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New York estate planning: what is a QTIP trust?

The term “QTIP” is shorthand for qualified-terminable-interest-property trust, a legal vehicle used through which property of one spouse can provide lifetime income to the other, usually after the death of the first spouse, with significant tax advantages. QTIPs make sense for married people of substantial wealth who would otherwise be subject to estate taxes.

QTIPs are often used in a second or subsequent marriage when a husband or wife wants to provide income for his or her spouse until death, but then would like that property to pass to children from a previous marriage.

The basics

A trust is a legal arrangement when a property owner transfers the assets to the control of another person, called the trustee, to use and distribute for the benefit of a third party or parties, called the beneficiaries. In a QTIP trust, the property of one spouse is put into the trust at his or her death (the QTIP is created by his or her will) and the other spouse gets during his or her lifetime all of the income generated by the trust property (such as interest income), taken at least once per year.

The spouse who created the trust may designate how the trust property is to pass at the time of the second spouse’s death, often to the first spouse’s children from a previous relationship.

The marital deduction

In such a blended family, the Q-tip allows the property-owning spouse to provide for the care of his or her second spouse without in effect disinheriting children from previous marriages. In tax terms, the Q-tip by definition qualifies for the federal marital tax deduction, reducing taxes when property is transferred between spouses either during their lifetimes or at the death of one of them. The marital deduction is taken by the executor of the deceased spouse’s estate in the case of a Q-tip arrangement, and the election is may not be revoked.

The marital deduction allows a surviving spouse to receive and use property from the deceased spouse without paying estate taxes on it, which are in effect deferred until the demise of the surviving spouse.

Another benefit of a Q-tip is that in most instances the assets are protected from both spouse’s creditors to satisfy debts.

Whether a Q-tip should be considered depends on the level of wealth of each spouse and whether it reaches the amount subject to federal, or state, estate taxes. In 2012, federal estate taxes kick in when taxable assets of an individual spouse reach $5.12 million. Smaller estates are exempt. If Congress does nothing to change things, in 2013 the exempt amount will become a much lower $1 million.

State estate tax exemption levels should also be considered. For example, the New York 2012 estate tax exemption is $1 million.

This article only touches on the basics of Q-tips. The law surrounding their use is complex and a knowledgeable lawyer should be consulted with questions. Anyone married with substantial assets should discuss with an experienced estate planning attorney whether a Q-tip makes sense.