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a lifetime qualified terminable interest property (QTIP) trust is a valuable estate planning tool that offers tax and nontax benefits to married couples. As an alternative to an outright gift to a spouse, these trusts can be an effective way to equalize estates in order to save gift and estate taxes and to maximize creditor protection for the donor, the donee spouse and their children, while allowing the donor to control the ultimate disposition of trust assets. Outright gifts to spouses have long been an important part of estate planning. These transfers provide many benefits, including estate equalization, protection of gifted assets from creditors of the donor spouse and a degree of fairness when one spouse has more assets in his or her name than the other spouse. Significantly, assuming that the donee spouse is a U.S. citizen, outright gifts to spouses qualify for the gift-tax marital deduction. (Special rules apply for gifts to noncitizen spouses, and all transfers described in this article will be assumed to have been made to a U.S. citizen spouse.) Moreover, from an administrative standpoint, outright gifts generally are easy to accomplish. On the other hand, depending on the viewpoint of the donor spouse, outright spousal gifts can have perceived disadvantages. These may include the fact that the donee spouse has complete control over the gifted property, including the ability to spend or re-gift the funds; the fact that donee spouse controls the ultimate disposition of any gifted funds held by the donee spouse at his or her death; and the fact that gifted assets are subject to claims of the donee spouse’s creditors. To some would-be donors, these disadvantages may make the prospect of outright spousal gifts unpalatable, especially in the case of a second marriage. The lifetime QTIP trust is a vehicle that can be used by a donor who wants to make nontaxable completed gifts for estate equalization and/or creditor protection purposes but who also wants to restrict the donee spouse’s control over the gifted property, control the disposition of any property remaining at the donee spouse’s death and/or provide protection from existing or potential future claims of the donee spouse’s creditors. Internal Revenue Code � 2523(f) sets forth the requirements for a lifetime QTIP trust. If these requirements are met, and if the gift to the trust is otherwise a completed gift under federal gift-tax law, the gift will qualify for the gift-tax marital deduction. Under Code � 2523(f), a lifetime QTIP trust must require that all income be payable at least annually to the donee spouse during his or her life. An income interest that terminates upon the occurrence of a post-creation contingency, such as divorce, or one granted only for a term of years, will not qualify. The trust may, but need not, provide for distributions of principal to the donee spouse. No person other than the donee spouse may receive distributions from the trust during the donee spouse’s life. These rules are similar to the rules for testamentary QTIP trusts under Code � 2056(b)(7). In addition, for a gift to a lifetime QTIP trust to qualify for the gift-tax marital deduction, the donor spouse must irrevocably elect to have the gift so qualify. This election is made by the donor spouse on a timely filed gift-tax return for the year in which the gift is made. In contrast to an election made for a testamentary QTIP trust, the election to qualify a gift to a lifetime QTIP trust for the marital deduction cannot be made on a late-filed return. Attention to proper and timely filing of the gift-tax return in these circumstances is crucial, as the failure to do so could result in an immediate, substantial and unintended taxable gift. Under Code � 2523(f), there are no restrictions on who may receive property remaining in the lifetime QTIP trust at the donee spouse’s death, and this often is perceived as a significant advantage to this trust vehicle. As discussed below, it is possible for the donor spouse to receive or otherwise benefit from property remaining in the trust at the donee spouse’s death if the donor spouse survives the donee spouse. Upon the surviving spouse’s death, under Code � 2044(b)(1)(B), any property remaining in the lifetime QTIP trust will be includible in the donee spouse’s gross estate for federal estate-tax purposes. Finally, under Code � 677, the lifetime QTIP trust will be treated as a grantor trust as to the donor spouse for income tax purposes so long as the donor and donee are both living and married to each other, thus making income tax filings relatively simple. There are many reasons why a lifetime QTIP may be a beneficial component to a married couple’s estate plan. � Estate equalization. First, like outright gifts to a spouse, gifts to a lifetime QTIP trust will increase the estate equalization of a married couple, which can be helpful in ensuring that each spouse fully utilizes his or her estate tax and generation-skipping transfer (GST) tax exemptions. Currently, for federal tax purposes, Congress grants every individual a unified credit against estate taxation that shelters up to $2 million of transfers either during life or at death (increasing to $3.5 million in 2009). In addition, every individual is allowed a GST tax exemption of $2 million, which may be applied to gifts and/or bequests that constitute generation-skipping transfers. By fully utilizing each spouse’s unified credit and GST tax exemption, an estate plan can allow a married couple to shelter up to a total of $4 million from estate and GST taxation. To ensure that both spouses can fully utilize their exemptions regardless of the order of the spouses’ deaths, each should own property at his or her death in an amount at least equal to the applicable estate-tax and GST exemption amount. If one spouse does not have enough assets in his or her name alone, a gift from the wealthier spouse to the less wealthy one may be desirable. A gift by the wealthier spouse to a lifetime QTIP trust can accomplish this, since the remaining trust property will be includible in the gross estate of the less wealthy spouse in the same manner as if it were owned directly by that spouse. � Restrictions on spouse’s control. Unlike an outright gift to a spouse, a lifetime QTIP trust allows the donor spouse to dictate (through terms in the trust instrument created by the donor spouse) the circumstances under which trust principal may be distributed to the donee spouse (although the donee spouse must always receive the trust income) as well as the people or trusts that will receive the trust property remaining at the donee spouse’s death. This can be particularly helpful in the case of a second marriage or a blended family. If the donor spouse wishes to give the donee spouse a degree of flexibility over who will receive the remaining property, the donor spouse could include a limited power of appointment in the trust instrument. � Retained income interest. In drafting the lifetime QTIP trust, one should consider the possibility that the donee spouse will predecease the donor spouse. Frequently, the donor spouse will be keenly interested in having the trust instrument provide that the donor spouse will become a trust beneficiary upon the donee spouse’s death and have a limited power of appointment over any trust property remaining at the donor spouse’s subsequent death. Treasury Regulations and an Internal Revenue Service (IRS) private-letter ruling appear to be favorable in allowing such retained interests without creating adverse estate-tax consequences. Under Treasury regulations � 25.2523(f)-1(f) (Example 11), if the lifetime QTIP trust property is includible in the donee spouse’s estate, the donee spouse will then be treated as the transferor for estate-tax purposes, thereby enabling the donor spouse thereafter to receive an income interest in the property without the interest being includible in the donor spouse’s gross estate under Code � 2036 or � 2038 (although the interest would be includible in the donor spouse’s estate if the property qualified for the estate-tax marital deduction in the donee spouse’s estate). The IRS confirmed this result in Private Letter Ruling 200406004 (Feb. 6, 2004), a ruling that extensively discusses the tax aspects of a retained interest by the donor spouse that begins at the donee spouse’s death. While the donor spouse’s retained right to the income of the trust should not cause the trust assets to be included in the donor spouse’s gross estate, query whether the donor spouse’s creditors could reach the interest after the donee spouse’s death (as discussed below). The claims of creditors � Creditor protection. Finally, a lifetime QTIP trust may offer protection against the claims of creditors of both the donor and the donor’s spouse. Gifts to spouses frequently are motivated, at least in part, by a desire to protect the transferred assets from future creditors of the donor. In general, creditors of one spouse cannot satisfy claims by reaching assets held solely in the other spouse’s name. This general rule does not apply, however, to joint debts, and may not protect assets held in community property states. While creditor protection is a legitimate element of careful estate, financial and business planning, any transfer to a spouse-outright, in trust, or otherwise-should take into consideration federal bankruptcy laws and state nonbankruptcy laws, including fraudulent transfer statutes, that could apply to the transfer. A donor’s gift to a lifetime QTIP trust generally offers the same creditor protection benefit (as to the donor spouse’s creditors) as a direct gift to the donee spouse, at least during the donee spouse’s lifetime when the donor spouse has no right to receive distributions of trust income or principal. As noted above, if the donee spouse dies and the donor spouse becomes a trust beneficiary, perhaps creditors of the donor spouse can thereafter reach the trust assets. Under the laws of most states, the “self-settled trust doctrine” dictates that when a person creates a trust for his or her own benefit, his or her creditors can reach the maximum income or principal amount that the trustee could pay to the donor spouse. Although for estate-tax purposes the death of the donee spouse causes that spouse to be treated as the donor, this rule may not apply in a nontax context. An additional advantage of a QTIP trust is that it offers some protection from claims of creditors of the donee spouse. If both spouses are in businesses or professions with exposure to creditor claims, the lifetime QTIP trust may be an attractive option that is materially better than a direct gift. Because the trust must be drafted so that no one other than the donee spouse may benefit from the trust during the donee’s life, the individuals or entities that are excluded from benefiting from the QTIP trust includes the donee spouse’s creditors. Thus, the lifetime QTIP trust should include a spendthrift provision, which would prohibit any voluntary or involuntary (such as bankruptcy) assignment of a beneficiary’s interest in the trust. Because the donee spouse is entitled to the income of the trust, however, that spouse’s creditors could reach the income each time it is distributed. The divorce drawback The possibility of divorce may discourage some donors from creating a lifetime QTIP trust. In that event, the donee spouse must still be entitled to the income of the trust; if not, it would not have qualified as a QTIP from inception. The trust could dictate, however, that the trustee’s power to invade principal (but not income) for the surviving spouse’s benefit terminates upon divorce. Any interspousal asset transfer could affect the rights and obligations of the parties in the event of a subsequent divorce. A donor considering a large gift to a spouse, in trust or otherwise, may want to discuss the issue with a qualified divorce attorney. In sum, the lifetime QTIP trust can be a valuable estate-planning technique. Donors considering transfers to spouses may find that it offers significant advantages over outright spousal gifts. Kurt Steinkrauss and Peter Miller are members, and Sara Condon is an associate, in the private client section of the Boston office of Mintz, Levin, Cohn, Ferris, Glovsky and Popeo.

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