The Problem for Non-Citizens

For federal estate tax purposes, U.S. citizens get a large tax break that is unavailable to non-citizens.  When both members of a married couple are U.S. citizens, the first spouse to die can leave any amount of money to the survivor, completely free of estate tax.  This is called the unlimited marital deduction.

 

The marital deduction does not apply, however, if the surviving spouse is not a U.S. citizen.  If a married couple each has an estate that is greater than the estate tax exemption (currently set at $13,610,000), and one or both of them are not U.S. citizens, estate taxes will be due on assets passing to non-citizen spouses.  In order to avoid estate taxes on the death of the first spouse, a Qualified Domestic Trust (QDOT) should be used.  For estates that are less than the estate tax exemption amount, no QDOT is needed since no federal estate tax would be due.  However, for estates greater than those amounts, no marital deduction will be allowed if the surviving spouse is not a U.S. citizen and does not become a citizen by the time that the estate tax return is filed.  Depending on the type of estate plan that a couple has, a lack of a marital deduction could result in substantial estate taxes on the first death.  This can be avoided if the assets are transferred to a QDOT.  

 

Definition & Purpose of 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.

 

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 their lifetime or at their 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, they 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. 

 

Planning Considerations

• To avoid the difficulties associated with QDOTs, it is advisable for clients to make use of the $185,000 gift tax exemption for 2024 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 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. 

• The QDOT should only be funded with assets in excess of the federal estate tax limit. 

 

Tax Consequences

• The QDOT should be taxed as a simple trust for income tax purposes.

• The assets transferred into the QDOT are eligible for the unlimited marital deduction.

• Each distribution from the QDOT triggers the federal estate tax.

• Form 706-QDT must be filed annually to report the amount in the trust as well as the distributions made from the trust.

• A non-citizen spouse cannot use the applicable exclusion amount to shelter any distributions of principal from a QDOT, because QDOT assets are never considered part of the non-citizen spouse's gross estate; they are part of the deceased spouse's estate for estate tax purposes.

• A non-citizen spouse cannot use the applicable exclusion amount to shelter assets in a QDOT from estate taxes upon their death.  However, the surviving non-citizen spouse may use the applicable exclusion amount ($13,610,000 million in 2024) to shelter their own assets from federal estate taxes.