Any transfer of assets at death involves a variety of tax consequences, but estate planning for a married couple where one spouse is not a United States citizen involves unique taxation issues and planning. Couples who find themselves in this unique circumstance should consider the benefits of an estate plan that includes a Qualified Domestic Trust (QDOT).
In 2012, the federal estate tax provides a credit of $5,120,000, meaning that the first $5,120,000 of any estate not diminished by taxable lifetime gifts will pass free of the federal estate tax.¹ This exemption is scheduled to fall to $1,00,000.00 in 2013². Further, 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.
However, the rules are different when the surviving spouse is not a United States citizen, out of the government’s concern that the non-citizen surviving spouse will return to his or her home county, depriving the IRS of the chance to collect an estate tax at death.³ The federal estate tax credit still applies to such couples, but the unlimited marital deduction does not. As such, for couples with assets greater than the federal estate tax exemption, the citizen spouse should strongly consider establishing a QDOT for the noncitizen 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 (currently, $5,120,000 for 2012, with the potential to be reduced to $1 million in 2013), 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 2012 the first $5,120,000 held in trust or given outright will not be subject to federal estate tax due to the application of the credit. In a properly constructed QDOT, the remaining assets in excess of the federal estate tax will not be subject to the federal estate tax until the surviving noncitizen spouse’s death. For example, if a resident of Philadelphia County is married to a German citizen and the Philadelphian has assets of $7 million, the resident of Philadelphia should strongly consider giving $5,120,00 to his German spouse either outright during his lifetime or in trust at his death, and establish a separate QDOT at his death to hold the remaining assets.
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. If any trust principal is distributed, the trustee must pay estate tax on that amount. 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 bond with the IRS in the amount of sixty-five percent of the value of the principal. If all of these features are met, the trust will qualify as a QDOT. Upon the death of the surviving noncitizen spouse, the IRS will assess the estate tax on the trust principal.
Any United States Citizen, whether a resident of Pennsylvania, New Jersey, New York or any other state citizen married to a non-United States citizen should consider a QDOT if their assets exceed the federal estate tax credit.
Throughout our website, klenklaw.com, you may find more information about QDOT Trusts, other Estate Planning issues and many other estate planning tools. Our firm focuses exclusively in the area of estate planning, probate, and the litigation surrounding estate planning and probate including Will Contests and Will Challenges. If your estate planning involves a noncitizen spouse, please call one of our Experienced Estate Planning Lawyers for a free consultation. We practice throughout New Jersey, Pennsylvania, New York, Minnesota and Florida.
¹ For Example, if a United States citizen, resident of Cherry Hill, New Jersey, married to a citizen of Israel, has made gifts subject to the Federal Gift Tax to her children during her lifetime totaling $400,000, then in 2012 she only has the right to leave her husband $4,720,000 at her death free of the Federal Estate tax ($5,120,000 – $400,000).
² Using the same fats as example 1 above, the Camden County resident now can only leave $600,000 to her Israeli husband free of the Federal Estate tax in 2013 if the rates are not changed. If the rates are reduced, the importance of a QDOT rises.
³ For example, if a Billionaire United States Citizen married a younger spouse from Vietnam or China, then died leaving all assets to the surviving spouse without paying tax, that spouse could return to Vietnam or China with the tax-free inheritance and, at the spouse’s death, it would be very difficult for the IRS to collect the federal estate tax due.