According to a US Census Bureau report, couples in which one or both spouses are foreign-born account for 20% of all marriages in the United States. Of these foreign-born spouses, approximately 60% are naturalized and 40% are noncitizens. The Bureau links this trend to both the growth of the US immigrant population and the increased number of Americans traveling and living abroad. This demographic faces unique estate and tax planning issues.
One of the most significant estate planning issues arises when a citizen spouse dies leaving assets to a noncitizen surviving spouse. Assets passing to the noncitizen spouse do not generally qualify for the unlimited estate tax marital deduction unless certain conditions are met. In addition, the noncitizen spouse is restricted in how he or she can use the deceased citizen spouse’s unused exemption (DSUE) amount by means of a portability election.
To qualify for the unlimited estate tax marital deduction, a noncitizen surviving spouse must (i) be from a country that has a treaty with the United States that provides for the marital deduction or a credit in lieu of the deduction or (ii) become a US citizen before the deceased citizen spouse’s estate tax return is due and be a resident of the United States at all times after the deceased citizen spouse’s death and before becoming a US citizen.
Alternatively, the noncitizen surviving spouse can receive the deceased citizen spouse’s property through a Qualified Domestic Trust (QDOT) (or, if the noncitizen surviving spouse receives such property outright, he or she can irrevocably assign the property to a QDOT before the deceased citizen spouse’s estate tax return is due, including extensions). Assets qualify for the marital deduction if they are received through a QDOT for the benefit of a noncitizen surviving spouse. As a result, the federal estate tax liability of the deceased citizen spouse’s estate will be deferred until distributions of principal are made to the noncitizen surviving spouse (with each distribution separately subject to estate tax). Any assets remaining in the QDOT are subject to tax upon the death of the noncitizen surviving spouse. For portability purposes, when property passes to a QDOT, the DSUE amount is computed as it is when property passes to a citizen spouse, less certain adjustments upon final distribution or other termination of the QDOT.
QDOTs have many technical requirements and must comply with the following:
- qualify as an ordinary trust under 26 CFR § Sec. 301.7701-4(a)
- qualify for the federal estate tax marital deduction as a power of appointment trust, a qualified terminable interest property trust, or a qualified charitable remainder trust of which the noncitizen spouse is the only noncharitable beneficiary; or meet the requirements of an estate trust
- require that at least one trustee be a US citizen or US corporation
- provide that no distributions (other than distributions of income) may be made from the trust unless the trustee has the right to withhold the estate tax imposed under Section 2056A
- be maintained in, administered under, and governed by the laws of a US state or the District of Columbia
- be accompanied by an affirmative election made by the executor of the deceased citizen spouse’s estate on the deceased citizen spouse’s estate tax return
QDOTs are subject to additional requirements that are dependent on their total trust values.
Proper planning with QDOTs is essential to ensure that couples with noncitizen spouses benefit from portability and the unlimited marital deduction.