[WSBAPT] 2519 and termination of QTIP

[Thomas E. Gates]

What an outstanding offering!

Tom

Sent from my iPad

> On Nov 30, 2014, at 1:56 PM, Nathan Hayes <hayesn03 at gmail.com> wrote:
> 
> Katherine,
> 
> I have been out of town and just catching up on emails.  I am a relative newcomer to Washington, but practiced estate and business succession planning in New York for over 12 years.
> 
> Here’s my understanding of the facts:  a deceased spouse’s estate is valued at $15M and his Will leaves everything to his surviving spouse in a QTIP eligible trust; the surviving spouse also has assets valued at $15M, she owns those assets outright, and her agent is making lifetime gifts of those assets to family members under a power of attorney.
> 
> In my estimation the best outcome, tax-wise, is to revoke any QTIP election made if you are still within the time to do so, or simply not make the election, and bring a TEDRA action to reform the husband’s Will to allow the surviving spouse to take the assets in her husband’s testamentary trust (above his applicable exclusion amount) outright.  That way you are assured to have the transfer to her qualify for the estate tax marital deduction. Once she owns the assets outright, have her agent give those assets away to family members under the power of attorney.  The gifts to family members could be outright, in trust or through entities.  (For details, see below).
> 
> It is not clear to me whether a QTIP election has been made by the husband’s executor with respect to the property in the husband’s testamentary trust. If made, and the trust otherwise qualifies for QTIP treatment, then the property in the trust qualifies for the estate tax marital deduction in his estate and is includible in the surviving spouse’s estate under section 2044.  If the executor did not make a QTIP election, and the trust doesn’t otherwise qualify for the estate tax marital deduction under some other section of the Code, then there is no marital deduction for his estate to claim and the value of the trust property ($15M) is includible and taxed in the husband's estate, with no off-setting deduction.  
> 
> An executor generally has at least 15 months (nine-month due date for filing decedent’s Form 706 plus a six-month extension) after the decedent’s death to make the QTIP election.  Once made, the election is irrevocable, although an election can be modified/revoked on a subsequent return filed on or before the due date of the 706 return (including any extensions of time actually granted).  It is also not clear to me, if an election was made, whether there is still time to modify/revoke it.
> 
> If no QTIP election has been made:
> 
> Maintain Status Quo (not recommended):
> - He died with $15M in his estate.  If no QTIP election was made, (and his testamentary trust does not otherwise qualify for the estate tax marital deduction), then no marital deduction is available in his estate, and the full $15M subject to taxation in his estate.
> - His executor could use his applicable exclusion amount (AEA) in his estate ($5.43M in 2014).
> - If he died in 2014, the combined (fed & state ) estate tax due on his $15M estate (after applying the AEA) would be:  $6,554,000 (estimated) - ouch!
> - After his death, she could transfer her interest in the testamentary trust to younger family members all she wants, but unless the transfer from his estate to her qualifies for the estate tax marital deduction, his estate will be taxed on the whole $15M, and her subsequent gifts of it or from it will not change that fact. 
> 
> Testamentary Transfers Between Spouses the Qualify for the Unlimited Marital Deduction:
>  
> There are two main ways a testamentary transfer from one spouse to the other qualifies for the estate tax marital deduction: (1) outright transfers (which will always qualify, so long as the surviving spouse is a U.S. citizen) and (2) transfers into any one of four types of trusts, reserving a lifetime interest for the surviving spouse: (a) a QTIP trust, (b) a General Power of Appointment (GPOA) Trust, (c) a Charitable Remainder Trust (CRT), or (d) an Estate Trust.
> 
> If his no election was made on his testamentary QTIP eligible trust, and the trust doesn’t otherwise qualify (in other words it doesn’t meet the requirements for a GPOA Trust, a CRT or an Estate Trust) then perhaps the best way to qualify the testamentary transfer from him to her is to reform his Will and have the assets in the trust pass directly to her, free and clear.
> 
>    
> Options (still assuming no QTIP election):
> 
> 1) Bring a TEDRA action to reform the Will to have her take everything outright except his AEA ($5.34M if he died in 2014). 
> - Is there language in the Will as to an alternate disposition?
> - I am assuming family members will consent.
> - Outright to her qualifies for the marital deduction, shifting the property to her estate.
> - No federal estate tax due in his estate (his AEA is applied to zero-out his estate tax).
> - WA state estate tax due on his $5.34M estate (after applying WA estate tax credit and assuming he died in 2014):  $791,200 (estimated).
> - Although it would be relatively small in amount, a PTP (previously taxed property) credit would be available to her estate for Washington State estate taxes paid in his estate (based on the actuarial value of her life income interest on the $5.34M that was held back in his estate) IRC section 2013.
> - From the roughly $10M she gets outright from his estate via the TEDRA order: (1) make nontaxable annual exclusion gifts of $14,000 per donee in Dec 2014  and again in Jan 2015, (2) make taxable gifts of up to $5.34M (her AEA in 2014) in Dec 2014 and pay no tax - to minimize the risk of mortality, (3) make a taxable gift of $90,000 in Jan 2015 - the difference between her 2015 AEA ($5.43M) and her 2014 AEA ($5.34M) - and pay no gift tax, and (4) make taxable gifts above her 2015 AEA ($5.43M) in Jan 2015 and pay gift tax.  I would report all gifts (even annual exclusion gifts) on timely filed Form 709s.
> - On Form 709, allocate appropriate GST tax exemption amounts to any direct skip gifts to grandchildren or other skip persons so as to create a zero inclusion ratio.
> - Your email didn’t indicate so, but I am assuming the POA is durable, which would be critical, given her mental condition.
> - As a general principle, because of the tax-inclusive nature of the gift tax (meaning the tax is calculated on the gift only and not the total property removed from the estate), and the fact that the state of Washington does not have a gift tax, gift taxes are cheaper than estate taxes.
> - If she dies within 3 years of making outright gifts, the amount of gift taxes paid will be brought back into her estate, but not the gifted property itself.  IRC section 2035(b) .
> - The value of the taxable gifts she makes will, however, be used to calculate the estate tax on her estate (using date of gift values rather than date of death values). As a result, it would be advantageous to have her make taxable gifts of assets likely to appreciate in the near-term.  If you have a choice, use the unproductive or fixed-income assets for annual exclusion gifts, and use assets that are likely to increase in value over the next year or two for the taxable gifts.
> - If her attorney-in-fact has the authority to create a FLP or LLC for her and there is a legitimate business reason for doing so, consider having her attorney-in-fact create a FLP or LLC and transfer property into the entity.  Merely transferring assets into the entity will reduce their value for transfer tax purposes (because ownership interests in the FLP or LLC would be harder to sell than the underlying assets).  The attorney-in-fact could then make gifts of minority ownership interests in the entity at discounted values (potentially discounted by 20%-40%).  There have been cases where near-death transfers of assets into FLPs or LLCs have been upheld (others not), but I would have to know more about the assets, the intentions of the parents, the overall family situation, and the business justification for creating the entity to comment more.  The fact that she is incompetent and near the end of her life makes the FLP/LLC option more challenging to justify.  It may be worth discussing with your client(s), if you haven’t already. The set-up costs, annual accountings and tax returns for the entity, risk of her death in mid-stream before the arrangement is finalized, and the risk of an IRS attack, predominatly under section 2703, must be taken into consideration.  With the dollars involved here, the transfer tax savings could be significant.  
> - Using a GRAT with a one to two year term might be a possibility (assuming the attorney-in-fact has authority under the POA to create trusts).  The AFRs are still quite low (2%-2.5% last time I looked) and all the trustee of the GRAT would have to do is outperform the APRs to create a transfer tax savings, although the potential tax savings might not be worth the legal, accounting, and fiduciary fees and commissions involved with the trust.  You’d have to run the numbers.  Of course there is the mortality risk as well - if she dies before the end of the term, the remaining portion of her annuity interest would be includible in her estate. 
> 
> 2) Have her disclaim everything other than his AEA.
> - On the federal level, a qualified disclaimer is a nontaxable event.  IRC section 2518.
> - Is a disclaimer not an option here because 9 months has elapsed since his date of death or because she has accepted some of the benefits under his testamentary trust? (Either one would disqualify the disclaimed property from transfer tax exclusion).
> - If she was able to make a qualified disclaimer, is there any language in his Will as to an alternate disposition?
> - If she makes a qualified disclaimer and the property disclaimed goes under the laws of descent and distribution (intestate), she would get most of the disclaimed property back anyway.
> 
> If a (full) QTIP election has been made:
> 
> - If the QTIP election has already been made for his testamentary trust, and the trust meets the requirements for a qualified terminable interest under section 2056 (b)(7), a marital deduction for the QTIP trust is available in his estate, reducing its value to zero; therefore no estate taxes due on his estate.
> - The $15M QTIP trust property is placed in her estate by statute. IRC section 2044.
> - “Port” his DSUE (deceased spouse’s unused exclusion) amount by making the portability election on a timely filed Form 706.
> - The DSUE amount may be used by her any time after his date of death, provided that portability has been or will be properly elected.  Temp. Reg section 25.2505-2T(a) (Note: check to see if that temporary regulation has been finalized, and if so, check to see if there were any changes made).
> - Make nontaxable annual exclusion gifts of $14,000 per donee in Dec 2014 and again in Jan 2015;  make taxable gifts up to her BEA (basic exclusion amount) plus his DSUE amount in 2014 without paying tax; and make taxable gifts over her BEA + his DSUE in 2015 and pay gift tax. (Note: BEA and AEA are the same; the code simply changed the name to BEA in reference to the surviving spouse)
> - File Form 709 for each year, and make a reverse QTIP election for GST tax purposes if gifts are made to grandchildren or other skip persons and allocate appropriate GST tax exemption amounts.
> 
> If the QTIP election has been made, it may be tempting to have her give the trust assets away as I have outlined immediately above.  However, here’s where it gets sticky:
> 
> Under section 2519, the transfer of an income interest in a QTIP trust is treated as a transfer of the entire interest (income and principal), which would cause the QTIP to lose its status as a qualifying terminable interest for the marital deduction.  As a result, the disqualified QTIP trust property would be brought back into his estate and be subjected to estate taxation. If you have already ported his DSUE, then his estate would have to pay estate tax on $15M with no AEA to use.  
> 
> The four basic requirements to qualify a QTIP trust for the marital deduction are:  (1) the surviving spouse must have the right to all income for life, (2)  the surviving spouse must be the sole lifetime beneficiary, (3) during the life of the surviving spouse, there can be no right to divert trust property to anyone else (other than the surviving spouse), and (4) the deceased spouse’s executor must make a timely election to treat the trust property as QTIP. IRS section 2056(b)(7).
> 
> Consider the possible ways she could transfer out her interest in the QTIP trust property:
> 
> 1) She could transfer or assign her rights in the trust to family members, but that would disqualify the QTIP for the marital deduction and bring the trust property into his estate under section 2519.
> 
> 2) I am not convinced that a TEDRA action would bring any different result. Any transfer by her to someone else (whether voluntarily made by her or pursuant to court order) is going to disqualify the marital deduction for the QTIP trust and thereby make his previously nontaxable estate subject to estate tax on whatever is in the trust.  A state court judge’s order is not going to trump a federal statute.
> 
> 3) She could disclaim, although, again, I am not sure whether she could make a qualified (i.e., tax-free) disclaimer at this point, and I do not know what the disposition would be if she were to disclaim.
> 
> As a result, if the QTIP election has been made and cannot now be modified, I don’t see any advantage of going through the expense and uncertainty of a TEDRA action, nor do I see any advantage in her making a gift of her interest in the QTIP trust. The impact of a qualified disclaimer, if it is even available, depends on what the alternate disposition would be.  
> 
> On the other hand, if the QTIP has not been made or can still be revoked, then a TEDRA action reforming the trust so as to allow her to take outright the amount over his AEA and then gifting that amount to others, consistent with her husband’s overall estate plan, makes the most sense to me.  As an alternative, you could reform the trust so as to have the entire trust property distributed to her outright and then simply port his DSUE and apply it to the gifts out - the net effect would be the same as the way I have proposed.  My thinking on that would be the less you attempt to change in the TEDRA action, the better.
> 
> If there is still time to make or modify the QTIP election, it is conceivable that a partial election could be made, but I don’t see how that would resolve the overall transfer tax issue any better than simply not electing QTIP treatment or revoking a previous election.  
> 
> The best outcome, transfer tax-wise, is to not elect to treat the trust as a QTIP trust and bring a TEDRA reformation action to get the trust assets (over his AEA) to her outright and then have her attorney-in-fact give those assets away.  A transfer into a FLP or LLC (assuming a legitimate business purpose) or a GRAT, if the attorney-in-fact has the authority to do so, would allow you to “leverage” the gifts, creating a greater transfer tax savings than outright gifts, although there are risks involved in their use. 
> 
> If the QTIP election was made and the due date on the husband’s Form 706 (with any extensions granted) has passed, you may want to dig into the regs to see under what circumstances, if any, the IRS has discretionary authority to accept a late revocation.
> 
> If you are absolutely stuck with a QTIP election, then perhaps it’s simply a matter of determining which way would your client(s) like to take the estate tax bullet - through her estate (via section 2044 without any subsequent gifting) or his (via section 2044 and then making transfers that disqualify the marital deduction in his estate).…its gonna hurt either way.  
> 
> As to the $15M of assets in her name:
> 
> - Have her agent give her assets away (except what will be needed to support her for the rest of her life), either by direct gifts or by way of a FLP, LLC or GRAT, and pay the gift tax on any taxable gifts if no AEA or DSUE is available.
> - Ideally the gifts would be made to the same individuals or class(es) of beneficiaries as named in her Will or other estate planning documents, if any, made while she was competent.  If any minors are involved, transfers of up to $14,000 to an UTMA/UGMA account or a section 2503 minor’s trust would qualify as annual exclusion gifts, even though the minor wouldn’t have the right to demand access to the funds until reaching age 21.  Gifts over $14,000 to a custodian of a UTMA/UGMA account or a trustee of a minor’s trust would be fine too, although taxable.
> - As is the case with the assets originating from his testamentary trust, if she dies within 3 years of making gifts of her assets, any gift tax paid will be included in her estate but not the gifted property itself - unless a FLP or LLC is used and the IRS is successful in arguing that the assets should be brought back into her estate under section 2036 or 2038 (too much retained control). 
>   
> 
> Charitable gifts:
> 
> I don’t know if your client(s) have any philanthropic intentions, and I don’t know the ages or financial situations of the younger family members, but have you considered something like a 10 year Charitable Lead Annuity Trust (CLAT)?  Again, with AFRs so low, if the trust outperforms them, you will have leveraged the gifts to the family members, while obtaining a substantial charitable deduction for mom’s estate. If mom, while she was competent, either through her estate planning documents or her actions, demonstrated an inclination to benefit charitable organizations, and her attorney-in-fact has express authority to create trusts on her behalf and make gifts to anyone, then a CLAT might be a viable option to consider.  The younger family members would just have to wait 10 years to receive the assets in the CLAT.
> 
> Thanks for sharing this case with the listserv.  I hope this response is helpful to you.  Please accept it cafeteria-style:  take what you’d like and leave the rest.  
> 
> If something I have written here is not clear or your understanding/viewpoint is something different from what I have expressed and you would like to discuss things further, please feel free to call me or email me back either directly or via the listserv.  
>  
> Sincerely,
> 
> Nathan M. Hayes
> P.O. Box 2204
> Olympia, WA 98507
> (360) 481-8966
> hayesn03 at gmail.com
> 
> 
> 
>   
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> 
>> On Nov 21, 2014, at 11:41 AM, Katharine P. Bauer <kpb at BPBLEGAL.COM> wrote:
>> 
>> Thanks, Sam.  That is about what I was thinking.  Joint estate of $30m sorry I wasn't clear.  We were wondering about terminating the QTIP and passing the income interest to her and balance to kids, not through disclaimer (would incur fed and state estate taxes) but by TEDRA.  Interesting situation where the family wants to avoid Washington State tax to the greatest extent, since there is no gift tax here (yet). She is definitely disposing of her half of the estate (yes $15 million).  If she has both their exemptions and uses them individually, he is not incurring Washington estate tax by transferring to her and she is taxed upon the gift at termination for federal purposes.  Just trying to figure out how to get it all to her and she makes all the taxable gifts during her lifetime.....Now, the coffee has worn off and I need more! :)  
>> Have a good weekend.
>> 
>>> On Fri, Nov 21, 2014 at 11:10 AM, Sam Furgason <sam at furgasons.com> wrote:
>>> Katherine,
>>> 
>>>  
>>> 
>>> If you have sufficient funds to merit a federal QTIP, his estate should have no DSUE because you will have used all of his exclusion amount. That should apply unless the first spouse was impecunious, in which case DSUE would apply (but your post refers to her “half”). ($30m/2 = $15m, which is >$5,340k.) The same logic would apply if the first decedent’s estate is $30m (your question does not make it clear in my mind whether the first spouse’s estate is $30m or the entire community estate is $30m, but implies the latter.)
>>> 
>>> As for terminating the QTIP (which I believe gifting of any income interest would do, per 2519), see if the QTIP language permits liberal distributions to the surviving spouse. If so, you could make large distributions to the spouse and she could make gifts, without terminating the entire QTIP. Since we are near a year end, she could make multiple annual exclusion gifts and reduce her taxable estate somewhat. Those gifts would be tax free, and could be spread among children, grandchildren, and spouses.
>>> 
>>> Also, if she gives away her own estate entirely, then withdrawals from the QTIP are more reasonable, if there is some sort of HEMS type restriction in place.
>>> 
>>> Is a QTIP “termination” even necessary?
>>> 
>>> Don’t forget, the executor makes the QTIP election; it’s not automatic. His executor can make a partial QTIP election rather than a full one, or no election at all, so that the portion of the decedent’s trust which is QTIP eligible can be defined as part of the overall plan. You can time this also, since the federal and state exclusion/exemption amounts rise on 1/1/2015. I don’t think the annual exclusion is changing for next year, but if you have 5 eligible gift recipients, that’s an extra $70k which will not be taxed at either the state or federal levels, thereby justifying  a part of your fees.
>>> 
>>>  
>>> 
>>> S                                 
>>> 
>>>  
>>> 
>>> From: wsbapt-bounces at lists.wsbarppt.com [mailto:wsbapt-bounces at lists.wsbarppt.com] On Behalf Of Katharine P. Bauer
>>> Sent: Friday, November 21, 2014 8:22 AM
>>> To: probate
>>> Subject: [WSBAPT] 2519 and termination of QTIP
>>> 
>>>  
>>> 
>>> Query:
>>> 
>>> I have a large probate ($30 million) where the first spouse died and his Will funds a QTIP for his surviving spouse.  We are contemplating using portability to transfer his unused amount to his spouse. Surviving spouse is incompetent and unlikely to live a long time.  Her POA has extremely broad powers - of gifting, disclaiming and ability to transfer to other trusts and family. Her AIF is in the process of gifting away her half of the estate, utilizing her fed applicable exemption amounts (no Washington gift tax) and paying any gift tax incurred.  
>>> 
>>>  
>>> 
>>> First, We are curious as to when she may use her spouse's amount in gifting.  Is it after the IRS accepts his 706?  She likely won't live that long.
>>> 
>>>  
>>> 
>>> Second, we are curious about terminating the QTIP and either giving her the life income interest or all of the trust.  The thought is to again gift it to children if she takes it all.  Does 2019 cause any further damage by pulling it into her "estate" and incurring gift tax?  She will have used all of her fed exemption anyway and will definitely incur further incur gift tax.  The purpose here would be to avoid the Washington state estate tax on the extra $15 million  by disposing of it now.  
>>> 
>>>  
>>> 
>>> Finally, and third, by paying gift tax now, does 2035 pull it back into her estate if she dies prior to 3 years, which she will?  I am having trouble interpreting the statute when we are contemplating terminating the QTIP and gifting her the income interest or all of it....
>>> 
>>>  
>>> 
>>> We could simply disclaim QTIP assets under husband's estate but then it would incur the Washington tax.
>>> 
>>>  
>>> 
>>> I have reviewed 2511, 2519 and 2035.  Since this is a 3:00 a.m. thought, I would appreciate any and all comments as to whether this is a good idea.  After I have my coffee, I may regret my stupidity in sending this out!
>>> 
>>>  
>>> 
>>>  
>>> 
>>> --
>>> 
>>> Katharine P. Bauer
>>> 
>>> Bauer Pitman Lifetime Legal, PLLC
>>> 1235 Fourth Ave. East, Suite 200
>>> Olympia, Washington 98501
>>> tel. 360.754.1976
>>> fax. 360.943.4427
>>> 
>>> e-mail: kpb at bpblegal.com
>>> 
>>> This message is confidential and may be protected by the attorney-client privilege; it is intended solely for the use of the individual named above. If you are not the intended recipient, you are hereby advised that any dissemination, distribution, or copying of this communication is strictly prohibited. If you have received this e-mail in error, please immediately notify the sender by telephone or e-mail, delete this message from your files, and return any printed copies to the sender by U.S. mail. Circular 230 Disclosure: Any tax advice contained in this communication (including any attachments) is not intended or written to be used, and cannot be used, for the purpose of (i) avoiding penalties that may be imposed under the Internal Revenue Code or (ii) promoting, marketing or recommending to another party any transaction, arrangement, or other matter
>>> 
>>> 
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>> 
>> 
>> 
>> -- 
>> Katharine P. Bauer
>> Bauer Pitman Lifetime Legal, PLLC
>> 1235 Fourth Ave. East, Suite 200
>> Olympia, Washington 98501
>> tel. 360.754.1976
>> fax. 360.943.4427
>> 
>> e-mail: kpb at bpblegal.com
>> 
>> 
>> This message is confidential and may be protected by the attorney-client privilege; it is intended solely for the use of the individual named above. If you are not the intended recipient, you are hereby advised that any dissemination, distribution, or copying of this communication is strictly prohibited. If you have received this e-mail in error, please immediately notify the sender by telephone or e-mail, delete this message from your files, and return any printed copies to the sender by U.S. mail. Circular 230 Disclosure: Any tax advice contained in this communication (including any attachments) is not intended or written to be used, and cannot be used, for the purpose of (i) avoiding penalties that may be imposed under the Internal Revenue Code or (ii) promoting, marketing or recommending to another party any transaction, arrangement, or other matter
>> 
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