Using the QTIP election to maximize generation-skipping transfers.

• Author: Russolillo, Raymond G.
• Position: Qualified terminable interest property

The qualified terminable interest property (QTIP) election under Sec. 2056(b)(7) is a handy pre- or post-mortem planning technique. it enables an estate owner to provide income and some principal for a surviving spouse during life while ensuring that the eventual disposition of the assets is in accordance with his wishes. A trust is created to hold the assets for the benefit of the spouse, with the remainder often passing to the children of the first spouse at the survivor's death. If properly structured, the assets in the QTIP trust escape taxation in the first estate (because they qualify for the unlimited marital deduction). They are includible in the estate of the second spouse and taxed accordingly. Coupling the deferred taxation of the assets with the control aspects of the QTIP trust makes a compelling argument for the use of this technique, especially in remarriage situations.

Unfortunately, while the QTIP trust makes eminent sense for the reasons given, it falls short with respect to the generation-skipping transfer tax (GSTT). For GSTT purposes, the surviving spouse is considered to be the transferor of the assets to the third generation, and any GSTT implications are calculated in the survivor's estate. if the surviving spouse has a sufficient amount of the $1 million lifetime GSTT exemption available to cover such a transfer, and the first spouse did not intend to leave much more than $1 million directly to his grandchildren, this may not be a problem. However, if the assets passing directly to the grandchildren are large enough, such a strategy may cause some or all of the first spouse's GSTT exemption to go unused.

Fortunately, there is a little-known solution to this problem. For generation-skipping transfers made, or treated as made, after Oct. 22, 1986, Sec. 2652(a)(3) allows the executor of the decedent's estate to make what is sometimes called a "reverse QTIP election" with respect to the assets in a QTIP trust. Essentially, what that means is that the trust is treated for GSTT purposes as if the first spouse were the transferor.

The flexibility in this technique enables one to control effectively the use of the GSTT exemption in both estates.

Example 1: Individual H has an estate valued at $1 1,000,000. His current (second) wife, W, has nominal assets. H wishes ultimately to pass the bulk of his estate to his children and grandchildren, yet he wishes to provide adequately" for W during her lifetime.

H should consider...