How can I give property to my non-citizen spouse and avoid paying estate taxes upfront?

Would you like to be able to pass on property in a taxable estate to your spouse (who isn't a citizen of the U.S. but does reside here) without burdening him or her with immediate estate taxes? Would you like to give them the time to take steps necessary for them to be able to enjoy the benefits of an unlimited marital deduction?

If the answer to either of these questions is yes, then a Qualified Domestic Trust (QDOT) may be the solution for you.

To explain how, it is important to understand a few key points about the marital deduction as well as why a non-citizen spouse does not benefit from it...

  • Put simply, the marital deduction is the government's way of deferring taxation on property passing from one spouse to another
  • In 1988, a law was passed that disallowed a marital deduction for Federal estate tax purposes to property passing to a surviving spouse who was not a U.S. citizen - Congress felt this would avoid the possibility that they would never get their money if the surviving spouse left the country for good

3 ways to help solve the marital deduction problem with non-citizen spouses include:

  • gifting sufficient assets during your lifetime to your spouse that reduce your taxable estate below the current exemption (Note: you may have to pay taxes on gifts of over $133,000/year, and this may reduce the amount of your exemption originally intended to cover distributions to other beneficiaries - discuss this strategy with your advisor before taking action)
  • becoming U.S. citizens (both you and your spouse to avoid guessing who will pass away first)
  • creating a QDOT to pass property to your spouse

A QDOT is a great solution for transferring property to a non-citizen spouse. It allows you to...

  • provide estate tax free income on trust property to your spouse
  • defer estate taxation of principal distributions (at your applicable estate tax rate)
  • give your spouse the time to become a U.S. citizen so as to take advantage of the unlimited marital deduction (or to decide not to do so)

The following requirements must be met for the QDOT to work:

  • one of the Trustees has to be a U.S. citizen or a domestic corporation (the U.S. Trustee)
  • all principal distributions are subject to the U.S. Trustee's ability to withhold estate taxes
  • the deceased spouse must make an irrevocable election to treat the property as marital deduction property on the deceased spouse's estate tax return; and
  • If the QDOT has assets >$2,000,000 then the trust must require that at least one of the trustees be a bank or that the U.S. Trustee furnishes a bond or letter of credit equal to 65% of the fair market value of the assets
  • the QDOT must meet the requirements of a trust that qualifies for the marital deduction

In addition to the above requirements, the QDOT must be drafted to ensure compliance with all applicable laws (both state and federal). Thus, while a QDOT can be an excellent tool for deferral of taxation you should contact a Connecticut Estate Planning Attorney to determine whether or not this strategy would be proper in the context of your estate planning needs.

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