What Distributions Can Be Made From a Marital Trust?

Since 1981, the unlimited marital deduction has been used to defer estate taxes until the surviving spouse’s death. One way to do this is by using a marital deduction trust. But when a large part of the couple’s estate is in this trust, other methods are needed to lower estate taxes for the surviving spouse. A new option to consider is to distribute assets from the trust to the surviving spouse’s descendants. This could be treated as gifts and might reduce the amount subject to estate tax when the surviving spouse dies. But the type of trust and its terms will affect the tax consequences of the distribution. Based on the assumed facts, if the surviving spouse makes gifts from the marital trust, it can result in tax savings upon her death. However, state law must be considered when making these distributions. The question is whether a state court would determine after the fact that the distributions were effective, rather than giving prior approval. This approach is favorable for the taxpayer, since most state cases indicate that distributions of this type would not be given prior court approval. There are a few recent cases and a private ruling about giving money from a trust to a spouse after their partner dies. In the first two cases, the courts decided that the trustee can give money to the surviving spouse as long as a state court would approve it later, even if they didn’t approve it beforehand. In the most recent case, the court said that the trustee gave money to the surviving spouse’s family without permission, so it wasn’t allowed. After Mr. Halpern died, money from the trust was given to Mrs. Halpern’s family every year from 1982 to 1988. They didn’t ask a judge before giving out the money. Mrs. Halpern agreed to the distributions from 1982 to 1986, but in 1986 she got sick and couldn’t agree to the money being given out in 1987 and 1988. Her sons, who were in charge of her affairs, also didn’t agree to the money being given out. The Tax Court said that because the people who were supposed to get the money didn’t actually own it yet, it was okay for the money to be given out without asking a judge first. The Tax Court said that Mrs. Halpern’s family couldn’t challenge the money she took out of a trust before she was declared too sick to make decisions about her money, because they had agreed to it and she had signed off on it. But after she got sick, the court said her family could challenge the money she took out. They also said it was a mistake that her guardians didn’t agree to those withdrawals for her. The consequences of a trustee making distributions from a Florida marital trust without following the terms of the trust could lead to legal challenges from the surviving spouse or other interested parties. Florida courts may not strictly uphold the terms of the trust and instead consider other factors, such as the intent of the settlor and whether the distributions would be allowed under Florida law. It’s important for trustees to carefully follow the trust terms to avoid potential legal issues. The benefit for taxpayers with the “after the fact” approach is that it’s hard for a Florida court to undo actions by the trustee when everyone involved agreed to and benefited from it. This is especially true if the distributions prevented a loss for the beneficiaries and helped carry out the testator’s wishes. Florida law also emphasizes the right of beneficiaries to consent to trustee actions, so if all the beneficiaries agreed to the distributions, they would likely be considered valid. The IRS argues that distributions from certain trusts are not effective, but the cases they rely on are not directly applicable to our situation. In a different case, gifts made under a power of attorney without the donor’s consent were found to be ineffective, but this does not apply to our situation. The IRS’s stance might affect distributions from our QTIP marital trust, but we need to consider the specific terms of our trust and consult with legal experts. If assets from a trust set up for a spouse are given to someone else without permission, it can be considered a reduction in the spouse’s share of the trust. This could have negative tax consequences. If the spouse had some limited power to decide where the trust assets go after their death, it might affect things differently, but it’s a complicated legal issue. The gift tax rules say that in order for a transfer to be considered a gift, the person giving it up must not have any control over what happens to the gift afterwards. A court case called Estate of Charles H. Sanford v. Commissioner said that if someone can still decide who gets the gift later on, it’s not a completed gift. So, in our situation, because the spouse has some control over who the gift goes to after their death, it shouldn’t count as a gift for tax purposes.

Even though there may not be a gift tax issue, there are other things we need to think about. When the surviving spouse dies, there could be estate tax consequences to consider. The specific tax rules that will apply depend on whether the distributions made from the trust were legally allowed under state law. Overall, we need to consider the potential tax implications when thinking about the trust and how it will be handled later on. In this situation, the surviving spouse has the power to decide who gets money from a trust, even after her death. This means that her children don’t have a guaranteed right to the money. This is similar to a case called Halpern, where the court said that the spouse didn’t have to pay taxes on the trust money. But there are rules about giving away money within three years of a person’s death, so it’s important to be careful. Overall, it’s important to think about the risks and costs before making any decisions about the money in the trust. From a tax perspective, it may be worth it to make distributions from a trust with limited testamentary power of appointment, even if the IRS might challenge it. However, there are legal and financial risks involved, and it’s important to get consent from all parties involved and review the trust document carefully. It’s also a good idea to consider other estate planning options, such as including a “five and five power” in the trust. When creating a will or trust with a QTIP, it’s important to include a limited testamentary power of appointment for the surviving spouse to benefit their children and/or a charity. This provides tax benefits and flexibility for the surviving spouse in case circumstances change. When drafting the marital trust, it’s best not to explicitly state that it’s exclusively for the surviving spouse, as this could cause legal issues. It’s a good idea for both spouses to have a durable power of attorney. This allows someone to make decisions for them if they become incapacitated. The power of attorney should specifically allow the person to make decisions about any money from a trust, like one set up by a deceased spouse. Without this specific authority, the IRS may not consider any gifts made by the person with power of attorney to be valid. This could have tax implications. So it’s important to make sure the power of attorney includes the right language.

Source: https://www.floridabar.org/the-florida-bar-journal/what-distributions-can-be-made-from-a-marital-trust/