Estate Planning for the Non-Citizen Spouse

If you have a large estate and either you or your spouse is not a U.S.citizen, you should consider setting up a Qualified Domestic Trust (QDOT).

If you and your spouse are both U.S. citizens, it is unlikely that you will be faced with an estate tax bill. You have the advantage of a federal estate tax exemption of $11.4 million dollars for each of you, an unlimited marital deduction that enables you to leave any amount to your spouse free of tax, and a portability election that allows you to add any of your spouse’s unused estate tax exemption to your own (provided that you make a timely election after their death).

If one of you is not a U.S. citizen, you may need to do some more extensive estate planning.

What are the estate tax rules for non-citizen spouses?

So long as your estate is below the federal estate tax exemption amount, you have nothing to worry about as there will be no estate tax due on your death. If it is above that amount and one spouse is not a U.S. citizen, the unlimited marital deduction – which allows an individual to transfer up to the entirety of their estate to their spouse free from estate tax – will not apply if the citizen spouse dies first. One way around this is to place those assets in a Qualified Domestic Trust (QDOT).

What is a Qualified Domestic Trust (QDOT)?

A QDOT allows a non-citizen spouse to qualify for the unlimited marital deduction by holding the funds (that would otherwise be transferred directly to them after their spouse’s death) in a trust with a U.S. Trustee. The purpose of the QDOT requirement is to ensure that non-citizens do not leave the U.S. with funds that they inherited and avoid paying estate tax on those amounts in the future.

How does a QDOT work?

When the first spouse dies, instead of the funds going directly to the surviving non-citizen spouse they are placed in a QDOT, with a U.S. citizen Trustee who has control of the trust assets. An irrevocable QDOT election must be made on the deceased spouse’s federal estate tax return, which must be filed within nine (9) months of the first spouse’s death, even if no tax is due.

The Trustee is then directed to distribute the trust income to the non-citizen spouse at least once a year throughout their lifetime, income which is subject to income taxes but not to estate taxes. Per 26 CFR § 20.2056A-5(c)(1), if the trustee of a QDOT makes a distribution of principal to the non-citizen surviving spouse, the amount of that distribution will be subject to estate taxes unless:

  1. the payments are made due to an “immediate and substantial financial need” (e.g., the health, maintenance, education, or support of the non-citizen spouse or his/her legal dependents), and
  2. the surviving spouse doesn’t have any other “reasonably available”
    assets.

“Reasonably available assets” include publicly traded stock that can be sold, CDs that can be cashed in, and other assets that can be liquidated easily. Closely held business interests, real estate, and tangible personal property need not be sold for the surviving spouse to qualify for an estate-tax-exempt distribution of principal from their QDOT.

In sum, with a QDOT the non-citizen surviving spouse benefits from the trust funds during their lifetime, and the deceased spouse’s estate taxes are deferred. Estate taxes on only paid on non-exempt principal distributions. After the surviving spouse’s death, the estate taxes are paid on whatever is remaining in the trust, and the balance is then paid to the trust’s remainder beneficiaries (typically the children). The QDOT funds are not included in the surviving spouse’s estate.

What are the requirements for a QDOT?

A QDOT should contain all assets that exceed the federal estate tax exemption amount. To qualify, the trust must meet
the requirements
set forth under 26 CFR § 20.2056A-2. These include, but are not limited to:

  1. The trust is a U.S. trust, governed by and maintained under the laws of a U.S. state or the District of Columbia.
  2. The executor/trustee elects to treat the trust as a QDOT on the U.S. citizen-spouse’s estate tax return, filed within nine (9) months of that person’s death.
  3. At least one trustee of the QDOT is a U.S. citizen or a domestic corporation (i.e., trust company or bank).
  4. The property being transferred to the QDOT qualifies for the federal estate tax marital deduction.
  5. If the assets in the QDOT exceed $2 million, the U.S. trustee is a U.S. bank or an individual who has posted a bond or a letter of credit to the IRS equal to 65% of the value of the assets in the trust as of the decedent’s date of death (or alternate valuation date).
  6. If the assets in the QDOT are $2 million or less, but the foreign
    real estate comprises more than 35% of the trust’s assets, the U.S.
    trustee is a bank or an individual who has posted bond per (4)
    above.

What if a non-citizen spouse obtains citizenship?

If a non-citizen spouse obtains citizenship before the federal estate tax return deadline, the unlimited marital deduction will become available to them.

San Francisco estate planning attorneys

Consult an experienced estate planning attorney at Moskowitz, LLP to create an estate plan that meets your specific needs.

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