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Qualified Domestic Trusts

Qualified Domestic Trusts

What Are Qualified Domestic Trusts (QDOTs or QDTs)?

When a United States citizen marries a non-citizen — special estate planning concerns result.

It may be tempting to think that because you and your non-citizen spouse have made it "official," you no longer have to worry about whether the assets your estate will pass to their control in the event of your death. Unfortunately, that is not the case. Similarly, if you do happen to be aware of the estate tax consequences for non-citizen spouses, you may also be tempted to think that you're not going to die any time soon — that your new husband or wife will be a full-fledged U.S. citizen long before then. Why take that chance?

Because the current tax laws prohibit surviving spouses who are not United States citizens from claiming the marital deduction generally allowed to surviving spouses, a creative approach must be taken in large estates to resolving the issue and save the non-US citizen surviving spouse from the huge estate taxes that would otherwise be payable at the death of his/her spouse. Qualified domestic trusts provide for significant income tax deferral to the non-US citizen surviving spouse.

Of course, becoming a citizen at the earliest possible time will resolve the problem for the non-citizen spouse. The non-citizen spouse would have up to nine months following the death of the US citizen spouse to become a citizen, rendering the QDOT unnecessary. However, it ordinarily takes longer than nine months to process citizenship.

If you are a non-United States citizen married to a citizen or if you are the citizen spouse, consider making use of the tax deferral benefits that qualified domestic trusts offer.

Tax Considerations

The Unlimited Marital Deduction allows spouses to make or receive lifetime gifts of any size with no gift tax or reporting requirement. If the spouse who is receiving the gift is not a citizen, then only gifts less than $136,000 can be made annually without the necessity of filing a gift tax return. Filing a gift tax return depletes your applicable exclusion amount (currently $5 million per person) and triggers a gift tax if the amount exceeds $5 million.

If a U.S. citizen inherits assets from a spouse, then the inheritance is not subject to estate tax, but must be reported if it is in excess of the applicable exclusion amount. If the spouse receiving the gift is a U.S. citizen, then the gift is not subject to estate tax, provided that the survivor gets at least all of the income. If it’s an unrestricted gift, then there is simply no estate tax no matter how much is being transferred.

If the inheriting spouse is not a U.S. citizen, then if the bequest is in excess of the applicable exclusion amount, there will be an estate tax just as there would be for any non-spouse beneficiary. Making the transfer to the non-citizen spouse subject to a Qualified Domestic Trust postpones any estate tax until the survivor dies. If your estate exceeds the applicable exclusion amount, then upon your death the excess will be subject to estate taxes unless:

  • It is being distributed outright to a spouse who is a U.S. citizen;
  • It is being distributed in a qualifying trust to a spouse, whether or not the spouse is a U.S. citizen;
  • It is being distributed to qualifying not-for-profit entities.
  • Distributions to a life partner who is not a spouse do not qualify for an unlimited exclusion.

Requirements for a QDOT to “Qualify”:

  • The executor must make an irrevocable QDOT election on the federal estate tax return.
  • At least one trustee must be a U.S. citizen or U.S. bank. The non-citizen spouse may be a co-trustee and can even appoint the co-trustee U.S. citizen/bank.
  • If the value of the QDOT is greater than $2 million, either a U.S. bank must be co-trustee or the individual U.S. citizen co-trustee must furnish a bond or irrevocable letter of credit to the U.S. government.
  • If the value of the QDOT is under$2 million, no more than 35% of its value can be invested in real estate outside the U.S. unless a U.S. bank is co-trustee or the individual U.S. citizen co-trustee furnishes a bond or irrevocable letter of credit to the U.S. government.

Income paid from the QDOT is taxed to the surviving non-citizen spouse. Principal payments may not be made to the surviving non-citizen spouse except for health, education and support (and then only if there is substantial financial need) unless funds equal to the presumptive estate tax are withheld.

If the deceased spouse did not establish a QDOT, but one is required to defer estate taxes, the surviving non-citizen spouse may establish one within 9 months after the first spouse dies.

Upon the surviving non-citizen spouse’s death, the remaining assets of the QDOT and other money withheld per the above is taxed to the first-to-die spouse’s estate.

If you live in the Chicago or Lake County area, and need an experienced Trust attorney, please contact Matlin and Associates.

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