When it comes to estate taxes, married couples in which one spouse is a resident non-citizen are treated differently than married couples where both spouses are U.S. citizens. Generally, assets that pass between spouses at the first death are free from estate taxes due to the Unlimited Marital Deduction, no matter how large the estate.
However, where the surviving spouse is a resident non-citizen, the Unlimited Marital Deduction is not automatically available. Although the government allows all taxpayers to pass a certain amount of assets at death estate tax-free, called the Applicable Exclusion Amount (“AEA”), estate taxes will be due on amounts in excess of the AEA (currently $2,000,000.00) unless proper estate planning is in place.
Yet, if either you or your spouse is a non-citizen, the difference in how you are treated does not end here. There are also limitations that apply while you are both alive. Generally, U.S. citizen couples can make unlimited gifts to each other without the gift being taxed. However, when gifting to a non-citizen spouse, a citizen spouse is limited to gifts of $125,000 per year.
This may seem like a sufficient amount, however, certain estate planning techniques may not be available where such a limitation is present. For example, a basic Estate plan may include a Revocable Living Trust which, upon the first spouse’s death, takes his or her assets and divides them into two sub-trusts: a Survivor’s Trust (sometimes called an “A” Trust) and a Family Trust (also called a “B” Trust). The purpose of the Family Trust is to segregate assets equal to the Applicable Exclusion Amount. By doing so, a married couple can pass double the AEA estate tax-free.
However, where one spouse owns more assets than the other spouse the estate may need to be “equalized” so that the spouse with fewer assets does not waste his or her AEA, in the event he or she dies first. This is accomplished by having the propertied spouse gift assets to the non-propertied spouse so that the estates are equal. Should the non-propertied spouse be a resident non-citizen, the gift would be limited to $125,000 annually, potentially hindering the effectiveness of the estate plan.
One way to resolve these planning problems is for the non-citizen spouse to become a U.S. citizen. Obviously, this can occur while both spouses are alive but also can be accomplished after the U.S. citizen spouse’s death. For gifting purposes, citizenship must be obtained before the death of the U.S. citizen spouse. In order to avoid an estate tax, without additional planning, citizenship would have to be obtained before the decedent spouse’s estate tax return is filed (generally within nine months of the citizen spouse’s death).
However, a non-citizen spouse may not want to obtain citizenship merely for planning purposes. These unwanted results, as discussed above, can be avoided through the use of a Qualified Domestic Trust, or “QDOT”. The non-citizen spouse’s inheritance could be put into a QDOT under the following provisions:
• The Trust must have at least one trustee who is a U.S. citizen. The spouse can be a trustee but he or she cannot be the only trustee. When assets reach a certain level, a professional trustee will be required.
• The surviving spouse must be entitled to all of the income of the QDOT.
• The QDOT must be established within nine months of the deceased spouse’s date of death and must be elected on his or her estate tax return (no later than one year after the time prescribed by law, including extensions, for filing the decedent’s federal estate tax return).
The non-citizen spouse’s inheritance goes into the QDOT when it is established and is tax-deferred until the non-citizen spouse dies or when he or she withdraws any or all of the principal.
The idea is to allow the non-citizen spouse the receipt of income generated by the QDOT assets, while at the same time securing the collection of the deferred taxes on the principal by the government. The requirement of having a U.S. citizen as one of the trustees was established to ensure the government had someone responsible to pay the taxes if the non-citizen decided to return to his or her country of origin without paying the taxes.
Generally, QDOT assets are taxed upon the occurrence of any of the following events.
• Principal withdrawn from the QDOT is subject to a QDOT tax.
• If the QDOT fails to meet the QDOT requirements at any time, all the trust assets are subject to a QDOT tax.
• When the non-citizen spouse dies, the QDOT assets are taxed.
The QDOT tax is incremental and is calculated in reference to the U.S. spouse’s estate tax. In broad strokes, the tax is determined by calculating what the QDOT assets would have generated in estate taxes were they in the estate of the U.S. citizen spouse. The QDOT amount is placed “on top” of the U.S. citizen’s estate to determine the applicable tax rate bracket for the QDOT assets, thereby generating the highest effective rates.
The mechanics of the QDOT, and the options available to a couple in which one is a non-citizen, are both complex and dependent upon a great number of personal factors (especially the value of the estate). If you or your spouse is a resident non-citizen, consult an estate planning professional at Smith Barid, LLC to discuss your specific planning needs.
If you are a non-citizen whose U.S. citizen spouse died recently, you may find yourself in a situation where proper planning has not been done. In this case it is imperative that you contact a qualified estate planning attorney immediately to discuss possible remedies that may still be available to you. The road to estate planning, especially in this situation, is dangerous without professional guidance.