Trump is facing a new inflation warning from the bond market, adding to his midterm challenges

The world is getting more uptight about lending money to President Donald Trump’s government — causing interest rates to climb in ways that are worsening affordability pressures, hampering economic growth and creating a new risk for Republicans in November’s midterm elections.

The energy price spike triggered by the Iran war has seeped into the price of bonds that help fund the U.S. government. Interest rates on a 10-year U.S. Treasury note are topping 4.44 percent, up from 3.95 percent before the war started at the end of February. Average mortgage rates have climbed to their highest levels in nine months, while auto sales are slumping.

The challenge is global in scale, as interest rates have risen for multiple countries as the world has been adjusting to the prospect of higher inflation, mounting questions about the sustainability of government debt and a dramatic surge in investment in artificial intelligence.

Trump has tried to assure Americans that he has a plan to trim the roughly $1.8 trillion annual budget deficit. In the past, he has pointed to revenue from tariffs, payments from foreigners for his “Gold Card” visa, spending cuts made by the Department of Government Efficiency, and faster economic growth. Last week, he said the fraud task force led by Vice President JD Vance would be the key to unlocking massive savings.

“If he does really great, we’ll have a balanced budget without having to do anything,” Trump said.

Economists say this is probably unrealistic

Economists say Trump’s strategies to meaningfully curb the deficit are unlikely to deliver the promised results.

The cost of servicing the national debt has tripled since 2021 to more than $1 trillion annually, said Jessica Riedl, a budget and tax fellow at the Brookings Institution.

“President Trump signed a tax cut bill that will likely add $5 trillion to 10-year deficits — and tariffs are offsetting only a small fraction of those costs,” she said. “Budget deficits are still projected to soar past $4 trillion annually within a decade under current policies.”

Deficits are expected to grow over the next decade as the costs of Social Security and Medicare outstrip tax revenues.

The 10-year U.S. Treasury rate climbed as high as 4.67 percent in the middle of May and has since eased as negotiations over the Iran ceasefire continued — just as rates initially climbed in 2025 because of Trump's “Liberation Day” tariffs and then began to decline once Trump backed off the most extreme increases.

When Kent Smetters, faculty director of the Penn Wharton Budget Model, broke down the math tied to rising 30-year Treasury yields, he estimated that 60 percent of the increase had come from the expectation that America will continue its outsized borrowing and the other 40 percent was tied to the inflation driven by the Iran war and Trump’s tariffs.

Glenn Hubbard, a former chairman of the White House Council of Economic Advisers during the George W. Bush administration, worries that the U.S. may no longer have the same borrowing capacity as before to effectively combat an economic crisis, such as the 2008 crash or the coronavirus pandemic.

“I don’t think we have the space that we had in 2008 or 2020 to deal with it,” said Hubbard, now a professor at Columbia University's Business School. “Washington doesn’t seem to be full of ideas — good or bad — to solve it.”

Interest rates are a concern for voters

Higher interest rates are giving Democratic candidates in the races to determine control of the House and Senate another line of attack at a time when voters are concerned about high costs for food and gasoline.

In Colorado’s fifth congressional district, Democrat Jessica Killin is leaning into the message that the persistent deficits and higher interest rates make it harder to buy or renovate a home, afford a new car or manage credit card debt.

“Things are already expensive,” said Killin, an Army veteran who was a top aide to Doug Emhoff, the former second gentleman. “We can already talk about gas, but the cost of borrowing only makes that worse.”

Joe Reagan, an Army veteran also seeking the Democratic nomination, said in an email that he is talking “a lot about fiscal stewardship” in his campaign. “Every dollar spent paying interest is a dollar that isn’t being invested in infrastructure, education, veterans’ services, or economic growth," he said.

They are challenging Republican Rep. Jeff Crank in a district that their party views as a potential pickup. Killin said the deficit is an example of how “Trump says one thing and does the opposite.”

In his March 2025 address to Congress, Trump declared that “in the near future, I want to do what has not been done in 24 years: balance the federal budget. We’re going to balance it.”

Crank, the Republican incumbent, did not reply to requests for comment.

Cutting fraud is the new deficit strategy

The administration maintains that it is going to steadily reduce budget deficits. As a share of the overall economy, the deficit last year was lower than it was in 2024, though that drop depended in part on tariff revenues that are subject to refunds after the Supreme Court ruled them to be illegal.

Treasury Secretary Scott Bessent last week cited a report showing that there was as much as $500 billion annually in fraudulent government spending that could be eliminated, “so that would reduce the deficit substantially.”

Bessent appeared to draw that conclusion from a 2024 report by the Government Accountability Office that estimated there had been between $233 billion to $521 billion each year in fraudulent spending. But those numbers were drawn in part from the pandemic era when the government borrowed heavily to stabilize the economy.

The White House and Treasury did not respond to questions about the source of Bessent’s claims.

On deficits, Bessent told reporters at the White House that the administration was essentially dealt a bad hand from former President Joe Biden, a Democrat. “We inherited the worst budget deficit in history — in history — when we were not in a recession or not at war,” Bessent said.

Bessent had previously announced that the administration would aim to reduce the annual deficit to 3 percent of overall U.S. gross domestic product. It’s roughly double that percentage currently and Bessent did not directly answer a question about the timeline for hitting his target.

As of now, investors continue to buy shares in U.S. companies, causing the stock market to increase in value in a sign of confidence in America’s economic potential. But the increase in interest rates also suggests that investors view the national debt as a vulnerability for the U.S.

The financial markets might be able to inflict enough pain with higher rates in order to compel political leaders to address the systemic imbalances. Multiple economists said they expected that markets would force the deficit issue before voters would.

Hubbard emphasized that the whole bond market system rests on the trust that the debt will be repaid. He noted that the word “credit” is linked to a Latin term that is also the root of the word creed about a system of beliefs.

“That is what debt is about: I believe you will pay me back,” Hubbard said. “That works until it doesn’t.”

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Brandy Hicks

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Gift Tax Triggered for Termination of Trust After Death – Houston Tax Attorneys

When someone sets up their estate plan, one would hope that the probate process would result in the terms of the estate plan being carried out. State law often allows beneficiaries and heirs to change the terms of someone’s estate plan after they die.

For example, in Texas, beneficiaries can usually agree to override the terms of a decedent’s will and distribute assets as they see fit. This is usually carried out using a family settlement agreement. The Texas Estates Code has been amended to include more liberal rules that allow trust beneficiaries to amend or reform the terms of trusts.

Even though state law allows for these post-mortem changes, the changes can have significant Federal tax consequences. The taxes can be significant and, in some cases, can result in the probate estate owing back taxes to the IRS. The recent McDougall v. Commissioner, 163 T.C. No. 5 provides an example. The case involves the termination of a trust by the trust beneficiaries after the trust settlor died. The termination triggered a massive gift tax liability.

Facts & Procedural History

The taxpayers in this case were a surviving spouse and his spouse’s adult children. The surviving spouse inherited an interest in a trust from his wife when she died. The interest he inherited was an income interest, so he was entitled to interest earned on the trust assets.

The children inherited remainder interests in the trust assets. These interests entitled the children to ownership of the trust assets when the surviving spouse died.

The surviving spouse was the executor of his wife’s estate. He made a QTIP election, which we’ll address below, which deferred the estate taxes that would have been due on the death of his spouse.

Several years later, the surviving spouse and children entered into an out-of-court agreement to terminate the trust and to distribute the assets to the surviving spouse. The taxpayers filed gift tax returns taking the position that there were two gifts, one from the surviving spouse on termination of the trust to children and then one from the children to transfer the assets to the surviving spouse. According to the taxpayers these transfers essentially offset each other and resulted in no gift tax due.

The IRS audited the gift tax returns, did not agree with the taxpayers reciprocal gift argument, and issued a statutory notice of deficiency. The dispute ended up in the U.S. Tax Court, which issued the tax court opinion that is the basis of this article.

About the QTIP Election

To understand this court case, we have to start with the QTIP election and the general concept for when the QTIP is used. QTIP elections typically involve trusts, so we’ll start with the QTIP trust.

A QTIP trust is one that holds some or all of the trust assets in trust for the surviving spouse. The surviving spouse has to be entitled to all of the income from the trust property and be paid at least annually. The trust also has to limit the power to appoint the property to anyone other than the surviving spouse during their lifetime.

This type of arrangement is often used to ensure that the income of the assets is used for the surviving spouse of the settlor, the person who set up the trust, with the remainder interest passing to the settlor’s children. This helps avoid a situation where assets are used for or transfered to the surviving spouse’s new spouse or the surviving spouse’s children from outside of the marriage. So second marriages and mixed families.

The QTIP election is an election made on the settlor’s estate tax return and is one of several estate tax planning considerations that one has to consider. It is similar to the GST election and tax planning in some ways. It is typically made on the estate tax return of the first spouse to die, which is usually due within 9 months of death (with a possible 6-month extension).

The election creates a legal fiction that the surviving s…

The election creates a legal fiction that the surviving spouse owns the trust assets when really they only have an income interest. This fiction allows the settlor’s estate to claim a 100% marital deduction for estate tax purposes. This marital deduction allows the trust assets to avoid estate tax on the death of the first spouse, which is usually not allowed when the surviving spouse does not actually have an ownership interest in the property in question and the settlor spouse retains control over who gets the property when the second spouse dies.

This election and tax planning involving valuation discounts can often significantly reduce ones estate tax liability. Charitable trusts can be used for similar purposes too, if there is a charitable intent involved.

The QTIP trust is an easy way the first spouse to die can limit the surviving spouse’s ability to transfer or control the property while still qualifying for the marital deduction. Similar results can be obtained using a bypass or credit shelter trust. Other strategies usually leave the surviving spouse with some control over who gets the property on their death.

Gift Tax for the Surviving Spouse

The first question in this case was whether executing the settlement agreement to terminate the trust, the surviving spouse and children triggered a gift tax.

The U.S. Tax Court concluded that it did not, which it referenced its prior opinion in Estate of Anenberg v.
Commissioner, No. 856-21, 162 T.C. (May 20, 2024) from earlier this year. The Estate of Anenberg stands for the proposition that a surviving spouse does not make a taxable gift when a QTIP trust is terminated and all its assets are distributed to the surviving spouse. This makes sense as the marital deduction is generally allowed when property passes to the surviving spouse and the estate tax is imposed when the surviving spouse dies.

The mechanics of the actual statutes are more complex than this. This is why the U.S. Tax Court had to analyze Section 2519 so closely, and then it just applied judicial reasoning instead of a close reading and application of Section 2519. In doing so, it concluded that the surviving spouse did not give away anything of value under Section 2519 and, alternatively, that there was an incomplete gift given that the surviving spouse ended up with the assets.

Thus, in applying these principles to the current case, the tax court concluded that the surviving spouse did not make a taxable gift when the residuary trust was terminated and its assets were distributed to him. This conclusion was reached despite the fact that the termination could be viewed as, and likely was, a disposition that should trigger gift tax under Section 2519.

Gift Tax for to the Children

The tax court then turned to the question of whether the termination of the residuary trust and transfer of the assets to the surviving spouse triggered a gift tax as to the children. The tax court concluded that it did.

The reasoning here is that the children had vested remainder interests in the trust property. They gave away the right to this property by allowing the property to be transferred to the surviving spouse. Thus, when viewed before and after the transfer, the children had a decrease in their net worth. They gave something up. The tax court concluded that this was sufficient to trigger a gift tax.

The tax court did not accept the taxpayer’s arguments about a reciprocal gift which negated any gift tax. The taxpayer’s argument was that the termination of the residuary trust resulted in a taxable gift for the surviving spouse. Then it also resulted in a taxable gift for the children for the transfer back to the surviving spouse.

As noted above, the tax court held that the first part of this argument–the gift tax for the surviving spouse–was not a gift and therefore did not trigger a gift tax. Thus, there could be no offsetting gift. The tax court also stated that there was no such concept as a reciprocal gift in the law that can be used to offset gift taxes. It noted that there is a concept of reciprocal trusts, but that that concept does not apply here.

To provide context

To provide context, we’ll briefly take a detour to discuss reciprocal trusts. The reciprocal trust doctrine is a legal principle that addresses situations where two individuals create similar trusts for each other’s benefit. This doctrine allows the IRS and courts to “uncross” or “unwind” trusts that are interrelated and leave the grantors in approximately the same economic position as they would have been if they had created trusts naming themselves as life beneficiaries.

This is similar to the economic substance doctrine that allows the IRS and/or the courts to void certain business transactions. When the IRS and/or courts apply this reciprocal trust doctrine, the result is that the trust assets are included in the settlor’s taxable estate under Sections 2036 or 2038. Again, this is not what we had in this case, so it was not applicable here according to the tax court.

The Takeaway

It is getting more common for beneficiaries of trusts to modify and even terminate their trusts. This can trigger significant tax liabilities, as in this case. This case helps to explain when the gift tax applies when one termites a trust. A QTIP trust can be terminated and this will not necessarily trigger gift taxes for the surviving spouse. If the termination results in the children getting their fair share of the trust assets, that may also avoid gift taxes. But as in this case, if the termination results in the surviving spouse getting more than what they otherwise would, the termination will likely trigger a gift tax for the children for the transfer to the surviving spouse.