The IRS's general aversion to loan guarantees on QTIP trust planning.

• Author: Easton, Reed W.
• Position: Qualified terminable interest property

A basic technique in marital deduction planning for over a decade has been to claim the maximum available marital deduction limited only by the amount sheltered by the unified credit. A credit shelter trust is often provided to use up the available unified credit. The exemption equivalent is payable to the credit shelter trust for the benefit of the surviving spouse for life with the remainder over to the children.

An opportunity for postmortem estate planning based on the actual value of a decedent-spouse's estate at death, as well as the financial requirements of the surviving spouse at such time, is commonly available, even in marginally taxable estates, through the use of a qualified disclaimer. Sec. 2518(b)(4) provides that a qualified disclaimer includes a disclaimed interest that passes without direction by the disclaimant either to the spouse of the decedent or to a person other than the disclaimant. A will provision might leave everything to the surviving spouse after certain specific bequests to others and a later provision might direct that any disclaimed bequests, including any disclaimed bequests of the surviving spouse, should pass to a trust under which the surviving spouse is given an income interest but no power of appointment. In addition to (or in lieu of) a credit shelter trust, such a trust might be designed to qualify under Sec. 2056(b)(7) as a qualified terminable interest property (QTIP) trust. The ability to delay most of a couple's combined estate planning until after the first death has led many spouses to add such contingent QTIP trusts to their wills.

Possible Consequences of Guarantees

to Marital Trusts

Now after more than a decade of the unlimited marital deduction and the QTIP trust, the Federal estate and gift tax consequences of guarantees on these fundamental techniques of testamentary planning must be considered. A guarantee might be used to help a child with a car loan or a home mortgage, or to start a new business or attend college. Yet such a guarantee may destroy existing marital deduction planning.

Sec. 2056 permits an estate tax marital deduction for property that passes to a surviving spouse and is not a terminable interest.(1) A "terminable interest" is an interest that will terminate or fail on the passage of time or on the occurrence of some contingency.(2)

Under Sec. 2056(b)(5), an interest in property passing from a decedent to a surviving spouse will qualify for the marital deduction if the surviving spouse is entitled to all of the income from the interest (or a specific portion of the property) together with a general power of appointment to appoint the interest (or a specific portion of the interest) to himself or his estate. The entire interest (or the specific portion) cannot be subject to a power in any other person to appoint a part to any person other than the surviving spouse (a "power of appointment trust").

Under Sec. 2056(b)(7), a surviving spouse's qualified income interest in a QTIP trust is not held to be a terminable interest. A "qualified income interest" exists if the surviving spouse is entitled to all of the income from the property payable at least annually and no person (including the surviving spouse) has a power during the spouse's life to appoint any part of the property to any person other than the surviving spouse.

In Letter Ruling 9113009,(3) the IRS ruled that the face amounts of any outstanding guarantees reduce the amount of the available estate tax marital deduction, yet are not deductible unless actually paid during the administration of the estate. The mere possibility of invasion of an otherwise qualified QTIP trust for payment of an outstanding guarantee, regardless of the amount of the guarantee, was found to cause the entire QTIP trust to fail to qualify for the estate tax marital deduction. The letter ruling also indicated that guaranteeing the loans of others is a transfer subject to the gift tax.

The IRS based its conclusion on the QTIP trust requirement that no person (including the surviving spouse) have a power during the spouse's life to appoint any part of the property to any person other than the surviving spouse. A power of appointment trust would be similarly affected as no person, other than the surviving spouse, may have a power during the spouse's life to appoint any part of the property to be deducted to any person other than the surviving spouse.

The ruling appears to be incorrect in light of other existing authorities and should be withdrawn and revised. This article will attempt to review these other existing authorities and offer planning alternatives to the ruling.

* QTIP trust requirement

A recent Tax Court decision, Est. of Manscill,(4) illustrates the extent of concern the courts have shown about this requirement. The will of a deceased spouse established a trust providing the surviving spouse with income for life. The trustee was allowed to invade principal for the benefit of the surviving spouse for maintenance and support. The trustee also had discretion, with the prior approval of the surviving spouse, to invade...