A QTIP trust is short for Qualified Terminable Interest Property Trust. Although many people think that trusts are only for high net-worth individuals, QTIP trusts have become a necessity for blended families. A QTIP trust is established by the settlor, usually via will, leaving an amount of assets to the trust, where the trust assets’ income will be used to provide for the surviving spouse (usually the second or subsequent spouse), and only after the surviving spouse’s death will the trust assets be distributed to the deceased settlor’s children (usually from the first or previous marriage).
Why is the QTIP trust important for blended families? Because the QTIP trust allows the deceased spouse to provide for the surviving spouse’s needs and at the same time, keep his assets for his own children.
For example, you married A when you were 25 years old. You had three children with A, named B, C, and D. You were married for 20 years to A. Now that the children are all grown up, you and A decide to divorce. You are now 45 years old. Five years after the divorce, you met Z, who is also a divorcee with 2 children from her previous marriage, Y and X. Two years after meeting Z, you and Z decide to get married. You are now 52 years old. Because of your age, you and Z cannot have children together anymore.
You wonder what the effect of marriage will be on your assets. Prior to marrying Z, you have already accumulated some wealth. You have no debts and a condominium in Manhattan worth $300,000, a 5-story brownstone townhouse in Brooklyn worth $5 million, and bank accounts in the total amount of $1,000,000. Under New York law, since you and Z are married, if you die, Z is entitled to a spousal right of election to receive 1/3 of your property, which is around $2.1 million. Z has the option to exercise this right of election if you leave her less than 1/3 of the net estate in your will. If Z receives $2.1 million and dies, this amount does not go to your children, but to Z’s children from her previous marriage, Y and X. Although you love Z very much, you prefer to have your assets go to your own children, B, C, and D. What is your remedy? A QTIP Trust.
In your will, you can create a QTIP trust, which states that when you die, your assets go to the QTIP Trust. The income of the assets in the QTIP trust will then be used to provide for Z’s needs during her lifetime. However, Z will not have the right to use the trust assets. When Z dies, the trust assets will be distributed to your children from your previous marriage, B, C, and D, who are the ultimate beneficiaries. Since trust assets are excluded from the probate estate, even if Z exercises her spousal right of election, there could be no asset in the probate estate to be distributed to Z.
Aside from the QTIP trust’s benefits to a blended family, QTIP trust offers significant tax advantages to high net-worth individuals.
Currently, there is a federal estate tax exemption of $11.7 million in 2021. You are only obligated to file a federal estate tax return if the decedent’s gross assets and prior taxable gifts are upwards of $11.7 million. Thus, if the decedent left assets more than $11.7 million, the difference between the net estate and $11.7 million is subject to estate tax. This means, only few people need to pay federal estate tax.
In New York, the basic exclusion amount is $5.93 million. For a net estate in excess of $5.93 million, the difference between the net estate and the basic exclusion amount is subject to estate tax.
In the example above, suppose that only the condominium in Manhattan worth $300,000 was transferred to QTIP trust, then this amount, being a life estate given to the spouse, can be deducted as a marital deduction from the gross estate of $6.3 million. Thus, if you die in 2021, the net estate is $6 million. Although you will not need to file a federal estate tax return because the taxable estate is below $11.7 million, you need to file a state estate tax return because your taxable estate is $6,000,000, above the basic exclusion amount of $5.93 million. Your net estate ($6 million) less the basic exclusion amount of $5.93 million equivalent to $70,000 (your taxable estate) is subject to New York estate tax of 3.06%.
However, if you did not leave any property to a QTIP trust, then the taxable estate is $6,3000,000 because New York estate law has an estate tax cliff that if your estate is more than 105% of the basic exclusion amount, the entire estate (and not the difference from the basic exclusion amount) is taxable. In this case, since $6,300,000 is greater than 105% of the basic exclusion amount of $,5930,000 which is $6,226,500, the entire estate of $6,300,000 is taxable. The tax is $522,800 plus 12.8% of the taxable estate in excess of $6,100,000, which is $25,600, giving a total estate tax of $548,400.
Suppose that you transferred the Manhattan apartment, the Brooklyn brownstone townhouse and your bank accounts to a QTIP trust, then the entire value of the assets of $6,300,000 is qualified for unlimited marital deduction, and you will have no taxable estate and no estate tax pay.
However, when Z dies, the amount in her estate plus the trust assets left in the QTIP trust, are subject to estate tax. In this case, estate tax is deferred, but not completely eliminated.
QTIP trusts are an indispensable way of planning your estate if you have a blended family or would like to reduce estate taxes if you are a high net worth individual. If you are in a blended family, seek to reduce your taxes, need to plan your estate, and would like a QTIP trust, we, at the Law Offices of Albert Goodwin, are here for you. We have offices in New York City, Brooklyn, NY, and Queens, NY. You can call us at 212-233-1233 or send us an email at [email protected].