Non-Citizen Spouses and Qualifying Domestic Trusts

In our increasingly globalized world, many American citizens have non-citizen spouses. This can present a serious problem when such couples consider estate planning. Normally, Internal Revenue Code Section 2056(d) denies the marital deduction to non-citizen spouses of a deceased U.S. citizen, meaning such couples have much greater estate tax exposure.

To understand this, first a bit about the estate tax. Each individual can give away up to $5,490,000 during life or at death (the “Applicable Exclusion Amount”), but amounts they transfer in excess of that are taxed at 40%. However, U.S. law also provides for an unlimited gifts to a spouse, that is, at least, a U.S. citizen spouse, the “marital deduction.” Couples in which both spouses are citizens are able to transfer unlimited amounts to each other during life or at death without affecting using up their $5,459,000 of Applicable Exclusion Amount.

Not so for couples in which one spouse is a non-citizen. Normally, non-citizen spouses must pay estate tax on any amount transferred in excess of the Applicable Exclusion Amount. (Similarly restrictive limits also apply to lifetime giving to non-citizen spouses). However, a qualified domestic trust (“QDOT”) under Internal Revenue Code Section 2056A provides a partial solution to this problem. If the citizen spouse leaves their assets at death to a qualifying QDOT trust, the estate tax on those assets is delayed.

In a QDOT plan, upon the death of the citizen spouse, assets in his or her estate are transferred to the QDOT instead of to the surviving, non-citizen spouse directly. Estate tax on the amount transferred to the QDOT on the death of the first spouse will still be owed upon the death of the surviving spouse . But during the life of the second to die, non-citizen spouse, the income from the assets in the trust can be distributed to the surviving spouse without estate tax. Moreover, there is also a partial exemption for distributions of principal to the surviving spouse provided it meets the requirements of the “hardship exemption.” Even without that exemption, however, during the life of the surviving non-citizen spouse, the income from the trust can be distributed to the surviving spouse without estate tax.