QTIP Trust Elections: Why Timely Filing of Estate Tax Returns Matters

A missed estate tax election can have significant income tax consequences years later

A Qualified Terminable Interest Property (QTIP) trust can be an important estate and income tax planning tool for married couples. However, obtaining the intended tax treatment requires more than establishing a trust that qualifies as a QTIP. A QTIP election generally must also be made on a timely filed Estate Tax Return (Form 706).

Filing Form 706 is intensive, and this filing may be overlooked when an estate’s value is below the federal estate tax filing threshold, which is currently $15,000,000 per spouse. However, missing the QTIP election can result in significant income tax implications for heirs upon the passing of the surviving spouse.

Why the QTIP Election Matters

When a QTIP election is made on Schedule M of Form 706 filed for the first-to-die spouse, the trust property is generally included in the surviving spouse’s gross estate. This estate tax “inclusion” generally allows the property to receive a basis step-up adjustment when the surviving spouse dies.

For appreciated assets, that basis adjustment can significantly reduce the capital gain recognized by heirs when the assets are later sold.

QTIP Election May Still Be Beneficial When Form 706 Is Not Otherwise Required

The QTIP election can be particularly important when the first spouse’s estate is below the federal estate tax filing threshold.

For example, assume the first spouse passes away and most of the assets pass under the estate plan to a marital trust that otherwise qualifies as a QTIP trust. Because the estate is below the filing threshold, no Form 706 is required to be filed. Without filing a Form 706, the QTIP election is not made.

When the surviving spouse passes away and the trust holds significantly appreciated assets, the missed election can become costly for the heirs since the assets do not receive a step-up in cost basis for inherited assets.

What Happens If the QTIP Election Is Missed?

A missed QTIP election does not necessarily mean that there are no options. In certain circumstances, a late Form 706 may be filed to make a missed QTIP election.

If a late Form 706 is not permissible, relief may also be available under Treasury Regulations Section 301.9100-3. Obtaining this relief generally requires requesting a private letter ruling from the IRS. Relief is not automatically granted and depends on the specific facts and circumstances.

Even when an estate is below the federal estate tax filing threshold, executors and their advisors should consider the long-term income tax implications of marital trusts, potential appreciation of assets, and the available post-mortem Form 706 elections. Reviewing these considerations after the first spouse’s death can help to preserve valuable tax benefits and avoid unexpected tax consequences in the future.

Keiter’s tax professionals can help individuals and families evaluate estate and trust tax considerations, including elections that may affect future tax treatment. Contact your Keiter Opportunity Advisor to learn more.