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In a recent private letter ruling, the IRS allowed a surviving spouse to refuse part of his inheritance without compromising the qualified terminable interest property (QTIP) status of the inheritance he received.
A QTIP is a marital-deduction trust in which the surviving spouse receives income from the trust's assets for life, but the trust's principal is left to someone else, usually children. A QTIP trust controls the eventual beneficiaries while at the same time taking advantage of the marital deduction and providing an income for the surviving spouse.
In the ruling (PLR 201118007), a decedent was survived by a spouse and two children. All three were beneficiaries of a trust established under the decedent's will (the marital trust). Under the terms of the trust, the trustees would pay to the surviving spouse all the net income from the marital trust in annual or more frequent intervals during the surviving spouse's life. The trustees could also distribute principal to the surviving spouse as they deem necessary for health, support and maintenance.
At the death of the surviving spouse, the remaining assets are to be distributed as directed by the surviving spouse among the two children. In the absence of a directive from the surviving spouse, the assets of the marital trust will be divided equally among the then-living children and the heirs of any then-deceased children.
The executor timely and properly elected to treat the marital trust as qualified terminable interest property.
The surviving spouse is the sole trustee of the marital trust. As trustee, the surviving spouse plans to file a petition with a competent state court, requesting an order to sever the marital trust into two trusts. Trust 1 will contain assets to fund separate trusts for the benefit of the children, as well as to pay all gift taxes. The remaining assets will fund Trust 2 and will remain in place for the benefit of the surviving spouse under the same terms as the marital trust.
After the severance, the surviving spouse intends to make a qualified disclaimer of the entire interest in Trust 1, resulting in the disclaimed property passing equally into trusts for the children.
Provided a court of competent jurisdiction approves the severing of the trust, and the surviving spouse's disclaimer is effective under state law, the IRS issued several rulings:
* Trust 1 and Trust 2 will continue to be QTIP trusts after the severance.
* The surviving spouse will be considered to have made a gift of a remainder interest in the assets in Trust 1, but not the assets in Trust 2.
* There will be no income tax consequences associated with the severance of the marital trust.
While private letter rulings can be relied on only by the taxpayer receiving the ruling, this ruling sets forth guidelines that others could follow to disclaim a partial interest in a QTIP trust.a
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