Understanding the Reverse QTIP Election 

When you are navigating the reverse QTIP trust opening process, you can benefit from an attorney’s help. Wood Law Group can help you if you are in this situation. Call us today.

What Is the Reverse QTIP Election?

QTIP trusts, formally known as qualifying terminable interest property trusts, are becoming increasingly popular as an estate planning tool in the U.S., especially among married couples. However, even though the trust offers several benefits and tax advantages, those who create them are often oblivious to the fact that the trust could lead to liability for another federal tax-the generation-skipping transfer tax (GSTT). Hence, they fail to make adequate plans for it.

Generally, there are tax exemptions that could help minimize or avoid GSTT payments. However, because of the nature of QTIP trusts, the exemptions may be lost without proper estate planning. If that happens, the affected QTIP beneficiaries would need to pay the GSTT, which is assessed at 40 percent of the assets they receive. Paying the tax at that rate would seriously deplete the value of their inheritance.

Thankfully, the law allows for a procedure known as the special election for qualified terminable interest property or reverse QTIP election that undoes certain aspects of the QTIP trust. The election helps those affected utilize the maximum GSTT exemptions available and reduce or minimize the amount of GSTT they’d have to pay.

If you’re considering making a QTIP trust, it is important that you understand the circumstances in which your trust would lead to GSTT liability so you can make arrangements to include the reverse QTIP election in your estate plan. This guide explains how the reverse QTIP election works to help you understand whether you need one and how to navigate the election process. Keep reading to learn more.

QTIP Trusts: The Foundation of the Reverse QTIP Election

QTIP trusts help individuals who intend to leave property to their surviving spouses specify how the remainder of their assets will be distributed when the spouse dies. They generally have the following characteristics as prescribed by law:

  • The donor (trust maker) transfers specific assets or a portion of their estate to the trust for the benefit of the surviving spouse, who is the trust’s primary beneficiary.

  • By the terms of the trust, the donor gives their spouse a qualifying income interest in the property for life. This means that the primary beneficiary spouse can receive an income from the trust assets for as long as they live.

  • The donor also stipulates the final beneficiaries who will benefit from the trust assets after the primary beneficiary’s death.

  • Once the trust is created, the donor spouse ceases to be the owner of the trust assets and is deemed to have transferred such ownership to the primary beneficiary spouse.

  •  Upon the primary beneficiary’s death, the final beneficiaries will receive any assets left under the trust directly from the primary beneficiary’s estate as though the gift came from the primary beneficiary.

What the Reverse QTIP Election Does

The reverse QTIP election is an exception to the rule that QTIP trust assets are treated as belonging to the primary beneficiary. When the election is made, it allows the trust assets to be treated as belonging to the donor spouse. But it does not negate the trust entirely.

The election can only be made for GSTT purposes to minimize or avoid the tax when payable. It cannot be used for estate tax purposes or for any other type of tax. The property would still be treated as belonging to the primary beneficiary spouse in all those other cases.,

When Is the GSTT Payable?

According to the Internal Revenue Code, the generation-skipping transfer tax targets property transfers made to beneficiaries two or more generations younger than the person making the transfer (also called skip persons). 

For example, if you intend for your grandchildren or great-grandchildren to be the final beneficiaries of your QTIP trust, there is a good chance that the GSTT will apply. This is because you may have skipped more than one generation by passing over your children in favor of your grand and great-grandchildren, depending on their ages. In such cases, a reverse QTIP election could help them minimize or avoid the payment of the GSTT. 

The rules on generation-skipping transfers are complex; sometimes, it could be difficult to tell when a beneficiary qualifies as a skip person. If you have such concerns, you can seek clarity from a skilled Estate Lawyer in Las Vegas to help you understand your position and whether a reverse QTIP election would be appropriate in your case.

How Does the Reverse QTIP Election Help To Avoid the Generation-Skipping Transfer Tax?

Every U.S. resident has a Lifetime GSTT exemption. The exemption works by setting a threshold amount that changes each year ($12.92 million in 2023). Those who have them can avoid GSTT liability for generation-skipping transfers or gifts as long as the value of the transferred asset is below the exemption amount. For each of such transfers, the person making the transfer can continuously deduct the value of the transferred assets from their exemption amount until the exemption is completely used up. 

Because the exemption amount is high, many people do not use theirs up before they die. But the exemption is not transferable, so if a person has not completely used theirs up at the time of their death or when their estate is being executed, the exemption expires. 

How does all of this relate to your QTIP trust or the reverse QTIP? Ordinarily, because the final beneficiaries receive the trust property directly from the final beneficiary’s estate, they can only rely on the primary beneficiary’s lifetime exemption, if any, to discharge any GSTT liability for the skip person(s) among them. This could be problematic if the primary beneficiary’s exemption is unavailable for any reason. 

So, if you have not used up your GSTT exemption, the reverse QTIP election allows you to divert the unused portion toward the QTIP trust for the benefit of your final beneficiaries who qualify as skip persons instead of allowing it go to waste, regardless of whether or not the primary beneficiary’s exemption would be available to them.

 How To Make the Reverse QTIP Election

The reverse QTIP election is called an election because it is a choice or option made by the donor spouse’s executor while completing the appropriate section of IRS Form 706-United States Estate (and Generation-Skipping Transfer) Tax Return after the donor spouse’s death.

The election is irrevocable and cannot be undone. It must cover all the assets in the QTIP trust. Otherwise, it could be declared invalid by the Internal Revenue Service (IRS).  

The election must be made on the last estate tax return, which must be filed by the donor spouse’s executor within nine months after the donor spouse’s death. Failure to make the election within that time may render it invalid. So, as you prepare your estate plan or  Last Will and Testament, ensure you pick an executor who will follow your instructions diligently to avoid such issues.

Contact the Wood Law Group if You Have More Questions About the Reverse QTIP Election 

The reverse QTIP election can help QTIP trust beneficiaries avoid the GSTT if the person who made them beneficiaries is older by at least two generations. It can help protect your loved ones from excessive taxes and secure their future after your death.

However, since the election must be made when you are no longer around, you need to be proactive and leave specific instructions for your executors to follow. The ideal way to do this is to set up a comprehensive estate plan that considers your desires. 

The outstanding estate planning attorneys at the Wood Law Group are committed to helping people like you who seek to create a personalized estate plan that can be enforced for the benefit of their loved ones in their absence. We know how QTIP trusts and the reverse QTIP election work, and we can help you understand whether both options are right for you.

 So, if you have further questions on the subject or related estate planning issues, such as Living Trusts, do not hesitate to contact us. Let us help you as you work to secure the future of your loved ones and minimize their tax liability.