Trust Modification
Sometimes a sound estate plan may need to be modified after it is put into effect. One such situation was recently outlined in Private Letter Ruling 202504006 from the IRS.
Decedent’s estate plan called for the creation of two trusts, a Marital Trust for the surviving spouse and a Decedent’s Trust. Although the Ruling doesn’t mention it, the Decedent’s Trust was likely funded so as to fully consume the Decedent’s federal estate tax exemption while avoiding being included in the taxable estate of the surviving spouse. With the unlimited marital deduction, there was probably no federal estate tax due at Decedent’s death.
The Marital Trust was a Qualified Terminable Interest Property (QTIP) trust, which meant that the surviving spouse could not change the final disposition of the trust assets. The trust beneficiaries arranged under state law to divide the QTIP trust into two nearly identical trusts, leaving all income and remainder interests intact. The difference was that Trust 1 would be funded to take full advantage of the surviving spouse’s federal estate tax exemption, and Trust 2 would hold the balance of the assets.
The next step was for the surviving spouse to disclaim her entire interest in the newly created Trust 1. This was a transfer subject to the federal gift tax. By doing so, the surviving spouse consumed her entire federal estate and gift tax exemption—she “locked in” the exemption, and will not lose should Congress decide to lower the exempt amount in the future.
The questions presented to the IRS were whether these actions required the recognition of gain or loss for income taxes, whether Trust 2 continued as a valid QTIP trust, whether the spouse would be treated as having made a transfer to Trust 2, and what the tax effects will be when the spouse dies. Happily, for this estate, there were no adverse tax determinations.
No numbers were presented in the Ruling, but it seems likely that this estate saved millions of dollars in estate tax obligations with this modification.
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