Blended Families

March 13, 2024

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?

<div class="Section1">As discussed in Q <a href="javascript:void(0)" class="accordion-cross-reference" id="9120">9120</a>, 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.<div class="Section1"> 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.<a href="#_ftn1" name="_ftnref1">1</a> 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). <hr> 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. <hr> 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 <a href="javascript:void(0)" class="accordion-cross-reference" id="9123">9123</a> and Q <a href="javascript:void(0)" class="accordion-cross-reference" id="9124">9124</a>. See Q <a href="javascript:void(0)" class="accordion-cross-reference" id="9125">9125</a> for a discussion of “A-B trusts”. Q <a href="javascript:void(0)" class="accordion-cross-reference" id="9126">9126</a> discusses some of the potential uses of an irrevocable life insurance trust (ILIT). </div><div class="refs"> <hr align="left" size="1" width="33%"> <a href="#_ftnref1" name="_ftn1">1</a>.  For examples of these types of trusts, see Let. Ruls. 200403094 and 200604028. </div></div>

March 13, 2024

9124 / What are some of the considerations that should be taken into account when deciding whether to use an inter vivos or a testamentary QTIP trust?

<div class="Section1">The difference between an inter vivos and testamentary qualified terminable interest property (QTIP) trust is that the inter vivos trust is created and funded during the grantor’s life, while the testamentary trust only becomes effective at the grantor’s death (i.e., his or her will provides for creation of the trust). <hr /> Planning Point: Note that with an inter vivos QTIP trust, the trust documents can provide that the funding spouse will actually become the trust beneficiary if the less wealthy spouse is the first-to-die spouse. This option, however, still requires that the grantor not be given the right to amend, alter, revoke or terminate the trust.<a href="#_ftn1" name="_ftnref1">1</a> This strategy also carries the risk that the trust could be treated as a self-settled trust reachable by the grantor’s creditors. <hr /> An inter vivos trust can also provide asset protection to the couple while both spouses are still living. Further, an inter vivos QTIP trust is “defective” for income tax purposes for the lives of both spouses—this eliminates the need to file separate income tax returns for the trust. Property held in the inter vivos trust is valued separately from property held individually by the surviving spouse for his or her benefit. This generally means that if, for example, a portion of a piece of property is held in the QTIP trust and a portion remains outside of the trust, each portion of the property could potentially be eligible for any applicable valuation discounts that may be available.<a href="#_ftn2" name="_ftnref2">2</a> One primary disadvantage to the inter vivos QTIP trust is that it is not revocable upon divorce. Therefore, once created, the divorced spouse remains entitled to the benefit of the QTIP trust assets if he or she survives the trust creator. Despite this, the trust document can limit the trustee’s power to invade the trust principal by providing that such a discretionary right is available only if the beneficiary was married to the trust creator at his or her death. Prior to 2018, after divorce, income from the trust was includable only in the income of the beneficiary spouse.<a href="#_ftn3" name="_ftnref3">3</a> Because the testamentary QTIP trust only becomes effective at death, the grantor is able to modify his or her will following a divorce so that a prior spouse does not receive the benefit of the QTIP trust. <hr /> Planning Point: The 2017 tax reform legislation repealed IRC Section 682. Generally, the legislation modified the treatment of alimony payments with respect to divorces that occur after December 31, 2018, so that alimony will no longer be included in the income of the payee and deductible by the payor. Prior to its repeal, Section 682(a) provided that if a divorced spouse received income from a grantor trust (which would otherwise be taxable to his or her former spouse), the income would be taxable to the spouse receiving the payments. New IRS guidance provides that this rule will continue to apply if the divorce occurred on or before December 31, 2018 (unless the relevant instrument is modified to provide that the post-reform rule will apply). For divorces that occur after December 31, 2018, the grantor will now be taxed on income paid to the former spouse through the grantor trust. Because of this, spouses who create grantor trusts prior to or during the marriage should consider this issue, and potentially provide that the grantor trust will terminate upon divorce (or that the payor spouse will otherwise be reimbursed for taxes through other assets of the donee spouse). <hr /> </div> <div class="refs"> <hr align="left" size="1" width="33%" /> <a href="#_ftnref1" name="_ftn1">1</a>. Treas. Reg. § 25.2523(f)-1(d). <a href="#_ftnref2" name="_ftn2">2</a>. See, e.g., Estate of Mellinger v. Comm., 112 TC 26 (1999). <a href="#_ftnref3" name="_ftn3">3</a>. IRC § 682(a). </div>

March 13, 2024

9121 / What issues need to be weighed when a blended family is choosing whether to rely upon portability or trust options to ensure that both spouses’ estate tax exemptions are fully used?

<div class="Section1">As discussed in Q <a href="javascript:void(0)" class="accordion-cross-reference" id="9120">9120</a>, portability can allow a surviving spouse to take advantage of both his or her federal estate tax exemption and the exemption of the first-to-die spouse (the generation skipping transfer tax exemption is not portable). For some couples, portability is appealing because of its simplicity—the executor of the estate is only required to file an estate tax return and elect portability.<a href="#_ftn1" name="_ftnref1">1</a> Using portability to take advantage of both spouses’ estate tax exemptions also avoids the necessity of forming a trust, which can be expensive to establish.<div class="Section1"> However, if an individual does not wish to leave the bulk of his or her assets to the surviving spouse, a trust option can prove more effective for carrying out the individual’s wishes. Using trusts to provide for various family members’ inheritances can also help prevent family conflict after the first-to-die spouse’s death, as all heirs (including the surviving spouse, adult children and grandchildren) can be informed ahead of time to avoid unpleasant surprises that can lead to disagreement and even lawsuits. Using a trust instead of portability can also create adverse tax consequences, however. As a general rule, the basis of property that has been acquired from a decedent is the fair market value of the property at the date of the decedent’s death (i.e., the basis is “stepped up” or “stepped down,” as the case may be, to the fair market value for estate tax valuation purposes). When portability is elected, the assets in the estate receive two basis adjustments—one after the death of the first-to-die spouse and one after the death of the surviving spouse, assuming the assets remain in the surviving spouse’s estate. When the same assets are held in a trust, the assets do not receive a step-up in basis at the death of the surviving spouse (assuming they are excluded from the surviving spouse’s estate, which is the goal of many trust options in blended family situations). If the assets appreciate substantially in value between the deaths of the two spouses, receiving a second step-up in basis can result in tax savings.<a href="#_ftn2" name="_ftnref2">2</a> Further, if the family resides in a state that imposes its own estate or inheritance tax, federal portability rules will not apply to those state-level taxes. The rates, exemption levels and how these taxes are imposed can vary significantly from state to state (i.e., the rate can vary based upon who inherits the property). </div><div class="refs"> <hr align="left" size="1" width="33%"> <a href="#_ftnref1" name="_ftn1">1</a>.  IRC § 2010(c)(5); Treas. Reg. § 20.2010-2. <a href="#_ftnref2" name="_ftn2">2</a>.  IRC § 1014(a). </div></div>

March 13, 2024

9123 / What is a qualified terminable interest property (QTIP) trust and how can QTIP trusts be useful in planning for the blended family?

<div class="Section1">In many cases, an individual may wish to provide security for a surviving spouse during that spouse’s lifetime, but simultaneously wish to ensure that his or her children are the ultimate trust beneficiaries. In a blended family, this issue becomes even more pronounced because a surviving spouse may have his or her own children from a prior marriage, or may remarry and have additional children after a prior spouse has died. Unlike trusts that grant the poorer spouse a power of appointment over trust assets, a qualified terminable interest property (QTIP) trust provides the surviving spouse with only a lifetime interest in trust assets, helping to ensure that the first-to-die spouse’s wishes are carried out. Unlike the trusts discussed in Q <a href="javascript:void(0)" class="accordion-cross-reference" id="9124">9124</a>, however, a QTIP trust is irrevocable <hr> Planning Point: If a substantial age disparity exists between the spouses, a QTIP trust may not be an attractive option, as it requires that the decedent’s children and other heirs wait until the death of a much younger spouse before receiving property that may form the bulk of their inheritance. <hr> A QTIP trust is a trust that contains qualified terminable interest property. “Qualified terminable interest property” means property (1) which passes from the decedent, (2) in which the surviving spouse has a “qualifying income interest for life,” and (3) as to which the executor makes an irrevocable election on the federal estate tax return to have the marital deduction apply. The surviving spouse has a “qualifying income interest for life” if (1) the surviving spouse is entitled to all the income from the property, payable annually or at more frequent intervals, and (2) no person has a power to appoint any part of the property to any person other than the surviving spouse unless the power is exercisable only at or after the death of the surviving spouse.<a href="#_ftn1" name="_ftnref1">1</a> The last requirement may be violated even if it is the surviving spouse who is given the lifetime power to appoint to someone other than the surviving spouse.<a href="#_ftn2" name="_ftnref2">2</a> A QTIP allows a decedent to provide for a surviving spouse, receive the marital deduction, and pass the remainder to beneficiaries the decedent selects in his or her will. <hr> Planning Point: A QTIP election is irrevocable, so that the property transferred to the QTIP trust will be included in the surviving spouse’s gross estate. <hr> An executor can elect under IRC Section 2056(b)(7) to treat an individual retirement account and a trust as QTIP if the trustee is the named beneficiary of decedent’s IRA and the surviving spouse can compel the trustee to withdraw from the IRA an amount equal to all the income earned on the IRA assets at least annually and to distribute that amount to the spouse. No person can have a power to appoint any part of the trust property to any person other than the spouse.<a href="#_ftn3" name="_ftnref3">3</a> Certain “terminable interests” in property do not qualify for the marital deduction. The purpose of this rule is to ensure inclusion in the surviving spouse’s estate of any property remaining in the estate at his or her death which escaped the initial tax in the predeceased spouse’s estate. A “terminable interest” in property is an interest which will terminate or fail on the lapse of time or on the occurrence or the failure to occur of some contingency. Life estates, terms for years, annuities, patents, and copyrights are therefore terminable interests.<a href="#_ftn4" name="_ftnref4">4</a> Some terminable interests are deductible and some are nondeductible under the marital deduction law. In general, a “terminable interest” is nondeductible if (1) another interest in the same property passes (for less than an adequate consideration) from the decedent to someone other than his or her spouse (or that spouse’s estate), and (2) the other person may possess or enjoy any part of the property after the spouse’s interest ends. See Q <a href="javascript:void(0)" class="accordion-cross-reference" id="9124">9124</a> for a discussion of some of the considerations that should be taken into account in deciding whether to create an inter vivos or testamentary QTIP trust. <div class="refs"> <hr align="left" size="1" width="33%"> <a href="#_ftnref1" name="_ftn1">1</a>.  IRC § 2056(b)(7). <a href="#_ftnref2" name="_ftn2">2</a>.  TAM 200234017. <a href="#_ftnref3" name="_ftn3">3</a>.  Rev. Rul. 2000-2, 2000-1 CB 305. <a href="#_ftnref4" name="_ftn4">4</a>.  IRC § 2056(b); Treas. Reg. § 20.2056(b)-1(b). </div></div>

March 13, 2024

9125 / How can an A-B trust be used by individuals in a blended family to plan for inheritances by children from prior marriages?

<div class="Section1">Planning for wealth transfer in a blended family can become complicated because, without proper planning, a surviving spouse could inherit all of a first-to-die spouse’s assets and gain complete control over how those assets will be distributed upon his or her death. If the first-to-die spouse has children from a first marriage, he or she may prefer that the assets benefit those children, rather than any children (or future children) of the surviving spouse. In the end, many individuals will wish to provide for a surviving spouse during life, but ultimately want to control the distribution of their assets upon the death of that surviving spouse.<div class="Section1"> In order to accomplish this, many individuals use trusts in order to ensure that a surviving spouse has sufficient income for life, but that the first-to-die spouse’s assets ultimately pass to his or her biological children (rather than to any stepchildren or future spouses of the surviving spouse). Creating what is known as an “A-B trust” (also known as a bypass trust, which were typically created to avoid estate taxes prior to the increase of the federal estate tax exemption and introduction of portability, see Q <a href="javascript:void(0)" class="accordion-cross-reference" id="9122">9122</a>) can ensure that both the spouse and decedent’s children benefit from a decedent’s estate according to his or her wishes. The A-B trust can really take many forms, depending upon the parties’ wishes. For example, the decedent can leave a portion of his or her estate in the “A trust”, typically a revocable grantor trust that gives the surviving spouse use of the trust income for life, but often leaves the remainder (trust principal) to the decedent’s children. The “B trust” is an irrevocable trust that would contain a portion of the decedent’s estate to either immediately benefit his or her own children, or to provide income to the surviving spouse with the trust principal preserved for the children (depending upon the wishes of the decedent). While the surviving spouse may have the ability to modify the beneficiaries of the A trust and retain some control over the principal of that trust (depending upon trust terms), the B trust is irrevocable. In this manner, both the surviving spouse and decedent’s children are protected. Further, the client has ensured that at least a portion of his or her assets will ultimately pass to his or her own children, rather than to stepchildren or as the surviving spouse directs. This type of trust structure also helps very wealthy families minimize estate taxes. The portion of the trust that does not pass unfettered to the surviving spouse is funded with an amount equal to the federal exemption amount to shield those assets from estate taxes, while the “marital” portion of the trust can be funded with whatever amount of assets the first-to-die spouse wishes (and will be sheltered from estate tax by the marital deduction). In these scenarios, the A trust is typically established as a grantor trust, which is taxed to the individual grantor. The B trust is irrevocable, so is taxed according to general trust rules and must file a Form 1041. Because the B trust is irrevocable, it could also potentially be used to protect the assets of the first-to-die spouse from a financially irresponsible surviving spouse (i.e., from the surviving spouse’s creditors, see Q <a href="javascript:void(0)" class="accordion-cross-reference" id="9074">9074</a> to Q <a href="javascript:void(0)" class="accordion-cross-reference" id="9088">9088</a> for a discussion of asset protection trusts). See Q <a href="javascript:void(0)" class="accordion-cross-reference" id="9123">9123</a> to Q <a href="javascript:void(0)" class="accordion-cross-reference" id="9124">9124</a> for a discussion of qualified terminable interest property (QTIP) trusts, which are another option that can be useful in the blended family context. </div></div>

March 13, 2024

9118 / What considerations should be accounted for in choosing a trustee when a blended family is involved?

<div class="Section1">Many individuals who are engaged in estate planning for a blended family choose to establish trusts to ensure that their wishes in providing for various heirs are carried out. In these cases, it is important to carefully consider who will serve as trustee in carrying out those wishes.</div> <div class="Section1"> Many remarried individuals may be tempted to appoint their surviving spouse as trustee, but the relationship between the surviving spouse and any children from prior marriages should be considered before making this choice. Animosity between these parties can make trust administration difficult, and can lead to dissatisfaction among the children that the deceased spouse intended to benefit. The same issues can arise if another family member is named as trustee. These issues are magnified if the trust provides for discretionary distributions, as many trusts do. For this reason, a corporate or institutional trustee may provide the best option in order to minimize conflict in blended family situations in that an impartial third-party will be making decisions regarding trust distributions and general administration. </div>

March 13, 2024

9116 / What is the impact of divorce and remarriage on Social Security planning?

<div class="Section1">Typically, a surviving spouse may be entitled to receive Social Security survivor benefits based upon the earnings record of the deceased spouse. In the case of divorce, however, if one spouse remarries before age 60, he or she may no longer be entitled to claim survivor benefits based on the prior marriage unless the subsequent marriage ends. This is the case unless the prior marriage lasted for at least 10 years.<a href="#_ftn1" name="_ftnref1">1</a></div> <div class="Section1"> Social Security survivor benefits are not impacted if the surviving spouse remarried after he or she reached age 60.<a href="#_ftn2" name="_ftnref2">2</a> In certain cases where the surviving spouse remarries after age 50, but before age 60, that spouse may remain entitled to a prior spouse’s Social Security benefits if he or she was disabled at the time of the remarriage.<a href="#_ftn3" name="_ftnref3">3</a> <hr /> Planning Point: Practically, the Social Security rules provide that a divorced surviving spouse will not be entitled to receive Social Security survivor benefits based on a prior spouse’s earnings record unless he or she is unmarried or has remarried after reaching age 60 (unless the disability exception applies). <hr /> </div> <div class="refs"> <hr align="left" size="1" width="33%" /> <a href="#_ftnref1" name="_ftn1">1</a>. 20 CFR § 404.331(a)(2). <a href="#_ftnref2" name="_ftn2">2</a>. 20 CFR § 404.335(e)(1). <a href="#_ftnref3" name="_ftn3">3</a>. 20 CFR § 404.335(e)(2). </div>

March 13, 2024

9113 / What is a blended family?

<div class="Section1">The term “blended family” can encompass any number of modern family structures. Most commonly, the term refers to individuals who have remarried after prior marriages have ended in divorce. These couples may have children from prior marriages, and may have children together, potentially resulting in a situation where individuals may wish to provide for children from both current and prior marriages, and also stepchildren. Each client may wish to ensure that his or her own children (rather than stepchildren) are provided for in the event that they are the first-to-die spouse, but may concurrently wish to provide for their surviving spouse even if their own children are the ultimate beneficiaries.</div>

March 13, 2024

9119 / What is a spouse’s elective share? How can a spouse’s election impact estate planning in a blended family?

<div class="Section1">Pursuant to state law, a surviving spouse is entitled to claim a portion of his or her deceased spouse’s estate in lieu of the inheritance that the decedent chose to leave for the survivor (whether via will, trust or otherwise). In the traditional family context, this is often not an issue because the first-to-die spouse simply leaves his or her entire estate to the survivor with the understanding that the surviving spouse has sufficient incentive to provide for the couple’s mutual children or other heirs.<div class="Section1"> In the blended family context, a deceased spouse may choose to leave certain of the assets to children from a prior marriage, with only a specified portion of the estate passing to the surviving spouse. This can create a problem when such a scenario intersects with state elective share rules, which may provide that the surviving spouse is entitled to a greater portion of the estate than the decedent directed. As a result, the elective share rules must be considered when engaging in estate planning for a blended family. In many cases, blended families will use a qualified terminable interest property (QTIP) trust (see Q <a href="javascript:void(0)" class="accordion-cross-reference" id="9123">9123</a> to Q <a href="javascript:void(0)" class="accordion-cross-reference" id="9124">9124</a>) to ensure that the surviving spouse is satisfied with his or her inheritance while still providing for children from a prior marriage. </div></div>

March 13, 2024

9114 / What basic planning considerations must be accounted for in blended family situations?

<div class="Section1">When an individual enters into a second or subsequent marriage, it is entirely possible that he or she has entered into agreements with a prior spouse (whether in the form of prenuptial or postnuptial agreements, divorce or property settlement agreements, see Q <a href="javascript:void(0)" class="accordion-cross-reference" id="9092">9092</a> to Q <a href="javascript:void(0)" class="accordion-cross-reference" id="9096">9096</a>) that must be taken into account when entering into estate planning strategies in contemplation of providing for a spouse from a subsequent marriage. These existing agreements could provide for continuing support obligations, required funding of life insurance policies for the benefit of a former spouse or previously agreed upon beneficiary designations on retirement accounts or other financial products.<div class="Section1"> Importantly, many individuals who enter into second or subsequent marriages already have children from a prior marriage, and may wish to ensure that those children are provided for before leaving any assets to stepchildren. Both accurate, updated beneficiary designations ( Q <a href="javascript:void(0)" class="accordion-cross-reference" id="9115">9115</a>) and trust arrangements ( Q <a href="javascript:void(0)" class="accordion-cross-reference" id="9123">9123</a> to Q <a href="javascript:void(0)" class="accordion-cross-reference" id="9124">9124</a>) can be useful in this context. Other issues can arise when there is a disparity in wealth or age between the spouses. Disparities in wealth can require planning to fully use the federal estate tax exemption (i.e., either through trust arrangements or by taking advantage of portability ( Q <a href="javascript:void(0)" class="accordion-cross-reference" id="9121">9121</a> to Q <a href="javascript:void(0)" class="accordion-cross-reference" id="9122">9122</a>)) of both the wealthier and less wealthy spouse. Disparities in age can lead to conflicts between adult children from prior marriages and stepparents that should be addressed in estate planning (i.e., via trust planning and open conversation) in order to ensure that a decedent’s wishes are properly carried out. </div><div class="refs"> <hr align="left" size="1" width="33%"> <a href="#_ftnref1" name="_ftn1">1</a>.  Del. Code. Ann. Tit. 12, § 3570(4). <a href="#_ftnref2" name="_ftn2">2</a>.  Del. Code. Ann. Tit. 12, § 3570(8). </div></div>