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QTIP deduction allowed despite accumulation clause in trust.

George and Lavedna Ellingson set up an irrevocable trust governing the disposition and management of their property during their lives and after their deaths. They also were the initial trustees of the trust. On George's death, the trust instrument directed the trust property to be distributed to three smaller trusts. One of these, the "marital deduction trust," contained the family farm and is the subject of this dispute.

Lavedna and her son were the trustees of that trust, which provided for the entire net income to be distributed to Lavedna. However, an accumulation provision said if income exceeded the amount the trustees deemed necessary for Lavedna's "needs, best interests and welfare," then the trustees had the discretion to accumulate the income. The trust instrument further said George and Lavedna's intention was the marital deduction trust property "may qualify" for the qualified terminable interest property (QTIP) deduction and "shall only" be taxed in the estate of the second spouse to die.

George's estate made a QTIP election for the marital deduction trust property and claimed the estate tax marital deduction for it. The IRS denied the QTIP deduction, and the Tax Court upheld the denial. Assessed taxes for the property were more than $8 million.

IRC section 2056(b)(7)--the QTIP provision--contains the rules for one category of property qualifying for an estate tax marital deduction. One of that section's requirements is the surviving spouse must be entitled to all the income from the property, payable at least annually. The IRS claimed that because of the accumulation clause, Lavedna was not entitled to all the income. The IRS's position was directly supported by proposed regulations sections 20.2056(b)-5(f)(7) and 20.2506(b)-7(c)(1), which say the income-for-life rule isn't satisfied if income can be accumulated in the discretion of any person other than the surviving spouse. (Here, that person would be the cotrustee-son. )

Result: For the estate. Under Arizona law, Lavedna was entitled to all income from the trust. Thus, the QTIP election was proper.

Arizona law says trusts must be interpreted by finding out the intent of the trust setriots (George and Layedna). Although the marital deduction trust provisions could have been more clearly drafted, it was the settlor's intent the property qualify for the QTIP deduction. Further, it would not have been in Lavedna's best interests for the trustee to accumulate income, since property then would have been ineligible for the QTIP election and the farm would had to have been sold during her lifetime to pay the estate taxes. Therefore, the trustee actually had no discretion to accumulate income.

* Ellingson Est. (9th Cir., 1992).
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Article Details
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Publication:Journal of Accountancy
Article Type:Brief Article
Date:Aug 1, 1992
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