New York Surrogate’s Court reverses Tax Department penalty on QTIP Trust

A New York Surrogate’s Court judge recently handed down a ruling striking down a substantial state Tax Department penalty levied against the surviving spouse who became the beneficiary of a qualified terminable interest property trust (QTIP) established by the deceased husband. The judge’s order could have further reaching implications for other QTIP trusts established under similar circumstances.


The ruling effectively reverses a $462,546 levied by the state Tax Department against because the QTIP trust was established in 2010 during a one-year suspension of the federal estate tax. Under the wording of New York state tax laws, the state could not levy taxes on a trust that the federal government itself could not. The case represents a special set of circumstances that other individuals in similar positions may be able to take advantage of in order to avoid paying costly taxes on their QTIP trust.


Ordinarily, a QTIP trust allows a tax deferral on an trust, not a tax avoidance, by allowing the assets of a deceased spouse to pass on to the surviving spouse without taxation. However, upon the passing of the second spouse, the QTIP assets and the second spouse’s estate are subject to inheritance taxes. In this case, the lawyers for the trust holders were savvy enough to argue that the way New York estate laws were written would allow QTIP trusts established in 2010 to be passed on without any tax.


While the facts of this case are unique, they nonetheless highlight aspects of estate planning that can help individuals defer and sometimes limit the amount of tax the state may be able to levy against estates. Typically, a QTIP trust is often used in order to take advantage of the marital deduction and still control the ultimate distribution of the assets at the death of the surviving spouse.


QTIP trusts are irrevocable trusts, meaning once they are established they are generally more difficult to dissolve. In order for a QTIP trust to be valid, the Internal Revenue Service (IRS) requires specific language designating the assets will qualify for the federal estate tax marital deduction and will not be included in the estate of the first spouse to pass.  Without this explicit language the QTIP trust will not actually save on estate taxes and defeat one of the main purposes of its creation in the first place.

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