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KBTA Holds Kentucky QTIP Election Is Valid Regardless of Federal Election

01.07.2009

In A.T. Arnold Heirs’ Trust v. Finance and Administration Cabinet, Order No. K-20185 (KBTA Dec. 4, 2008), the Kentucky Board of Tax Appeals (“KBTA”) found that an election to treat one half of a surviving spouse’s life estate in real property as Qualified Terminable Interest Property (“QTIP”) for purposes of Kentucky Estate and Inheritance Tax was a valid election, regardless of whether such election was made on a decedent’s Federal Estate Tax return.

A QTIP election allows Qualified Terminable Interest Property, as defined under Section 2056(b)(7)(B) of the Internal Revenue Code of 1986, as amended (“Code”), to be included in the marital deduction from the gross estate for Federal Estate Tax purposes. Such property is then included in the surviving spouse’s gross estate and is subject to Federal Estate Tax at the surviving spouse’s death. The filing of a QTIP election to treat property that is otherwise taxable as deductible martial property is irrevocable. KRS 140.080(1)(a) allows a deduction for Kentucky Estate and Inheritance Tax purposes of property that meets the definition of a QTIP as defined under Code Section 2056(b)(7), if an election to treat the property as deductible QTIP is filed with the Kentucky Estate and Inheritance Tax return.

A.T. Arnold (“Decedent”) devised a life estate in all of his real property to his wife, Mary E. Arnold, upon his death and provided her the power to convert any portion of the real property to cash, if necessary, for her care, support and maintenance. When the Decedent’s Federal Estate Tax return was filed, no QTIP election was filed related to the life estate. However, when the Decedent’s estate filed the Kentucky Estate and Inheritance Tax return, a QTIP election was filed for one half of the life estate interest of the surviving spouse and, accordingly, the value of said property was deducted from the gross estate on the Decedent’s Kentucky Estate and Inheritance Tax return.

Upon the death of the surviving spouse, all real property in the life estate passed into the A.T. Arnold Heirs’ Trust (“Trust”). The life estate interest for which a Kentucky QTIP election was filed was not included in the surviving spouse’s gross estate for Federal or Kentucky tax purposes. The Department of Revenue (“Department”) audited the estate of the surviving spouse and assessed an additional tax upon the portion of the life estate interest for which the Decedent’s estate filed a Kentucky QTIP election.

The Trust paid the assessment under protest and submitted a claim for refund of the additional tax and interest paid, claiming the QTIP election was not valid under KRS 140.080(1)(a) and that the property was not eligible for the Federal or Kentucky QTIP election. The Department denied the claim for refund, finding that the property was eligible for the marital deduction for Federal Estate Tax purposes as QTIP property under Code Section 2056(b)(7)(B) and that the election to treat one half of the life estate as QTIP property on the Kentucky Return was valid under KRS 140.080(1)(a).

At protest, the Department determined the life estate met the definition of a “qualifying income interest for life” pursuant to Section 2056(b)(7)(B)(ii) of the Internal Revenue Code of 1986, as amended (“Code”) and, further, met the definition of “Qualified Terminable Interest Property” as defined in Code Section 2056(b)(7)(B)(i). As such, the estate could have elected to treat such property as marital property that is deductible from the gross estate for Federal tax purposes by filing a QTIP election.

Moreover, the Department determined that any property eligible for the Federal QTIP election is also eligible for a Kentucky QTIP election. In its Final Ruling, the Department stated that KRS 140.080(1)(a), which allows a deduction from Kentucky Estate and Inheritance Tax for QTIP property, does not require that the estate file a QTIP election on such property with the Federal Estate Tax return.

The Final Ruling was appealed to the KBTA. On appeal, the KBTA affirmed both of the Department’s determinations, holding that the property at issue qualified for the marital deduction pursuant to Code Section 2056(b)(7) and that a properly filed Kentucky Estate and Inheritance Tax QTIP election is valid under KRS 140.080(1)(a) regardless of whether a QTIP election is filed with the corresponding Federal Estate Tax return.

If you have questions about this topic or any other legal issue, please contact any member of the firm's State and Local Tax Team.

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