Special Tax Election Now Available for Spouses Under Revenue Procedure 2016-49

by Lilian H. Walden Esq.

Effective September 27, 2016, the IRS will now permit a special tax election for surviving spouses (known as a QTIP election).  This will apply even  when it is not necessary to reduce the estate tax liability to zero upon the death of the first spouse, pursuant to Revenue Procedure 2016-49.  Prior to this point, there was some uncertainty over whether or not with the new portability rules, a QTIP election that was not needed to reduce the estate tax would be treated as void.   Previously, under Revenue Procedure 2001-38, any QTIP election that was not necessary to reduce the decedent’s estate tax liability would be treated as void.  However, Rev. Proc. 2001-38 was issued before the advent of portability, which allows the deceased spouse’s unused exclusion/credit to pass to the surviving spouse. Now, with the new Revenue Procedure, the IRS has explicitly stated that QTIP elections may be made even when it is not necessary for estate tax purposes.  This is important for a few reasons:

First, a QTIP Trust allows the deceased spouse to transfer assets to the surviving spouse, qualifying for the unlimited marital deduction, while also placing restrictions on what the surviving spouse can or can’t do with the assets, typically preventing the surviving spouse from re-directing those assets outside the family. Before Rev. Proc. 2016-49 was issued, if you wanted your assets to qualify for the marital deduction but your estate was less than the federal estate tax applicable exclusion amount ($5,490,000 for 2017), you had to either transfer the assets outright to your surviving spouse or leave them in a Trust that the spouse could redirect to anyone on death, which left those assets vulnerable to predatory future spouses or caregivers.

Second, because the QTIP is owned by the surviving spouse for estate tax purposes, the cost/basis in those QTIP Trust assets will get stepped up on the second death, eliminating (on later sale) the capital gains tax otherwise owed on the assets’ appreciation between the first and second death.  By contrast, the cost/basis in Bypass (Exemption) Trust assets does not receive a step up on the death of the second spouse, trapping capital gain for future taxation.

Summary:

If you are married and you and your spouse currently have a standard Bypass (Exemption)/Survivor’s Trust (often referred to as an “AB Trust”) and less than $11,000,000 in assets you may want to consider changing your estate plan to allow for a QTIP Trust in the place of the Bypass (Exemption) Trust to minimize capital gains taxes for your ultimate beneficiaries.   We encourage you to set up a meeting or phone call with us to talk about this and other available planning options.

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