Tuesday, July 12, 2016

Estate Planning for Non-US Citizen Spouses

A surviving spouse is entitled to to the unlimited marital deduction. In other words, assets left to a surviving spouse are not subject to federal estate tax. There is no limit to the amount inherited by the surviving spouse. However, the caveat is that this only applies for a surviving spouse who is a US citizen.

If a surviving spouse is NOT a US citizen, including a person who is a legal permanent resident, he or she does not get the benefit of the unlimited marital deduction when inheriting property from a deceased spouse. Therefore, providing for a non-US citizen spouse requires special planning. If it is the non-US citizen spouse that dies first, then property left to a surviving spouse who is a US citizen is entitled to the unlimited marital deduction.

A surviving spouse who is not a US citizen can qualify for the unlimited marital deduction when inheriting property from his or her deceased spouse if the property is held in a qualified domestic trust ("QDOT") for the benefit of the non-US citizen spouse. 26 U.S. Code § 2056A. Instead of passing property directly in the name of the surviving non-US citizen spouse, the property is placed in trust of which the surviving non-US citizen spouse is the sole beneficiary.

In a QDOT, the non-US citizen spouse cannot be the sole trustee. A US citizen or a US bank must act as co-trustee or may be the sole trustee. If the QDOT assets exceed $2 million, the US trustee must be a bank, or the individual must obtain a bond or an irrevocable US letter of credit for 65% of the assets in the QDOT.

Distributions of income to the beneficiary from the QDOT are not subject to estate tax. However, distributions of principal are subject to federal estate taxes calculated at the marginal estate tax rate of the deceased spouse. There is an exception, however, when distributions of principal are made because the beneficiary has an urgent, immediate need and no other resources. When the beneficiary dies, the QDOT assets are included in his or her estate for estate tax purposes.

It is best to plan in advance prior to the death of the first spouse to ensure that the estate is handled in in accordance to the wishes of the deceased spouse and so that the non-US citizen spouse is sufficiently provided for. However, it is possible to establish a QDOT after the death of the first spouse under limited circumstances. The executor or the surviving spouse may elect to establish a QDOT and transfer property to the trust before the estate tax return is due, which is nine months after the date of death of the deceased spouse. Property which passes to the surviving spouse outside of probate by way of joint tenancy or payable-on-death designation may be transferred to a QDOT without being subject to estate tax if the property is transferred prior to the due date of the estate tax return.

Gifts During Lifetime
Similarly, gifts made to a spouse during lifetime is free of gift tax, except if the donee is not a US citizen spouse. If the donee is a non-US citizen spouse, tax-free gifts are limited to $148,000 per year for 2016, indexed for inflation.