A spouse could make a gift to a “QTIPable” trust for the other spouse. Advantages of this planning approach include the following:
a. Defer Taxable Gift Decision. The grantor can defer the decision of whether to
treat the transfer as a taxable gift utilizing the grantor’s lifetime gift exemption amount (or requiring the payment of current gift taxes) until the grantor’s gift tax return is filed (possibly until October 15 of the following calendar year). If the grantor decides that it would be best not to make a taxable gift, the grantor would make a QTIP election so that the transfer qualifies for the gift tax marital deduction (in which event the trust assets will be included in the donee-spouse’s estate for estate tax purposes). If the grantor decides to treat the transfer as a taxable gift (using up gift exemption or requiring the payment of gift tax), the QTIP election would not be made. For example, if the assets decline in value substantially the grantor may decide not to treat the transfer as a taxable gift using up gift exemption based on the higher date of gift value.
b. Formula QTIP Election as Defined Value Approach. Though untested by cases
but apparently allowed by regulations, a formula QTIP election may allow the grantor to limit gift tax exposure to a desired specified amount. In effect, this would have the same advantages of defined value clauses, and would be based on provisions in regulations allowing formula QTIP elections. See Treas. Reg. §§20.2056(b)-7(b)(2)(i) & 20.2056(b)-7(h) Exs. (7-8). For a discussion of the mechanics of making a formula election, see Tech. Adv. Memo. 9116003 (discussing validity of QTIP election of "an amount from the assets ... equal to the minimum amount necessary to reduce the federal estate tax payable as a result of my death to least amount possible …").
c. GST Exemption Allocation. There is flexibility to allocate the grantor’s GST
exemption (by making a “reverse QTIP” election under §2652(a)(3)), to allocate the spouse’s GST exemption, or not to allocate any GST exemption to the trust. This decision can be deferred until when the gift tax return is due (possibly until October 15 of the following year).
d. No Clayton QTIP For Inter Vivos QTIPs. The “Clayton regulation” provides that
for testamentary transfers, the instrument can provide that the portion of the assets for which the QTIP election is not made may pass to a trust having different terms than the required terms for a QTIP trust — including a trust that would be similar to a standard “bypass trust” for the spouse and descendants and that would not be in the spouse’s estate for estate tax purposes. However, there is no similar regulation that clearly applies for gift tax purposes for inter vivos transfers. The Clayton provision in Treas. Reg. §20.2056(b)-7(d)(3) appears only in the estate tax regulation — it is not also in the similar gift tax regulation, Reg. §25.2523(f)-1(b). Indeed, if a Clayton provision added other beneficiaries if the QTIP election is not made, it would seem that the gift would not be complete in the year of the original transfer — because the donor would retain the power to shift benefits among beneficiaries until the gift tax return filing date has passed. (Conceivably the gift would never become complete during the donor’s lifetime because the return making the election would always be due the following year, thus extending the completion of the gift to the following year, extending the due date of the return to the year after that, etc.)
25. Gift Strategies That May Benefit Grantor and/or Grantor’s Spouse — Retained Income Gift Trust
The “Retained Income Gift Trust” (RIGT) is an idea that has been suggested for making a completed gift, retaining the right to the income from the trust, and shifting future appreciation so that it is excluded from the grantor’s gross estate. The income itself would be distributed back to the donor resulting in a “leaky” freeze, but if the assets are invested for capital appreciation the income might be relatively small.
Advantages. If the strategy works as intended, when the grantor dies, the grantor would
not be treated as having used up any of his or her estate tax exemption amount and there would be a stepped up basis for the trust assets. Furthermore, any gift taxes paid more than three years before the grantor’s death would also be removed from the estate. The plan has been suggested by Igor Potym (with VedderPrice P.C. in Chicago, Illinois) and was discussed by Richard Covey in the mid-1990s. Igor describes the plan: There is another type of irrevocable trust where the grantor is a beneficiary, a retained income gift trust (RIGT), that seems attractive now. Donor makes a gift and retains an income interest (but not a principal interest) for life.The trust is a completed gift and the retained income interest does not reduce the gift because it is not a qualified interest under section 2702. This looks a lot like a pre-chapter 14 GRIT, except it lasts for life and we now have section 2702.
The trustee is given discretion to distribute principal to descendants at any time and typically will strip off appreciation, keeping the trust at its original gift value. When the grantor dies, the trust is included in his gross estate. Because it is included, the gift is not treated as an adjusted taxable gift and therefore no unified credit is wasted. The assets get a stepped-up basis. The principal that was distributed to descendants during the grantor's life is not included in the gross estate and is not an additional gift because the gift was complete on day one. In effect, this is a freeze with respect to appreciation in excess of the gift, whether the gift is $5,120,000 or greater. Also, if gift tax is paid, the tax is excluded from the gross estate unless the three-year rule applies, but in such case all the assets of the trust get a stepped-up basis.
This trust can be used to deal with the claw back under section 2001(b), at least in part (upon death, it can qualify for the marital deduction).
In the mid 1990s, I ran this by Dick Covey and, with our permission, he mentioned it briefly in Practical Drafting (April 1997, at 4788-4789) and talked about it in Miami. He was convinced it worked. In fact, it has withstood audit every time. No agent has ever seriously questioned it, perhaps because the agents think it was a drafting mistake. I believe the technique works, possibly better than ever.
Think about the client who can't afford to make a $5,120,000 gift because he needs the income, but would love to shift future appreciation on this amount without incurring an estate tax at the death of the first spouse due to the claw back. Or, possibly even better, a client who makes a gift and pays gift tax. The gift tax is out of the estate, the grantor keeps the income from
principal remaining in the trust, the trust gets a stepped-up basis, there is no adjusted taxable gift at death because the trust is included in the gross estate, the estate tax on the trust is reduced by the gift tax paid dollar for dollar (in other words, inclusion in the gross estate does not generate any additional estate tax) and stripped off appreciation avoids estate tax.
Some commentators have suggested that the IRS might question whether the gift to the trust would properly be excluded from the estate tax calculation as an adjusted taxable gift under §2001(b) because the gift assets are included in the estate under §2036, in light of the fact that all appreciation of the gift assets are not being included in the gross estate.