Shelfer v. Comissioner
86 F.3d 1045 (1996)

  • Shelfer died, leaving two separate trusts. The income from each trust was to be paid to his wife Lucille.
    • The first trust consisted of one-third of the estate and was covered by the marital deduction.
    • The second trust consisted of two-thirds of the estate and terminated upon Lucille’s death. At that point it went to Shelfer’s niece Betty.
      • A trust/gift to a spouse that goes to someone else after a contingency occurs (like death of the spouse) is called a terminable interest.
      • Lucille couldn’t take any of the principle or the interest from this trust. She just sat on it.
  • The bank filed a tax return on behalf of the estate. It claimed a deduction for half the assets in the second trust under the Federal qualified terminable interest property trust (QTIP) Statute (26 U.S.C. 2056(b)(7)), and the IRS allowed the deduction.
    • A QTIP allows for a trust to qualify for the marital deduction even though it is a terminable interest.
    • If the trust was a valid QTIP, then the taxes get paid out of Lucille’s estate. If it is not a valid QTIP, then the taxes are paid out of Shelfer’s estate.
  • Lucille died. The bank filed a tax return that did not include the assets of the QTIP trust. The IRS audited and demanded $$$.
    • After Lucille died, but before the estate was probated, the QTIP continued to generate income (aka stub income).
      • Since the trust technically terminated upon the death of Lucille, this stub income was not under the control of Lucille and therefore the entire trust was not valid as a QTIP.
    • The IRS claimed that the assets of a QTIP trust are taxable upon the death of the surviving spouse.
    • Lucille’s estate turned around that argued that the trust did not meet the statutory definition of a QTIP.
      • Because Lucille was never given power of appointment of the trust, and could never take any of the money.
  • The Tax Court found for Lucille’s estate. The IRS appealed.
    • Under 26 U.S.C. 2056(b) it explicitly says that in order to qualify as a QTIP “the surviving spouse is entitled to all the income from the property, payable annually or at more frequent intervals.”
      • Lucille argued that under the plain meaning of the Statute, it wasn’t a QTIP because she didn’t have control over the stub income.
  • The Federal Appellate Court reversed and found for the IRS.
    • The Appellate Court found that there were two purposes to QTIP:
      • Treating the married couple as one economic unit
      • Expanding the marital deduction to include arrangements that divest the surviving spouse of control over the property.
    • The Appellate Court found that both of these goals were best accomplished by allowing the marital deduction in the decedent’s estate and then requiring subsequent inclusion in the surviving spouse’s estate when trust documents do not grant control over the stub income to the surviving spouse.
  • The basic purpose of a QTIP is so the decedent can provide for their surviving spouse via interest income, and still leave the principle to their children/heirs.
    • Before QTIP, the only thing that qualified for the marital deduction was $$$ you completely 100% gave to the surviving spouse. But this left the children (especially children from a previous marriage) unable to inherit.