A Different Set of Tax Rules for Non-U.S. Citizen Spouses

Thanks to Michael Keenan of the The Connecticut Elder Law Blog for this post warning those couples who are not both US residents.

When you have two spouses who are both U.S. citizens, then upon the death of the first spouse there is never any tax regardless of how large your estate is. [This is called the Marital Deduction and it can be found in §2056(a) of the IRS Code. Its unlimited as to both the amount of assets and the kind.] It’s upon the death of the second spouse when estate tax can become an issue if the surviving spouse dies with an estate that exceeds the federal exemption amount (currently $2 million).

But…if one spouse is a U.S. citizen and one is not, and the U.S. citizen spouse dies first, then estate tax could become due at that point and the government is not going to wait until the death of the second spouse before collecting a tax. Why not? Because the government is worried about that foreign spouse high-tailing it back to his or her home country and dying there, in which case the U.S. government can’t collect a single penny of estate tax. So the government has decided to tax while the taxing is good…while that non U.S. citizen spouse is still here in the country.

And he’s right! Kinda crappy isn’t it!

So how do you get around this? (‘Cause you know there’s a way right…):

Its called the Qualified Domestic Trust or QDOT. Basically a QDOT is a trust used to postpone the estate tax due when the first spouse dies when more than the amount of the individual federal estate tax exemption is left to a non-U.S. citizen spouse by the first-to-die where the first-to-die was the US citizen.

A QDOT works by making the amount of money passed to it taxable in the estate of the surviving non-US resident spouse. However, the deferred tax is calculated using the tax rates in effect at the time of death of the first decedent. This differs from the approach used with the ordinary marital deduction trust in that the combined estates are taxed at the rates in effect when the surviving spouse dies. In a normal marital deduction trust, the decedent’s estate is added to that of the surviving spouse and tax at the higher marginal rate is imposed. However, with a QDOT, the decedent’s estate is run through the lower brackets as is the estate of the surviving spouse.

QDOT Provisions

    1.The trust must have at least one U.S. trustee who is a U.S. citizen or domestic corporation.
    2.The trust document must provide that a distribution must not be made unless the U.S. trustee is permitted to withhold tax as required.
    3.The trust provisions must insure that there are proper provisions for the collection of the tax as provided for in the Treasury Regulations; and
    4.A QDOT election is made on the decedent’s estate tax return. §2056A(a).

Basically, what I’m saying is: If you’re spouse is a non-US resident, then please contact an estate planning expert near you. As with all estate planning, you will have to pay the lawyer a little bit now, but it will save you even more later.

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