Building Flexibility into the Estate Plan Formula Clauses: “General Power of Appointment Marital Trust”

In developing an estate plan for a married couple, we may direct that all assets pass to the surviving spouse, place assets in a Marital Trust or Credit Shelter Trust for the benefit of the surviving spouse, or a combination thereof.

In the past, this decision was usually made at the time the will or trust was drafted. However, with the advent of “portability” and the creative use of formula clauses, a final decision can be postponed until after the death of the first spouse.

The most common marital trusts include the “General Power of Appointment Marital Trust” and the “Qualified Terminal Interest Property (QTIP) Trust.”

General Power of Appointment Marital Trust: 

Prior to 1981 when the qualified terminable interest property (QTIP) trust was introduced into the law, the general power of appointment trust was the most widely used means of securing the marital deduction for property placed in trust.

To qualify for the marital deduction under Section 2056(b)(5) of the Code, a trust must provide that:

  1. All trust income must be payable to the surviving spouse at least annually for life.
  2. No person other than the surviving spouse may be a beneficiary of the trust during the lifetime of the surviving spouse.
  3. The surviving spouse must be granted a general power of appointment, which permits the surviving spouse to appoint trust property to the surviving spouse or to his or her estate.
  4. There may be no substantive restrictions, conditions, or limitations placed on the surviving spouse’s ability to exercise the power of appointment. (1) 
  5. Unlike a QTIP trust, which requires an election by the personal representative to qualify for the marital deduction, property placed in a GPOA marital trust automatically qualifies for the marital deduction, and it is not necessary to file Form 706 to obtain a second step up in basis at the death of the surviving spouse. (2)

Qualified Terminable Interest Property (QTIP) Trust:

The concept of the QTIP trust was originally created to allow a spouse, with children from a prior marriage, to provide for his or her surviving spouse, without giving the surviving spouse full control over the property in the marital trust.  At the death of the surviving spouse, the remaining assets in the martial trust pass to the children from the prior marriage.

As long as the trust meets the requirements for a QTIP trust, the bequest to the trust will qualify for the marital deduction at the death of the first spouse and will be included in the estate of the surviving spouse. To qualify for QTIP treatment under Section 2056(b)(7) of the Code:

  1. The property must pass from the decedent.
  2. The surviving spouse must receive all the income from the trust at least annually for life.
  3. The surviving spouse must have the right to make non-income producing property productive.
  4. During the term of the trust, no distributions may be made to any person other than the surviving spouse.
  5. The QTIP election must be made on the last estate tax return filed by the executor on or before the due date of the return, including extensions or, if a timely return is not filed, the first estate tax return filed by the executor after the due date. In effect, nine (9) months after the date of death plus a six month extension, if requested. Treas. Reg. 20.2056(b)-7(b)(4)(i).

To increase flexibility:

  1. The trust may permit distributions of principal to the surviving spouse limited by an ascertainable standard.
  2. The surviving spouse may be given a limited testamentary power of appointment.
  3. The surviving spouse may serve as Trustee of the QTIP trust.

Partial QTIP election

If authorized by the trust or governing law, the personal representative may elect to qualify only a portion of the QTIP trust for the marital deduction. If a partial QTIP election is made, the trust will be divided into two identical trusts, one that qualifies for the marital deduction and one that does not qualify for the marital deduction. To avoid estate taxes, property placed in the non-elected portion should not exceed the decedent’s remaining applicable exclusion. Treas. Reg. 20.2056(b)-7(b)(2)(ii)(A)

The primary disadvantage to the partial QTIP election is that all trust income must be distributed to the surviving spouse, unlike the traditional credit shelter trust, which may distribute income and principal among the spouse and children. (3)

Need more information on building flexibility into your Estate Plan? Whether you are planning for yourself or a family member, The Elder Law Center of Mondschein and Mondschein, P.A. is here for you. Please contact us using this online form here, or call our office at 305.274.0955 to schedule a free phone consultation.

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References

(1) Jeffrey N. Pennell, Tax Management portfolio series, Estate Tax Marital Deduction, 843-3rd T.M. Estates, Gifts, and Trusts at page A-59 (2013)

(2) Edwin P. Morrow, III, The Optimal Basis Increase and Income Tax Efficiency Trust (2013), page 10

(3) Barbara A. Sloan, Spousal Transfers – During Life, at Death and Beyond, Chapter 12, pages 39-63, 47th Annual Heckerling Institute on Estate Planning, January, 2013