retain the

power. Similarly, a person who possesses an interest and a power can

transfer the interest and retain the power. Again similarly, a person who

possesses only a power can exercise the power to transfer the property

subject to the retention of a power. Although the example at Treasury

regulations section 25.2523(b)-1(d)(3) appears to illustrate the last type of

retained power, “retains” in Treasury regulations section 25.2523(f)-1(a)(1)

and “retained” in Treasury regulations section 25.2523(b)-1(d)(3) appear

consistent with the application of the principle of the example to each of the

types of retained powers. Accordingly, for planning purposes, the writer

counsels treating the principle as equally applicable to each type of retained

power.

Yet another type of power contrasts with the various types of retained

powers. This type is a power that the donor receives from a third party after

the donor transfers the property. Arguably, not being a retained power, this

type of power does not prevent qualification for the marital deduction.

A power that the donor retains prevents the transfer from qualifying for

the marital deduction, at least unless the power is a fiduciary power limited

by an ascertainable standard. According to Code Section 2523(b)(2), a

power that the donor retains to allow an appointee to enjoy the property

after the termination of the interest of the donee spouse prevents the transfer

to the donee spouse from qualifying for the marital deduction: