Back to Blended Families

Blended Families

  • 9113. What is a blended family?

    • 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.

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

    • 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 9001 to Q 9005 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.

      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 9042) and trust arrangements (Q 9032 to Q 9106) 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 9103 to Q 9104) 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.

  • 9115. Why are beneficiary designations especially important in blended family scenarios?

    • When an individual remarries, it can become especially important to review his or her beneficiary designations to ensure they are current. Beneficiary designations in existing retirement plans, life insurance policies, annuities and other financial accounts must be carefully examined in order to determine who the individual intends to benefit, and whether any waivers will be required from a current or former spouse in order to make those intended designations effective.

      Planning Point: Importantly, beneficiary designations will override any instructions that the individual provides in his or her will, so it is crucial that each relevant plan and policy be examined to ensure beneficiary designations are accurate.

      While in some cases changes in beneficiary designation can be effected unilaterally, it is more complicated to change beneficiary designations in a qualified retirement plan that is subject to the automatic survivor benefit rules (i.e., ERISA plans, those which automatically provide benefits to a surviving spouse). These plans typically must provide that participants can only elect to waive the survivor benefits during a designated election period (see Q 3890).1 This type of waiver must be in writing, must specify a new beneficiary (or provide that the plan participant is allowed to change or name the beneficiary without the spouse’s consent), must acknowledge the effect of the waiver and must be witnessed or notarized.2

      Planning Point: Clients should be advised to carefully follow the procedures set forth by the relevant retirement or pension plan in order to ensure that the intended beneficiary designations become effective, as recent court decisions have made clear that even substantial compliance is insufficient. This has been the case even where the intention to change beneficiaries was clear and where the intended new beneficiaries could be identified.3

      If the plan is a nonqualified plan (such as an IRA or SEP IRA), the account owner is free to name whoever he or she wishes as beneficiary. However, if community property rules apply, the plan will be subject to the relevant community property rules, which could give each spouse a one-half interest in the account value (or any growth in the account that occurred during the marriage).

      The account owner can designate multiple beneficiaries and provide that each will receive a share of his or her account value (it is generally advisable to specify percentages, rather than dollar amounts, that each beneficiary will receive to account for growth in value).

      Further, existing agreements or orders (i.e., prenuptial agreements, postnuptial agreements, qualified domestic relations orders (QDROs), divorce settlements, etc.) can interfere with an individual’s ability to unilaterally change the beneficiary designation on his or her accounts.

      1 .IRC Sec. 417(a)(1)(a).

      2 .IRC Sec. 417(a)(2); Treas. Reg. §1.401(a)-20.

      3 .See, for example, Kennedy v. DuPont Savings and Investment Plan, 55 U.S. 285 (2009), in which the Supreme Court held that a waiver of beneficiary rights contained in a divorce decree did not override the actual beneficiary designation contained in the plan.

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

    • 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 sixty, 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 ten years.1

      Social Security survivor benefits are not impacted if the surviving spouse remarried after he or she reached age sixty.2 In certain cases where the surviving spouse remarries after age fifty, but before age sixty, 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.3

      ­­­­­­­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 sixty (unless the disability exception applies).

      1 .20 CFR 404.331(a)(2).

      2 .20 CFR 404.335(e)(1).

      3 .20 CFR 404.335(e)(2).

  • 9117. What gift and estate tax issues typically arise in the case of couples who have divorced and remarried?

    • It is common for couples who have been divorced and remarried to have children from prior marriages, complicating the transfer of wealth both during life and upon death. In some cases, an individual may have some idea of the specific assets he or she wishes to transfer to a particular child, or may wish to provide more generous gifts to heirs who are less able to provide for themselves. In other cases, the goal of the individual is to create some level of equality in each heir’s inheritance and minimize conflict in general. In any event, federal transfer taxes (estate, gift and generation skipping transfer taxes) must be taken into account in order to minimize tax liability.

      If the individual plans to begin making gifts during life (perhaps in order to minimize the necessity for complicated estate planning or to ensure that specific tangible assets pass to a certain beneficiary), he or she should attempt to take advantage of the $15,000 (in 2019-2021) per donor/donee annual gift tax exclusion amount (if the spouse consents, up to $30,000 per donee can be sheltered each year).1 The exclusion amount applies only to present interest gifts (i.e., it does not apply to gifts where the donee only has the right to enjoy the property in the future (see Q 915)). Generally, if the gifts exceed the annual exclusion amount, the donor is responsible for paying gift tax on the fair market value of the property transferred and must file a gift tax return (Form 709) by April 15 in the year following the year in which the gift is made.2

      Individuals who choose not to transfer wealth gradually during life should plan for the estate tax and the generation skipping transfer tax (GSTT; applicable if the individual wishes to “skip” a generation in making his or her bequests).

      With respect to the estate tax, individuals should note that most transfers between spouses fall within the unlimited marital deduction, so will not be subject to estate tax.3 Transfers to certain types of trusts (QTIP trusts, see Q 9050 and Q 9051) also qualify for the marital deduction.4 Estates that are valued at below the transfer tax exemption amount ($5.6 million in 2018) are also exempt from the estate tax. In the blended family context (where age and wealth disparity are often factors), it can be important to plan to make use of both spouses’ exemption amounts (either through portability or trust planning (see Q 9120 to Q 9122).

      If an individual wishes to transfer wealth to a “skip” generation (i.e., his or her grandchildren or great-grandchildren), GSTT planning becomes important. The transfer tax exemption amount discussed above also applies to the GSTT. In many cases, the individual may wish to transfer assets into a trust, allocating a portion of his or her GSTT exemption to the transfer. In this case, the assets in the trust can be allowed to grow sheltered from any GSTT and provide for grandchildren and great-grandchildren in the future while using up only a minimal amount of the transferor’s GSTT exemption. Of course, for direct transfers to skip generations made during life, the $15,000 per donor/donee gift tax annual exclusion amount is available. See Q 874 to Q 891 for an in-depth discussion of the GSTT.

      1 .Rev. Proc. 2018-57; Rev. Proc. 2019-44; Rev. Proc. 2020-45; IRC Sec. 2513; Treas. Reg. §25.2513-2.

      2 .IRC Sec. 6019.

      3 .IRC Sec. 2056.

      4 .See IRC Sec. 2056(b)(7).

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

    • 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.

      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.

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

    • 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.

      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 9123 to Q 9124) to ensure that the surviving spouse is satisfied with his or her inheritance while still providing for children from a prior marriage.

  • 9120. What issues involving the use of spouses’ estate tax exemption amounts can arise in a blended family? What is portability?

    • Although the issue of wealth disparity can present an issue in any marital context, more extreme differences in both age and wealth tend to become important in the blended family context (where individuals may be entering a second or third marriage, potentially later in life). In these cases, estate planning must take into account the potential use of a less wealthy spouse’s estate tax exemption, especially if the couple intends to keep their assets relatively separate.

      For some couples, portability makes it easier to make full use of both spouses’ estate tax exemptions even in the face of wealth disparity. Portability, which is the right of a surviving spouse to use any of a deceased spouse’s unused transfer tax exemption amount, allows the surviving spouse to increase his or her own estate and gift tax exemption amount in order to exclude more of his or her assets from transfer tax liability (essentially excluding $23.4 million from estate tax liability per couple in 2021; $23.16 in 2020).1

      In a first marriage, portability can be useful because the assets of the first-to-die spouse will typically pass directly to the surviving spouse (sheltered by the marital deduction), so that the first-to-die spouse will use none of his or her exemption. Portability ensures that the surviving spouse (whose eventual estate may be larger because he or she has inherited the assets of the first-to-die spouse) can make use of both spouses’ exemption amounts.

      In the case of a subsequent marriage/blended family scenario, however, using portability may not be ideal because the spouses may wish to leave more property to children from previous marriages rather than leaving all assets to the surviving spouse. As a result, trust options may provide a more attractive strategy to allow spouses in a blended family to make full use of both spouses’ estate tax exemption amounts. See Q 9121 to Q 9123 for a discussion of some of the trust options that can be used by spouses in a blended family.

      Planning Point: Clients should be aware that only the estate tax exemption of the most recent spouse can be used via portability.2 Therefore, if a client’s spouse predeceases him or her and the client chooses to remarry, the exemption amount of the first spouse will be lost if the subsequent spouse dies before the client. However, the client can continue to use his or her first spouse’s exemption for lifetime gifts made before the death of the subsequent spouse.

      Portability is also discussed in Q 9108.

      1 . Rev. Proc. 2019-44, Rev. Proc. 2020-45. Portability was introduced in the Tax Relief, Unemployment Reauthorization and Job Creation Act of 2010, and was made permanent by the American Taxpayer Relief Act of 2012.

      2 .Treas. Reg. §§20.2010-3(a), 20.2010-1(d)(5).

  • 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?

    • As discussed in Q 9120, 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.1 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.

      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.2

      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).

      1 .IRC Sec. 2010(c)(5); Treas. Reg. §20.2010-2.

      2 .IRC Sec. 1014(a).

  • 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).

      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.

      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.

      See Q 9125 for a discussion of “A-B trusts”. Q 9126 discusses some of the potential uses of an irrevocable life insurance trust (ILIT).

      1 .For examples of these types of trusts, see Let. Ruls. 200403094 and 200604028.

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

    • 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 9124, however, a QTIP trust is irrevocable

      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.

      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.1 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.2 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.

      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.

      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.3

      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.4 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 9124 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.

      1 .IRC Sec. 2056(b)(7).

      2 .TAM 200234017.

      3 .Rev. Rul. 2000-2, 2000-1 CB 305.

      4 .IRC Sec. 2056(b); Treas. Reg. §20.2056(b)-1(b).

  • 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?

    • 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).

      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.1 This strategy also carries the risk that the trust could be treated as a self-settled trust reachable by the grantor’s creditors.

      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.2

      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. After divorce, income from the trust is includable only in the income of the beneficiary spouse.3 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.

      1 .Treas. Reg. §25.2523(f)-1(d).

      2 .See, for example, Estate of Mellinger v. Comm., 112 TC 26 (1999).

      3 .IRC Sec. 682(a).

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

    • 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.

      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 9122) 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 9074 to Q 9088 for a discussion of asset protection trusts).

      See Q 9122 to Q 9124 for a discussion of qualified terminable interest property (QTIP) trusts, which are another option that can be useful in the blended family context.

  • 9126. What is an irrevocable life insurance trust (ILIT) and how can an ILIT be useful in a blended family’s estate plan?

    • An irrevocable life insurance trust (ILIT) is a trust funded by life insurance that cannot be modified, amended or revoked without the permission of the beneficiary. It is mechanism used in estate planning in which a grantor effectively removes all of his or her rights of ownership to the assets that have been transferred to the trust. The primary purpose of an ILIT is to reduce a decedent’s estate tax liability (while simultaneously providing for heirs) by removing a life insurance policy from the decedent’s gross estate.

      An ILIT can be a valuable tool both for providing for children from a first marriage or a surviving spouse, and for reducing a decedent’s taxable estate. Prenuptial agreements (Q 9092 to Q 9093) can be helpful in providing that a surviving spouse’s inheritance will be limited to proceeds from the life insurance policy held by the ILIT. A prenuptial agreement can also provide that if the couple divorces, the beneficiary-spouse must forfeit all rights to the trust assets (which would presumably then pass to the insured’s children or other heirs).

      An ILIT allows a decedent to control who receives the proceeds of the life insurance policy because the proceeds are actually paid to the trust, and the governing trust documents then provide specific details as to who should receive the proceeds and under what circumstances. This strategy can also allow a decedent to protect an inheritance from the beneficiary’s creditors.

      For individuals who wish to benefit a generation of beneficiaries that is more than one removed (so that the generation skipping transfer (GST) tax would apply), a portion of the GST exemption amount ($11.7 million per individual in 2021;  $11.58 million in 2020)1 can be applied to the transfers to the trust (thereby sheltering the entire amount of the proceeds from the GST tax). It should be noted that this can provide a valuable strategy for wealthy individuals who anticipate transferring wealth in excess of the exemption amount, as only the cash actually transferred to the trust to fund the life insurance policy premiums must be exempted. By allocating the GST tax exemption to those cash transfers, the larger value of the life insurance proceeds can be paid out entirely GST tax-free, while leaving a greater proportion of the exemption for allocation to other assets.

      1 .Rev. Proc. 2019-44, Rev. Proc. 2020-45.

  • 9127. In the blended family context, what issues should be considered in planning for who will be responsible for payment of any transfer tax liability?

    • In the blended family context, an individual is likely to spend more time in his or her estate planning because of the inherent complications that can arise in these scenarios. Despite this, many may forget that any estate tax liability can reduce the carefully planned out inheritances that the decedent’s heirs will actually receive—generating potential conflict despite the most careful trust and gifting strategies.

      In most cases, the decedent can specify in his or her will how estate taxes should be apportioned among the beneficiaries. In the absence of specific instructions from the decedent as to how the estate tax will be paid, both state and federal laws will need to be examined. For example, in New York and Florida, tax is generally apportioned among the estate beneficiaries in proportion to the value of the estate property that each beneficiary has received.1 Certain types of property (including marital deduction property) are specifically addressed at the federal level, and taxes relating to that property will be allocated to the person who received the property.2

      In some cases, it can be beneficial for an individual to establish an irrevocable life insurance trust (see Q 9126) to provide liquidity to the estate in order to pay any anticipated estate taxes, rather than dividing liability for estate taxes between the heirs.

      1 .NY CLS EPTL §2-1.8; Fla. Stat. §733.817(2).

      2 .See IRC Secs. 2207A, 2058.