Benefits of a QDOT for a Non-Citizen Spouse.

Posted on Wed Sep 19, 2012, on QDOT Trust

Last Updated Nov. 4, 2017: Benefits of a QDOT for a Non-Citizen Spouse.

From our “Ask a Question” mailbag: Benefits of a QDOT for a Non-Citizen Spouse.

Estate Planning Attorney, Tatyana Gleyzer.

Extra Tax Complications With a Non-Citizen Spouse.

Any asset transfer at death may trigger a variety of tax consequences. But, unique tax problems arise when one spouse is a non-United States citizen. Couples who find themselves in this exceptional circumstance should consider the benefits of an estate plan that includes a Qualified Domestic Trust (QDOT).

Federal Estate Tax Exemption is Unlimited for Citizen Spouses.

Section 2056 of the Internal Revenue Code contains the “marital deduction,” which provides that any property left to a surviving spouse following a decedent’s death is not taxed until the surviving spouse’s death. These provisions give married couples options for deferring estate tax payments until after the surviving spouse’s death.

For example, a billionaire can leave her US citizen husband all her money without paying the estate tax.

Federal Estate Tax Exemption

The federal estate tax provides a credit from taxation. The credit is based on $5,000,000 adjusted each year for inflation. This means that the first $5,000,000 (adjusted for inflation) of any estate not diminished by taxable lifetime gifts will pass free of the federal estate tax.

For example, a US Citizen can leave $5,000,000 (adjusted for inflation) to anyone without paying the estate tax. This includes non-citizens.

Non-Citizen Spouses are Treated Differently.

However, the rules are different when the surviving spouse is not a United States citizen. The government’s concern that the non-citizen surviving spouse will return to his or her home county. Thus depriving the IRS of the chance to collect an estate tax at death.

For example, let’s say a Billionaire United States Citizen married a younger spouse from Vietnam or China. At the US citizen’s death, he leaves all assets to the surviving spouse. If the standard spousal exemption applied, she would receive all the money without tax. That spouse could return to Vietnam or China with the tax-free inheritance. Then, at the spouse’s death, it would be complicated for the IRS to collect the federal estate tax due.

The federal estate tax credit still applies to such couples, but the unlimited marital deduction does not. As such, for couples with assets higher than the federal estate tax exemption, the citizen spouse should strongly consider establishing a QDOT for the noncitizen spouse.

Enter The QDOT.

Congress created the Qualified Domestic Trust to allow a US Citizen to leave assets over the exemption amount for a non-citizen spouse without paying the estate tax. In short, the US Citizen first uses his or her $5,000,000 exemption and then shelters anything beyond that $5,000,000 in a properly drafted QDOT.

Federal Estate Tax Exemption Planning with a Non-Citizen Spouse.

To take the maximum benefit of the QDOT, the citizen spouse can establish two trusts for the noncitizen spouse: one to hold the assets that amount to the federal estate tax credit and a QDOT to hold any assets that exceed that amount.

Alternatively, the citizen spouse could give an amount up to the federal estate tax credit to the noncitizen-surviving spouse outright, and establish a QDOT to hold any assets that exceed the federal estate tax credit.

For example, let’s say a Philadelphia County resident marries a German citizen. The Philadelphian has assets of $7 million. To avoid the federal estate tax at death, the Philadelphian may give $5,000,00 to his German spouse either outright during his lifetime or in trust at his death. Further, he would establish a separate QDOT at his death to hold the remaining assets.

What is a QDOT?

A trust that qualifies as a QDOT must have several features. If any of these are missing, the trust will fail to qualify for the tax deferral, so consulting with an experienced Estate Planning Attorney familiar with drafting QDOT Trusts is advisable.

In general terms, the trust must be for the noncitizen surviving spouse’s benefit, with income distributed to the noncitizen surviving spouse or for his or her benefit at least annually. The trustee pays estate tax on principal distributions.

The noncitizen-surviving spouse cannot serve as the sole trustee of the QDOT. A corporate trustee or a United States citizen must serve as trustee. If the trust principal exceeds $2 million, the trustee must post a bond with the IRS in the amount of sixty-five percent of the value of the principal. Meeting these features qualifies the QDOT. Upon the death of the surviving noncitizen spouse, the IRS will assess the estate tax on the trust principal.