9122 / How can members of a blended family use trusts in estate planning to fully use the exemption of both spouses when relying on portability is undesirable?

As discussed in Q 9120, many individuals in a second or subsequent marriage may not wish to rely on portability in order to make use of both spouses’ federal estate tax exemption amounts. If the first-to-die spouse were to leave all assets outright to the surviving spouse (in order to take advantage of portability), that surviving spouse would have total control over those assets, including the ability to disinherit children from a prior marriage or even leave the first-to-die spouse’s assets to a new spouse.

In this case, an inter vivos trust may be desirable, as it can allow the first-to-die spouse to control the ultimate disposition of his or her assets, and can also provide the spouse with income during life.

One example of such a trust provides the less wealthy spouse with a testamentary general power of appointment over the trust assets in the amount necessary to use that spouse’s estate tax exemption if he or she is the first-to-die spouse. This type of trust can also continue to provide the grantor of the trust (the wealthier spouse) with income rights during life. These trusts can be revocable, so as to provide protection in the event of a divorce.¹ One downside to these types of trusts is that the power of appointment allows the poorer spouse to provide an inheritance to whomever he or she chooses (this feature avoids gift tax issues that would otherwise arise to make the trust structure undesirable).

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Planning Point: Because these types of trusts are not specifically approved by IRS regulation, competent professional advice must be sought out in order to weigh the potential risks and benefits of the many available types of trust structures.

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A joint revocable trust is another type of revocable trust that can be used to ensure both spouses’ exemptions are used, but this type of trust requires both spouses to contribute the assets (in the case of wealth disparity, this would mean that the wealthy spouse makes gifts to the poorer spouse to fund the trust).

With both of these types of trust, a risk also exists that the IRS will determine that one spouse actually made the gift after his or her spouse’s death, causing potential problems in claiming the marital deduction. While a lifetime power of appointment may avoid this problem, it causes another in that the poorer spouse then has the lifetime power to appoint to whomever he or she chooses, unless the spouses agree that the spouse either exercise the power immediately in writing (with testamentary effect, becoming effective on the wealthier spouse’s death) or release the power. Because of these complications, many individuals prefer to use the qualified terminable interest property (QTIP) trust structure, which is governed by specific IRS regulations, discussed in Q 9123 and Q 9124.