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Prior to 1981 the only way to avoid estate tax for a married person was to leave all of the assets over and above the estate tax exemption to the surviving spouse. Transfers between husband and wife were exempt from estate tax if the surviving spouse was a United States citizen.
However, the surviving spouse could leave the assets to whomever the surviving spouse wished. John Doe had $2,000,000 of separate property. When he died the estate tax exemption was $1,500,000. What happens to the extra $500,000? The decedent could pay estate tax of approximately $225,000, or could give it outright to his wife, or put it in a special "marital deduction" trust which the wife could control when she died. Control versus tax savings is the sole issue.
One option under the 1981 act is to allow the spouse who dies to place the excess over and above the estate tax exemption in a special form of an irrevocable trust called a "qualified terminable interest trust" (frequently called a "QTip Trust"). This is an irrevocable trust for the benefit only of the surviving spouse. The trust must last for the surviving spouse's lifetime and the spouse must receive all of the income or earnings from the trust (interest, dividends, and net rents). Any capital gains from the sale of estate assets may be kept in the trust and the capital gains tax paid by the trust.
In addition, no one other than the surviving spouse may receive any payments from this type of trust until the surviving spouse dies. The principal of the trust may be invaded for the surviving spouse's health, support, maintenance, and education, if the trust contains provisions allowing this. It is not necessary that the trust allow the principal to be used. The only legal requirement is that the spouse receives all of the income from the trust for his or her lifetime.
At the death of the surviving spouse the assets in the trust pass to whomever the first decedent designated. The surviving spouse is not able to control the disposition of the assets in this trust. Estate tax on the assets is paid at the death of the surviving spouse, but these taxes are paid out of this trust, so the surviving spouse's relatives do not have to pay tax on the assets.
The requirements for the use of a qualified terminable interest trust include the following:
The typical arrangement with a husband and wife in connection with a living trust is for the decedent to leave the maximum amount which is exempt from estate tax ($1,500,000 to $3,500,000) in an irrevocable trust. The excess over and above this exemption can be left outright to the surviving spouse, placed in a revocable trust which the surviving spouse controls, or placed in a qualified terminable interest trust. In all of these arrangements, the assets are not taxed when the first spouse dies, but are taxed when the surviving spouse dies.
"Control" of the assets is the sole issue. If the couple has been married for many years and there are no children by a former marriage, then assets are probably left outright to the surviving spouse or placed in the surviving spouse's revocable trust. If the decedent has a large amount of separate property or children by a former marriage, then control becomes the issue and a qualified terminable interest trust may appear indicated.
Although many attorneys use qualified terminable interest trusts routinely, they create complications since instead of one irrevocable trust after the death of the first spouse there are now two irrevocable trusts. They appear useful if the spouse is concerned about his or her spouse changing the disposition of assets.
The qualified terminable interest trust appears useful for a spouse that either has a large amount of separate property, has children by a former marriage, or is concerned about locking up his or her assets for certain relatives or charities.
The qualified terminable interest trust allows a spouse options with regard to the control of his or her assets.
İMilton Berry Scott, 2005