Shelfer died, leaving two
separate trusts. The income from each trust was to be paid to his wife
The first trust consisted of
one-third of the estate and was covered by the marital deduction.
The second trust consisted
of two-thirds of the estate and terminated upon Lucille's death. At that
point it went to Shelfer's niece Betty.
A trust/gift to a spouse
that goes to someone else after a contingency occurs (like death of the
spouse) is called a terminable interest.
Lucille couldn't take any
of the principle or the interest from this trust. She just sat on it.
The bank filed a tax return on
behalf of the estate. It claimed a deduction for half the assets in the
second trust under the Federal qualified terminable interest property
trust (QTIP) Statute (26 U.S.C.
2056(b)(7)), and the IRS allowed the deduction.
A QTIP allows for a trust to
qualify for the marital deduction
even though it is a terminable interest.
If the trust was a valid
QTIP, then the taxes get paid out of Lucille's estate. If it is not a
valid QTIP, then the taxes are paid out of Shelfer's estate.
Lucille died. The bank filed
a tax return that did not include the assets of the QTIP trust. The IRS
audited and demanded $$$.
After Lucille died, but
before the estate was probated, the QTIP continued to generate income
(aka stub income).
Since the trust technically
terminated upon the death of Lucille, this stub income was not under the control of Lucille and
therefore the entire trust was not valid as a QTIP.
The IRS claimed that the
assets of a QTIP trust are taxable upon the death of the surviving
Lucille's estate turned
around that argued that the trust did not meet the statutory definition
of a QTIP.
Because Lucille was never
given power of appointment of the trust, and could never take any of the
The Tax Court found for
Lucille's estate. The IRS appealed.
Under 26 U.S.C. 2056(b) it explicitly says that in order to qualify
as a QTIP "the surviving spouse is entitled to all the income from
the property, payable annually or at more frequent intervals."
Lucille argued that under
the plain meaning of the Statute, it wasn't a QTIP because she didn't
have control over the stub income.
The Federal Appellate Court
reversed and found for the IRS.
The Appellate Court found
that there were two purposes to QTIP:
Treating the married couple
as one economic unit
Expanding the marital
deduction to include arrangements
that divest the surviving spouse of control over the property.
The Appellate Court found
that both of these goals were best accomplished by allowing the marital
deduction in the decedent's estate
and then requiring subsequent inclusion in the surviving spouse's estate
when trust documents do not grant control over the stub income to the surviving spouse.
The basic purpose of a QTIP is
so the decedent can provide for their surviving spouse via interest
income, and still leave the principle to their children/heirs.
Before QTIP, the only thing
that qualified for the marital deduction was $$$ you completely 100% gave to the surviving spouse. But
this left the children (especially children from a previous marriage)
unable to inherit.