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Monday, October 03, 2016

No Later Voiding of Unnecessary QTIP Elections if Portability Elected


Rev. Proc. 2016-49


    • A QTIP election, once made, is irrevocable. The election has various implications, including:
      • GOOD: Allowance of the marital deduction.
      • ADVERSE: §2044 includes the QTIP trust property in the gross estate of the surviving spouse, and §2519 will take dispositions of the QTIP trust property.
      • ADVERSE: Absent a "reverse QTIP" election under §2652(a)(3), the surviving spouse is treated as the transferor of the property for GST purposes under §2652(a).
    • A decedent's estate should be able to make a QTIP election even though one is not needed (e.g., adequate unified credit would allow for no estate tax even without the election). See the discussion on this below. If unneeded, the above adverse consequences still apply.
    • Rev. Proc. 2001-38 provides that the election will be void and the above adverse consequences will NOT apply if the election was not needed to reduce the estate tax liability to zero, and the procedures of the Revenue Procedure are followed. Note that the procedure does describe various circumstances when it will nonetheless not apply.


    • The voiding procedures of Rev. Proc. 2001-38 are not available if a portability election is made (unless the DSUE amount is zero, or in other limited circumstances).
    • In estates in which the estate makes the portability election, QTIP elections will not be treated as void.


    • The premise of Rev. Proc. 2001-38 was that no one would intentionally make an unneeded QTIP election, since the adverse effects are significant. With portability, this is not the case. For example, the adverse effects may be mitigated or eliminated - the surviving spouse may have an enhanced gross estate but is also now receiving the DSUE amount to reduce or eliminate future transfer tax on it. Therefore, with portability the adverse effects are ameliorated or eliminated, so it is no longer appropriate to allow for automatic voiding of the QTIP election when it was unneeded to reduce estate tax at the first spouse's death.
    • With portability, at times it may be advantageous to make an unnecessary QTIP election for what would otherwise be an exempt credit shelter trust. For example, by including the bypass trust in the gross estate of the surviving spouse, its assets can now receive a basis step-up at the death of the second spouse - that would not be the case if the trust was an exempt bypass trust. This is more the case for lower value estates where growth in the QTIP trust is not projected to put the surviving spouse's estate into a taxable situation. The estate tax cost of inclusion under §2044 is offset, at least in part,  by the DSUE amount coming over. Thus, this ruling may be a boon to some taxpayers.
    • By affirmatively making an unnecessary election in combination with portability, can the IRS nonetheless void the election of its own accord if it provides an advantage to the surviving spouse's estate, like the above basis step-up? Clearly, the IRS may want to void it, since it provides a basis step-up for what would otherwise have been a by-pass trust. Both the old and the new procedures are relief provisions for taxpayers, and require them to undertake steps to come within them to void the election - they really don't address what the IRS can do on its own motion. The procedures imply that if the taxpayer takes no action, then the QTIP election remains in force. Rev. Proc. 2001-38 was silent on the issue whether the IRS could void the election on its initiative  - that makes sense since there was little reason for it to do so. Now, however, the IRS may want to do so to remove the above basis step-up effect.  Can it do so, even though the taxpayer cannot? The 2016 procedure contains the language "In estates in which the executor made the portability election, QTIP elections will not be treated as void." Clearly, this means the taxpayers cannot use the voiding procedures to later take a second look at the situation and decide to void the prior QTIP election, and that makes sense. But should this be read as a commitment by the IRS that it won't void the election as unnecessary on its own initiative and motion - or just that the taxpayer cannot gain the relief of voiding an election in these circumstances? There are many who think the procedure is a statement by the IRS to not act on its own motion to void, but perhaps that quoted sentence applies only in context of the procedure - i.e., TAXPAYER requests for relief - since the IRS would not need to use the procedure to void then that statement may have no applicability?
    • If the IRS does challenge such a QTIP election, could it prevail in its challenge? It would be difficult, since there are only 3 requirements to make a QTIP election, and none of them relate to whether it is needed to reduce estate tax. For more on this question see the article of Austin Bramwell, Brad Dillon and Lisi Mullen here.
    • Note that taxpayers can still get the same basis step-up and transfer of DSUE without these issues by leaving the assets of the first spouse outright to the surviving spouse.  But they cannot do so when a trust for the surviving spouse is desired (e.g., for asset protection, spendthrift, or remarriage purposes), so the procedure is valuable for supporting this tax planning opportunity when a trust is desirable.  Of course, making a QTIP trust election for the bypass trust comes with other potential adverse consequences, and thus may not often be desirable. For example, if the bypass trust is expected to materially appreciate in value, making the QTIP election exposes that appreciation to estate tax at the second spouse's death if available unified credit amounts are exceeded, as well as potential generation skipping tax.


QTIP, portability, marital deduction

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