Estate Planning for the Non-Citizen Spouse

By: Randall A. Denha, J.D., LL.M.

If you have a large estate and either you or your spouse is not a U.S. citizen, you should consider setting up a Qualified Domestic Trust (QDOT). Traditional estate planning strategies generally are based on the assumption that all family members involved are U.S. citizens. However, if you or your spouse is a noncitizen, special rules apply that may require additional planning.

If you and your spouse are both U.S. citizens, it is unlikely that you will be faced with an estate tax bill. You have the advantage of a federal estate tax exemption of $11.7 million dollars for each of you, an unlimited marital deduction that enables you to leave any amount to your spouse free of tax, and a portability election that allows you to add any of your spouse’s unused estate tax exemption to your own (provided that you make a timely election after their death).

What if one spouse is a U.S. resident, but not a citizen?

If you’re a U.S. resident, but not a citizen, you’re treated similarly to a U.S. citizen by the Internal Revenue Code. You’re subject to federal gift and estate taxes on your worldwide assets, but you also enjoy the benefits of the $11.7 million (for 2021) gift and estate tax exemption and the $15,000 annual gift tax exclusion. And you can double the annual exclusion to $30,000 through gift-splitting with your spouse, so long as your spouse is a U.S. citizen or resident.

Residency is a complicated subject. IRS regulations define a U.S. resident for federal estate tax purposes as someone who had his or her domicile in the United States at the time of death. One acquires a domicile in a place by living there, even briefly, with a present intention of making that place a permanent home.

Whether you have your domicile in the United States depends on an analysis of several factors, including the relative time you spend in the United States and abroad, the locations and relative values of your residences and business interests, visa status, community ties, and the location of family members.

What are the estate tax rules for non-citizen spouses?

So long as your estate is below the federal estate tax exemption amount, you have nothing to worry about as there will be no estate tax due on your death. If it is above that amount and one spouse is not a U.S. citizen, the unlimited marital deduction – which allows an individual to transfer up to the entirety of their estate to their spouse free from estate tax – will not apply if the citizen spouse dies first. One way around this is to place those assets in a Qualified Domestic Trust (QDOT).

What is a Qualified Domestic Trust (QDOT)?

A QDOT allows a non-citizen spouse to qualify for the unlimited marital deduction by holding the funds (that would otherwise be transferred directly to them after their spouse’s death) in a trust with a U.S. Trustee. The purpose of the QDOT requirement is to ensure that non-citizens do not leave the U.S. with funds that they inherited and avoid paying estate tax on those amounts in the future.

What is the purpose of a QDOT?

A QDOT is a statutorily created trust designed to allow a surviving spouse, who is not a U.S. citizen, to qualify for the unlimited marital deduction. The intent of the QDOT legislation is to preserve the marital deduction to ensure that a noncitizen spouse does not leave the United States with assets inherited without paying federal estate tax on those assets. When the first spouse dies, instead of the funds going directly to the surviving non-citizen spouse they are placed in a QDOT, with a U.S. citizen Trustee who has control of the trust assets. An irrevocable QDOT election must be made on the deceased spouse’s federal estate tax return, which must be filed within nine (9) months of the first spouse’s death, even if no tax is due.

In sum, with a QDOT the non-citizen surviving spouse benefits from the trust funds during their lifetime, and the deceased spouse’s estate taxes are deferred. Estate taxes on only paid on non-exempt principal distributions. After the surviving spouse’s death, the estate taxes are paid on whatever is remaining in the trust, and the balance is then paid to the trust’s remainder beneficiaries (typically the children). The QDOT funds are not included in the surviving spouse’s estate.

What are the requirements for a QDOT?

To qualify as a QDOT, the trust must meet the following requirements:

The executor must elect on the estate tax return to treat the trust as a QDOT (called a QDOT election).
Every distribution of principal from the QDOT to the surviving spouse during his or her lifetime or at his or her death will be subject to payment of estate tax, and this tax is computed as if the distributions were included and taxed in the first spouse’s estate.
The terms of a QDOT should provide that all income is distributable to the surviving non-citizen spouse.
The trustee of the QDOT must be a citizen of the United States.
If the QDOT assets exceed $2 million, then one of the trustees must be a U.S. bank, and if there is an individual trustee, he or she must post a bond or letter of credit to the IRS in the amount of 65 percent of the value of the trust assets to secure payment of the tax.
If the trust assets are under $2 million, then no bond need be posted and a U.S. bank need not be a trustee, provided that no more than 35 percent of the trust assets consists of real estate located outside the U.S.

What Planning Opportunities Exist?

To avoid the difficulties associated with QDOTs, it is advisable for clients to make use of the $159,000 gift tax exemption for 2021 available for transfers to a non-citizen spouse.
Taxpayers may also consider purchasing sufficient life insurance within an irrevocable life insurance trust that can provide for the estate tax upon the death of the (citizen) spouse. The use of the life insurance to pay the estate tax would avoid having to use a QDOT.
A QDOT need not be created in the decedent’s will (or in a revocable living trust); it may be created by the surviving non-citizen spouse provided it is funded prior to the due date for the federal estate tax return.
If the surviving non-citizen spouse becomes a citizen prior to the filing of the estate tax return, there will be no need for a QDOT.
If the surviving spouse becomes a citizen after the assets are transferred to the QDOT, distribution of property from the QDOT will not be taxed if:
- The surviving spouse either was a U.S. resident from the date of death of the decedent or no taxable distributions were made from the QDOT prior to the surviving spouse becoming a citizen; and
- The United States trustee notifies the IRS that the surviving spouse has become a U.S. citizen.
- Special rules apply if the QDOT had already made taxable distributions.
A QDOT Rollover IRA should be considered for the decedent’s IRA and 401(k) assets to avoid an immediate income tax and estate tax.
Joint property owned by the decedent and the non-citizen spouse will follow the established rules, which basically state that the asset will be includible in the gross estate of the person who paid for the asset.