Trusts and Estates

Ca. Trs. & Estates Quarterly Volume 14, Issue 4, Winter 2008


By Adam F. Streisand, Esq. and Deborah J. Bross, Esq.*


The estate tax marital deduction in effect defers federal estate taxes on assets distributable to or (in the case of qualifying trusts) for the benefit of the surviving spouse. The deceased spouse’s assets provide economic security for the surviving spouse, and estate tax is paid on assets remaining when the surviving spouse dies. That deferral can be lost, however, and potentially ruinous gift taxes immediately imposed, if there is a transfer of even a small part of the surviving spouse’s interest in a QTIP trust. Moreover, this can occur even in circumstances where the transfer involves a bona fide, arm’s-length transaction, such as the settlement of litigation.

By way of illustration, consider the following commonplace scenario. A surviving spouse is embroiled in litigation with her husband’s children from a prior marriage. The children are contesting their father’s trust, which was amended to reduce the children’s interest in favor of the surviving spouse’s heirs. The trust is a QTIP trust. Its value is $1,000,000, of which $400,000 represents the current value of the spouse’s income interest. After protracted negotiations, the parties enter into a settlement agreement that requires a payment from the QTIP trust. Though not spelled out in the agreement, because the funds paid to the children are no longer subject to the trust, the surviving spouse has in effect transferred her income interest in the funds to the children. The agreement includes broad releases all around. The surviving spouse is relieved that the case is finally settled, and may even be congratulating herself on its modest cost. She will probably be shocked, however, to learn that the tax treatment is as follows:

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