As a general rule, when a testamentary instrument creates a trust for the benefit of a surviving spouse, the trust property would be included in the deceased spouse’s estate and would not qualify for a marital deduction. Federal tax law contains an exception to this general rule by allowing an estate to claim a marital deduction through the creation of a specific kind of trust for the benefit of a surviving spouse, called a QTIP trust (“Qualified Terminable Interest Property” trust). Upon termination of the surviving spouse’s interest (i.e., the surviving spouse’s death), the QTIP trust property is includable in the surviving spouse’s gross estate for the purpose of calculating federal estate tax, and any remaining assets in the trust pass to the remainder beneficiaries.
Prior to 2001, Washington—like many other states—collected estate tax revenue through a “pickup tax.” That is, the estate would prepare a federal tax return which would be remitted to both the state and the Internal Revenue Service. All tax calculations were made according to federal law on a federal return, and the portion of estate tax remitted to the state was denoted as a tax credit on the federal return. The state simply collected the credited amount. The result of this system, is that the state and the federal government shared the estate tax revenue. In 2001, Congress eliminated this credit, eliminating the “pickup tax” in all states, including Washington. See Estate of Hemphill v. Dep’t of Revenue, 153 Wn.2d 544, 551, 105 P.3d 391 (2005).
In response to the elimination of the pickup tax, the Legislature in 2005 passed the Estate and Transfer Act (“Act”), which imposes a stand-alone estate tax (i.e., a tax not tied to any federal tax) effective prospectively only on “every transfer of property located in Washington” made on or after May 17, 2005. RCW 83.100.040(1). The Act relies heavily on federal law in defining what constitutes a taxable estate for state tax purposes. In 2006, the Department of Revenue promulgated regulations creating a state QTIP election. Revenue’s regulations allowed a surviving spouse’s estate to exclude federal QTIP trust property for which a marital deduction was taken in the first spouse’s estate from the calculation of the gross estate in the surviving spouse’s estate, but required the estate to include the value of any property in a QTIP trust for which the Washington marital deduction was made in the first spouse’s estate in the estate of the surviving spouse for Washington estate tax purposes. Thus, according to the Regulations, only property subject to a Washington QTIP election (which was available only after 2006) was includable in the surviving spouse’s estate; property for which a federal QTIP election was made was not subject to the Washington estate tax.
In 1984 and 2004, respectively, the estates of Jim Bracken and William Nelson elected to treat trusts created for Sharon Bracken and Barbara Nelson as QTIP trusts under federal tax law. At the time those trusts were created, Washington law did not provide for a deferral of state estate taxes through a QTIP trust or other election. That is because Washington – like many other states – collected estate tax revenue through the federal estate tax, as discussed above.
When Ms. Bracken and Ms. Nelson died, their respective estates declined to include property in a QTIP trust for which a federal marital deduction was taken because no Washington marital deduction was taken. Indeed, such a deduction did not exist at the time of Mr. Bracken and Mr. Nelson’s deaths. The Washington Department of Revenue (“DOR”) asserted that its 2006 Regulations concerning state QTIP trusts did not apply to the estate of a decedent whose federal taxable estate included a QTIP trust where a federal marital deduction was made prior to May 17, 2005. The trial court deferred to the DOR’s interpretation and granted summary judgment.
On direct review, the Supreme Court reversed:
- Where a statute is unambiguous, deference to an agency’s interpretation is not warranted.
- Property is transferred from a trustor when a trust is created, not when an income interest on the trust expires.
- The Washington Act imposes an estate tax “only prospectively, on the transfer of property,” and “must be read to exclude items that aren’t transfers.
- Thus, where a transfer to a QTIP trust occurred before May 17, 2005, there is no transfer upon the surviving spouse’s death and the state could not retroactively tax the property in that trust.
Chief Justice Madsen concurred in the judgment but dissented from the majority’s reasoning, on the basis that estate of the surviving spouse does in fact make a transfer of the QTIP trust property to the remainder beneficiary, which transfer would be subject to the Washington estate tax.