Estate planning for non-citizen spouses

By Julius Giarmarco

Giarmarco, Mullins & Horton, P.C.


A systematic gifting program should be considered where it is desirable for tax and/or non-tax reasons to transfer assets to a non-citizen spouse.

Gift and estate tax laws permit spouses to transfer unlimited amounts of property to each other without gift or estate taxes. The “unlimited marital deduction” does not apply, however, to non-citizen spouses. Congress is concerned that a non-citizen spouse might move to another country, thereby avoiding the U.S. gift and estate taxes. Therefore, providing for a non-citizen spouse requires special planning.

Under the Tax Relief Act of 2010, the estate and gift tax exemption is $5 million per person with a top tax rate of 35 percent. The exemption is adjusted for inflation beginning in 2012. However, without further Congressional action, on Jan. 1, 2013, the estate and gift tax exemption decreases to $1 million per person, and the top tax rate increases to 55 percent.

Gift taxes

Lifetime gifts to a non-citizen spouse can be made up to $134,000 per year in 2011. This gift tax marital deduction for non-citizen spouses is indexed for inflation. In addition, each year gifts of up to the annual exclusion amount ($13,000 for 2011, as indexed for inflation) can be made to a non-citizen spouse without gift tax.

Thus, a systematic gifting program should be considered where it is desirable for tax and/or non-tax reasons to transfer assets to a non-citizen spouse. For example, the spouse with a larger estate might desire to transfer some assets to his/her non-citizen spouse to ensure the non-citizen spouse has sufficient assets to shelter his/her estate tax exemption at death (see below). Or that same spouse might want to transfer assets to his/her non-citizen spouse for asset protection purposes.

Estate taxes

No estate tax marital deduction is available for transfers at death unless the property is held for the benefit of the non-citizen spouse in a qualified domestic trust. However, a deceased spouse can leave assets to a surviving non-citizen spouse – estate tax free – up to the decedent’s estate tax exemption. But assets left to a surviving non-citizen spouse using the decedent’s estate tax exemption will be subject to estate taxes when the non-citizen spouse dies, thereby wasting the deceased spouse’s estate tax exemption.

A QDOT allows the deceased spouse to defer estate taxes until the surviving non-citizen spouse’s death, while sheltering his/her estate tax exemption. This is typically accomplished by a living trust that allocates the decedent’s estate tax exemption to a credit-shelter trust and the balance of the estate to a QDOT.

During the non-citizen spouse’s lifetime, the trustee of the credit-shelter trust can provide the surviving spouse with income and principal as needed for health, education, maintenance and support. Upon the surviving spouse’s death, the assets remaining in the credit-shelter trust then pass – estate tax free – to the remaindermen (i.e., children and/or grandchildren).
The surviving spouse is also able to receive income from the QDOT. However, the surviving spouse will incur estate taxes at the tax rate in place at the time of the first spouse’s death upon two taxable events: the trustee distributes principal from the QDOT to the surviving spouse or the surviving spouse dies.

Any distributions of principal to the non-citizen spouse are subject to estate taxes, and the trustee must withhold funds equal to the tax. However, exceptions are made for principal distributions due to an immediate and substantial financial need relating to the spouse’s health, education or support, or the needs of a child or other person who the spouse is legally obligated to support.

QDOT requirements

The basic requirements of a QDOT are:
  • The QDOT must have at least one trustee who is an individual U.S. citizen or a domestic corporation.

  • The executor of the estate must make an irrevocable QDOT election to qualify for the marital deduction on the federal estate tax return (Form 709) within nine months from the date of death.

  • If the QDOT has assets equal to or less than $2 million, then no more than 35 percent of the value can be in real property outside of the United States or else:
    • The U.S. trustee must be a bank;

    • The individual U.S. trustee must furnish a bond for 65 percent of the value of the QDOT assets at the transferor’s demise; or

    • The individual U.S. trustee must furnish an irrevocable letter of credit to the U .S. government for 65 percent of the value.

  • If the QDOT has assets exceeding $2 million, either:
    • The U.S. trustee must be a bank;

    • The individual U.S. trustee must furnish a bond for 65 percent of the value of the QDOT assets at the transferor’s demise; or

    • The individual U.S. trustee must furnish an irrevocable letter of credit to the U.S. government for 65 percent of the value.
Post death QDOTs

Any property that the deceased spouse transfers to the surviving spouse outside of the QDOT (e.g. through joint tenancy or a beneficiary designation) may be transferred to the QDOT without being subject to estate tax if the property is transferred prior to the estate tax return due date (which is nine months after the date of death, plus an extension of six months).

If the deceased spouse’s will or living trust does not provide for a QDOT, the executor or the surviving spouse may elect to establish a QDOT and transfer the assets to the trust before the date on which the tax return is due. However, creating a QDOT in advance will ensure that the estate is handled in the manner that the decedent desires and also ensures that the non-citizen spouse is properly provided for.

Summary

The primary requirement for a QDOT is that the non-citizen spouse cannot be the sole trustee. A U.S. citizen or a U.S. bank must act as a co-trustee or may be the sole trustee. If the QDOT assets exceed $2 million, the U.S. trustee must be a bank or the individual trustee must furnish a bond or an irrevocable U.S. letter of credit for 65 percent of the QDOT’s assets.

Distributions of QDOT income are not subject to estate tax when made. However, distributions of trust principal are subject to federal estate taxes when made, calculated at the marginal estate tax rate of the deceased spouse. Finally, when the non-citizen spouse dies, the QDOT assets will be included in his/her taxable estate (as is the case with surviving spouses that are U.S. citizens).

THIS ARTICLE MAY NOT BE USED FOR PENALTY PROTECTION. THE MATERIAL IS BASED UPON GENERAL TAX RULES AND FOR INFORMATION PURPOSES ONLY. IT IS NOT INTENDED AS LEGAL OR TAX ADVICE AND TAXPAYERS SHOULD CONSULT THEIR OWN LEGAL AND TAX ADVISORS AS TO THEIR SPECIFIC SITUATION.