Family Business Planning and The Spouse-Irrevocable QTIP Trust

By: Randall A. Denha, Esq.

As many know, a Buy Sell Agreement is an agreement among owners of a business which outlines who would purchase the stock of the business in the event of the death, disability, involuntary or voluntary transfer of shares of any of its business owners.

A common provision in many buy-sell agreements prevents transfers to a spouse of an owner, either during lifetime or at death.  Once again, many owners of a closely held business want to work only with each other (or with their children), but do not want spouses to become owners. Why?  Spouses may be active in other businesses or professions or may have never worked in the operations of a family business.

 The consequence of a provision which prohibits transfers to a spouse is the denial of a marital deduction when any owner of the business dies.

 That is, the owner cannot transfer an ownership interest to his or her spouse; therefore, the stock can only be left to descendants as permissible transferees when the owner dies. This prohibition on transfers to or for the benefit of spouse will accelerate the payment of death tax which could have been delayed until the subsequent death of the surviving spouse if a marital transfer had been permitted by the buy-sell agreement.

 To eliminate this problem, the agreement could permit transfers to an irrevocable QTIP trust for the benefit of the surviving spouse when an owner dies. The ownership interest is not given outright to the surviving spouse; rather, it is placed in trust for the lifetime benefit of the surviving spouse.

 To qualify for the federal estate tax marital deduction, the surviving spouse must receive all the net income earned by the trust assets for life, no one else can be a beneficiary during the lifetime of the surviving spouse and the personal representative of the deceased owner’s estate must file the necessary election with the federal estate tax return.

 The spouse must be given the power to force the trustee to make the trust assets income producing, however, which may be troublesome if those assets consist of stock in a family business which has never declared a dividend.

 I would recommend that this irrevocable QTIP trust be permitted by the buy-sell agreement so long as (1) the beneficiaries who will receive the ownership interest upon the subsequent death of the surviving spouse are permissible transferees (such as descendants of the deceased owner) and (2) the trustee of the trust is himself or herself a permissible transferee (such as a descendant of the owner, for example) or is a corporate fiduciary.

 The deceased owner could thereby delay until the subsequent death of the surviving spouse any federal estate tax levied upon the value of the ownership interest. Because of our ever changing death tax systems, at both the federal and state levels, I recommend that you put off as long as possible the imposition of any death tax. As is oftentimes said, “A Tax Deferred is a Tax Preferred.”