Problems Foreseen with Estate Taxes for QTIP Trusts

A tax attorney is sounding a warning about some unfavorable estate tax consequences for surviving spouses in many states across the country from the use of so-called “QTIP trusts.”

Seymour Goldberg, senior partner at the law firm Goldberg & Goldberg in Woodbury, N.Y., contacted Treasury Secretary Jacob Lew and officials with the Internal Revenue Service earlier this year about the problem. In his letter to the Treasury, Goldberg—who is a CPA—warned about how the problem could jeopardize the tax treatment of qualified terminable interest property, or QTIP, trusts.

“It appears, based upon certain state trust law changes in many jurisdictions, that the state trust laws as modified may adversely affect estate plans throughout the United States,” he wrote.

He noted that the issue can arise when a QTIP trust holds an interest in a limited liability company or in a partnership and suggested it could be resolved by the IRS by means of a Revenue Ruling so practitioners could advise their clients accordingly.

Goldberg pointed out that many estate practitioners provide that a decedent’s interest in a limited liability company or partnership interest be held in trust. The trust thus provides for a mandatory income interest to be paid to the surviving spouse at least annually for QTIP trust treatment.

A mandatory income interest under the Uniform Principal and Income Act, or UPAIA, which has been adopted by most jurisdictions around the country, “means the right of an income beneficiary to receive net income that the terms of the trust require the fiduciary to distribute.” According to the UPAIA, if a limited liability company or partnership makes a distribution to a trust, it is for the most part considered to be income, except when money is received in partial liquidation, Goldberg noted, while money received in partial liquidation is considered to be principal.

“The issue is triggered when the trustee receives a K-1 from an interest in a limited liability company or partnership in an amount that is greater than the actual cash distribution from the interest in said entities,” he wrote. “For example, a K-1 of $100,000 is issued to the trust from a limited liability company and the cash distribution is only $30,000. In many jurisdictions, but not all, the $30,000 distribution is not paid to the income beneficiary and is used by the trustee to pay the income tax liability on the $100,000 K-1. In other jurisdictions, the $30,000 gets paid to the trustee income beneficiary and the trustee pays income tax on $70,000 while the beneficiary pays income taxes on the $30,000 distribution amount. My concern is that most jurisdictions are amending their statutes to preclude the $30,000 from being paid to the mandatory income beneficiary. This may jeopardize QTIP trust treatment in these jurisdictions.”

If the mandatory income beneficiary is the surviving spouse, then a spouse in most jurisdictions would not receive the $30,000 of accounting income, Goldberg pointed out, which seems to be in conflict with the QTIP trust rules.

“From a practical point of view the majority of jurisdictions are concerned about the fact that the trustee may not have a sufficient amount of cash to pay the income tax liability on the phantom income that is triggered when the K-1 and the cash distributions are not the same,” he added.

On Thursday, the American Bar Association published a book by Goldberg, “Can You Trust Your Trust? What You Need to Know about the Advantages and Disadvantages of Trusts and Trust Compliance Issues,”  which examines the benefits and pitfalls of creating and administering a trust for an estate, especially as states revamp their trust laws in response to the UPAIA and other laws.

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Financial planning Wealth management Estate planning Tax planning
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