Making a lifetime gift of the $1,000,000 federal gift tax exemption amount can substantially reduce estate taxes. Appreciation and income from the gifted property between the date of the gift and the donor’s death can escape federal transfer taxes. My clients are generally unwilling to make such a gift because it would require the payment of Tennessee gift taxes. A second problem is that the donor loses access to the income from the gift.
A Tennessee QTIP Trust™ provides an opportunity for making a lifetime gift without paying Tennessee gift tax while retaining indirect access to the income through your spouse. A Tennessee QTIP Trust™ is a trust that would qualify for the federal gift tax marital deduction but for which the donor elects not to make a QTIP election on the federal gift tax return. The donor does make the QTIP Trust election on the Tennessee gift tax return.
The Tennessee QTIP Trust must make income available to the donee spouse. Rather than requiring income to be paid to the spouse, the spouse should be given the right to withdraw income. There are two benefits from using the right to withdraw income as opposed to the mandatory payment of income. First, to the extent that income accumulates in the trust, it will escape federal transfer tax. The second benefit is that either the donor spouse or the donee spouse will be required to pay federal income taxes attributable to trust income even though the income remains in the trust. Thus, the trust is able to grow in value on a pre-tax basis.
The donor spouse should not have a successor life estate or discretionary principal interest following the death of the donee spouse. This would cause estate tax inclusion for the donor spouse.
The downside with a Tennessee QTIP Trust occurs when the donee spouse predeceases the donor spouse. If the value of the trust upon the donee spouse’s death exceeds the $1,000,000 Tennessee inheritance tax exemption, the donee spouse’s estate will pay Tennessee inheritance tax. This means that some transfer tax will be paid prior to the death of the survivor. Because the lifetime Tennessee QTIP Trust will exhaust the donee spouse’s Tennessee inheritance tax exemption, the donee spouse’s Will should establish a testamentary Tennessee QTIP Trust (as opposed to a traditional credit shelter trust) for the donee spouse’s federal estate tax exemption amount.
Due to the potential Tennessee inheritance tax upon the death of the donee spouse, and the necessity of the donee spouse’s establishment of a testamentary Tennessee QTIP Trust, it may be advisable for the spouse with the shortest life expectancy to be the one who establishes the lifetime trust. Access to income will also be preserved if the survivor is the donee spouse. Nevertheless, the greatest benefit from accelerating the use of the federal gift tax exemption will occur if the trust is established by the spouse with the longest life expectancy.
A Tennessee QTIP Trust™ can reduce estate taxes while allowing the donee spouse to retain access to the income and corpus of the trust.