When a spouse leaves money or property to the surviving spouse, it usually qualifies for a marital deduction, making the transfer tax-free. Then, at the surviving spouse’s death, the government gets its tax because the property is included in the survivor’s estate. However, with a non-citizen-surviving spouse, the government might not get the tax if the survivor left the country.
The typical situation might involve a couple where one or both of the spouses are non-citizens. If you leave your estate to a non-citizen spouse, your spouse might return to his or her country of origin, giving up his or her status as a resident of the U.S. Upon your spouse’s death, with some relatively simple planning regarding the investment portfolio, the estate of your nonresident spouse, including what had been yours, would completely avoid U.S. estate tax. The ability to legally avoid U.S. estate tax through the use of the unlimited marital deduction by a non-citizen spouse was viewed by Congress as a potential abuse.
In 1988, Congress passed the Technical and Miscellaneous Revenue Act of 1988 (TAMRA). This Act eliminated the opportunity for a non-citizen spouse to take advantage of the unlimited marital deduction for gift and estate tax purposes.
- The unlimited gift tax marital deduction is disallowed if the donor’s spouse is not a U.S. citizen. An annual gift tax exclusion of up to $149,000 (2017) is allowed if the gifts over $14,000 would qualify for the marital deduction if given to a citizen spouse.
- An unlimited exclusion still remains when a husband or wife makes a gift to a citizen spouse. Although gifting assets will reduce the taxable estate, a trade-off is that the benefit of stepping up the basis of the assets to the fair market value at date of death is lost.
- A non-resident alien donor will be entitled to a martial deduction or annual exclusion for gift taxes. For example, a gift from a Canadian citizen and resident (a non-resident alien) to a S. citizen spouse, will qualify for a full gift tax marital deduction.
- Gift and estate tax rates are now uniform for non-resident aliens, residents, and citizens. However, the exemptions for a non-resident alien’s S. estate is only $149,000 compared to $5.49 million for a resident or citizen.
- In order for the marital deduction to apply, the estate must pass into a Qualified Domestic Trust (“QDOT”). The QDOT will be taxable in the estate of the surviving spouse. However, the deferred tax is calculated using the tax rates in effect at the time of death of the first decedent.
How Does a QDOT Keep Taxes in the United States?
A QDOT ensures that the property does not escape the country without taxation. QDOT must have a U.S. citizen or financial institution as a Trustee. The QDOT can periodically pay the Trust’s income to the surviving spouse. Any other distributions must have estate tax withheld unless hardship can be shown. The American Trustee must be given the power to withhold these taxes. If the surviving spouse becomes a U.S. citizen, the assets can be removed from the QDOT.
In order for the QDOT provisions to apply, the Trust must comply with the following:
- The Trust must have at least one U.S. Trustee who is a U.S. citizen or domestic corporation. In the case where the value of the assets passing into the QDOT exceed $2 million, one of the Trustees must be a corporate (bank or Trust company) Trustee. Otherwise, the Trustee must furnish a bond equal to 65 percent of the fair market value of the corpus to insure payment of the tax.
- The Trust document must provide that a distribution must not be made unless the U.S. Trustee is permitted to withhold tax as required.
- The Trust provisions must insure that there are proper provisions for the collection of the tax as provided for in the Treasury Regulations.
- No more than 35 percent of the estate can be held in the form of real property located outside the United States.
- The assets must be held in the US.
Distributions From a QDOT
Distributions of income from the QDOT to the surviving spouse will be taxable as ordinary income. The Trustee will be the withholding agent and can be personally liable for the tax for failure to withhold. Distributions of principle will also be subject to estate tax in accordance with the estate tax tables.
A QDOT provides for the deferral of estate tax. The tax will be imposed upon a “taxable event.” Taxable events are usually the following:
- Death of the spouse
- Distributions of principle
- Termination of the Trust’s QDOT status
Form 706-QDT must be filed for taxable distributions (prior to the death of the surviving spouse) no later than April 15th of the year following the calendar year in which the distribution occurred.
If the taxable event is the surviving spouse’s death, then the return is due within nine months following the ate of death.
If the taxable event is the termination of the Trust’s qualification, the due date is nine months after the event.
While the QDOT is in existence, an annual income tax return must be filed on Form 1041, U.S. Fiduciary Income Tax Return. The return is due no later than the 15th day of the fourth month following the Trust’s year end.
As you can see, estate planning with a non-citizen spouse is quite complicated and these laws, like other estate planning laws, change constantly! Even minor differences in your situation can lead to drastic differences when it comes to planning. That is why it is crucial that you consult with an attorney that focuses on estate planning.