The Estate Tax and Non-Citizen Spouses

One of the most important tools used in federal estate tax planning is the marital deduction. This deduction normally provides an unlimited deduction for any transfers made to the surviving spouse.

Unfortunately, this deduction is not available when the surviving spouse is a non-citizen. The rationale for this distinction is that a surviving spouse was viewed by Congress as likely to return to his or her country of origin, taking his or her inheritance along and thus, avoiding estate taxes on the surviving spouse’s death as well.

Currently, the estate tax basic exclusion amount is $11,200,000, which generally allows an estate of up to that amount (subject to adjustments for past gifts) to pass without estate tax being imposed. Essentially, if both spouses’ estates file timely tax returns and the first spouse to die fully utilizes his or her marital deduction this lifetime amount is $22,400,000 per couple. Thus, the availability of the marital deduction is not an issue for estates valued at less than these amounts. However, if the citizen spouse has an estate of greater than $11,200,000.00, transfers to the surviving non-citizen spouse at death in excess of that amount would, unless otherwise planned for, be subject to tax.

One widely recognized planning method used to avoid this problem is the “Qualified Domestic Trust” (or QDOT), which is the Internal Revenue Code’s way of providing relief from estate tax upon the death of a citizen who leaves a non-citizen spouse, while still maintaining the ability to tax those assets in the future: at latest, upon the death of the surviving non-citizen spouse. It is a way of deferring the estate tax, but not necessarily a way of avoiding it.

A QDOT trust is essentially a marital trust (as recognized by the Internal Revenue Code), with three added requirements that:
The Trustee must be an individual citizen of the U.S. or a domestic corporation;
No distribution be made from the trust unless an individual citizen of the U.S. or a domestic corporation has the right to withhold taxes from it; and
The decedent’s executor makes the QDOT election on the appropriate estate tax return.

Additionally, for larger QDOT trusts, one trustee must be a U.S. bank, and certain other security provisions (such as the posting of a bond or a letter of credit) are required of that trustee.

As noted above, assets flowing into such a trust avoid estate tax on the death of the citizen spouse, however, withdrawals from the principal of such a trust may be taxable at the time of withdrawal and the assets of the trust would be taxable at the time of the death of the surviving spouse.
– Rod Fluck

Posted in Estates / Wills, Newsletters