ABC Credit shelter and QTIP trusts

ABC Credit Shelter And QTIP Trusts

Under current law, a person can pass any size estate to his or her U.S. citizen spouse without concern for a federal estate tax because of the unlimited marital deduction. IRC Sec. 2056

However, when the surviving spouse later dies and passes the combined estate to his or her heirs, there is only that spouse's unified credit to reduce the death tax. Therefore, the unified credit of the first spouse to die was wasted.

To preserve the unified credit of the first spouse to die, many couples use a credit shelter trust (also called an "exemption" or "by-pass" trust). When the first spouse dies, an amount equal to the unified credit' is placed into the shelter trust. It is not taxed at that time nor at the later death of the surviving spouse, even though it may appreciate great-ly in value.

The surviving spouse, however, can have access to the income from the trust for life and can use the principal if necessary for his or her health, education, support and maintenance.

Sometimes a third trust, called a QTIP (or ABC) trust, is added to the AB Trust. QTIP means "qualified terminable interest property trust." The QTIP allows the first spouse to die to give lifetime benefits (like income earned on the trust assets) to his or her spouse while still retaining the right to name the persons who will ultimately receive the trust assets.

This trust is particularly useful in protecting children of a prior marriage from being cut off by the surviving stepparent spouse.

It also reduces the possibility of the estate passing to a subsequent marriage partner or "close friend" of the surviving spouse.

Careful drafting is required to make certain the QTIP trust qualifies for the marital deduction. Special language may be required if the QTIP trust is the beneficiary of an IRA. See Rev. Rul. 89-89, 1989-2 C.B. 23 1.

Estates of married couples which are less than the applicable exclusion amounts now (including life insurance), and are not likely to exceed these amounts in the future, will generally not benefit taxwise from this type of trust.

For 2000 and 2001, $675,000 is the amount of assets protected by an individual's unified credit. The amount of assets protected by the unified credit is termed the "applicable exclusion amount." This amount will change each year, as follows: $700,000 in 2002 and 2003; $850,000 in 2004; $950,000 in 2005; $1,000,000 in 2006 or thereafter. The amount which could be placed in the trust may be higher if the decedent held any qualified family-owned business interest property.