Tuesday, May 09, 2006


Some spouses desire that when they pass away, instead of their Individual Retirement Account (IRA) funds being made immediately available to the surviving spouse they want the IRA funds to be held in trust for the surviving spouse. This may be desireable where there are concerns about the surviving spouse’s ability to directly manage the IRA funds, or whether there is a desire to make provisions of the remaining assets to children after the death of the surviving spouse (including just to children of the first spouse to die, in a second marriage situation). By leaving the assets in trust instead of outright to the surviving spouse, the IRA and the trust must meet the special qualifications of the Code for the estate tax marital deduction - otherwise the IRS may become a taxable asset for estate tax purposes.

The usual method of qualifying a trust for a surviving spouse for the estate tax marital deduction is to qualify it as a Qualified Terminable Interest Property trust (commonly known as a "QTIP Trust"). One of the requirements that a QTIP Trust must meet is that all of its income must be distributable to the surviving spouse on an annual or more frequent basis. In the context of an IRA, the IRA and QTIP Trust must be arranged so that both the income of the IRA is distributed to the QTIP Trust annually, and then that income must be distributed to the surviving spouse.

In recent years, many States have adopted versions of the Uniform Principal and Income Act that modify traditional definitions of "income" for trust accounting and similar purposes. Such modifications include powers in the trustee to adjust receipts between income and principal, and unitrust provisions that define income as a fixed percentage of the annual value of the principal assets. The IRS in turn has issued regulations that will generally respect such "income" characterizations if certain requirements are met.

Consequently, there have been a lot of questions on how the new State law definitions of income interface with the requirements for distributing the income of an IRA and QTIP Trust in a manner that allows for the estate tax marital deduction. In Revenue Ruling 2006-26, the IRS has made some pronouncements that will help guide practitioners in this area.

Some of the key conclusions of the Revenue Ruling are:

a. If applicable State law alloallows for a power to adjust as provided for under the Uniform Principal and Income Act, trustee reallocations between income and principal of both the IRA and the QTIP Trust under those provisions will produce “income” that can be used to satisfy the QTIP Trust requirements;

b. If “income” is computed under the IRA or the QTIP Trust using State law unitrust provisions that meet the requirements of the Section 643(b) regulations, such computations will produce “income” that can be used to satisfy the QTIP Trust requirements;

c. If IRA “income” is computed using the provisions of the Uniform Principal and Income Act that characterize 10% of certain distributions as “income,” or that allow for an allocation to income to satisfy the estate tax marital deduction (e.g., Fla.Stats. §738.602(3) and (4)), computations of income under those provisions will NOT in and of themselves produce “income” that can be used to satisfy the QTIP Trust requirements.
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