Transfers Of Assets To A Spouse Who Is Not A U.S. Citizen

\| DT Online Home \| Site Search \| Personal Finance Advisor \|
	When Your Spouse Isn't a Citizen Personal Finance Advisor by Deloitte & Touche OnLine January 11, 1999

Transfers of assets aren't subject to taxes, but there are other traps.

Transfers of assets to a surviving spouse who is a U.S. citizen are not subject to federal transfer taxes because of an unlimited marital deduction (that is, the taxes are postponed until the date of the widow’s/widower’s death). However, as a general rule, the marital deduction is not available for transfers to a surviving spouse who is not a U.S. citizen. Congress denied the marital deduction for transfers to non-U.S. citizens in order to discourage the removal of assets from the United States by a surviving spouse (consequently avoiding U.S. transfer taxes).

Non-U.S. Citizen Spouse: For a surviving spouse who is not a U.S. citizen, a qualified domestic trust (QDOT) may be an attractive tax-planning vehicle. A QDOT is an irrevocable trust that is created by an election made by the executor or surviving spouse (the deceased spouse’s will should include instructions for the establishment of a QDOT). Among other requirements:

The QDOT may be established under the laws of a U.S. state or the laws of a foreign jurisdiction; however, the QDOT must be an ordinary trust and the QDOT documents must provide that the laws of a U.S. state (or the District of Columbia) will govern the administration of the trust. Copies of the QDOT documents are to be maintained in the United States.
A least one of the trustees of the QDOT must be a U.S. citizen or a U.S. domestic corporation, whose tax home is the United States. Trustees usually will be personally liable for estate taxes not paid by the QDOT.
A bond or an irrevocable letter of credit (equal to at least 65 percent of the fair market value of the assets transferred to a QDOT) is required if the gross amount of transferred assets exceeds $2 million (an exclusion of up to $600,000 for a principal residence is available).
All assets in the QDOT must qualify for the marital deduction.

If the surviving spouse becomes a U.S. citizen before the due date of the estate tax return, and resides in the United States between the date of his/her spouse’s death and the date of naturalization, the surviving spouse will qualify for the marital deduction (that is, use of the QDOT will not be necessary).

Also, the United States has established transfer tax treaties with Canada, Denmark, France, Germany, and Sweden, that allow some form of a marital deduction or credit for transfers to a surviving spouse by a decedent who was a resident of one of these countries.

Estate Tax: Federal estate tax (up to 55 percent of the value of transferred assets) generally applies to transfers to nonspouse beneficiaries as well as to a non-U.S. citizen surviving spouse. For 1999, a decedent (U.S. citizen or resident alien -- RA) is entitled to a unified tax credit of $211,300 (transfer tax on $650,000) for transfers to U.S. citizens or RAs. The transfer tax is based on all assets transferred, even if the assets are not located in the United States. Therefore, a transfer in excess of $650,000 from a U.S. citizen or RA to a surviving spouse who is not a U.S. citizen will be subject to federal estate tax.

The rules are different for transfers by a nonresident alien (NRA) -- the unified tax credit is only $13,000 (estate tax on $60,000 of transferred assets) and an NRA will be subject to estate tax on U.S.-situs assets transferred upon death. Consequently, federal estate tax will apply to transfers by a NRA of assets in excess of $60,000 that are located in the United States to a surviving spouse who is not a U.S. citizen.

Estate Tax with a QDOT: The fair market value of assets in a QDOT will be subject to federal estate tax on the date of the widow’s/widower’s death, or the date the trust fails to qualify as a QDOT. Transfers from a QDOT (e.g., distributions of trust principal, taxes paid/withheld by the QDOT on distributions of trust principal) will be subject to federal estate tax at the time of the transfer. In most cases, distributions of income generated by QDOT assets to the surviving spouse are not subject to estate tax. Other distributions from a QDOT that are not subject to federal estate tax include

Withdrawals for substantial financial needs relating to the basic support of the surviving spouse or a dependent, and his/her medical or education expenses ("hardship distributions"),
Distributions for the ordinary and necessary expenses of the QDOT,
Payments for income taxes imposed on the QDOT,
Fees associated with the disposition of QDOT assets, and
Reimbursements for certain taxes paid by the surviving spouse.

Gift Tax Considerations: U.S. citizens and RAs are subject to gift tax on transfers of assets that occur during their lifetime, regardless of the location of the assets. In most cases, a donor is entitled to a $10,000 annual exclusion for "present interest gifts." A gift to a non-U.S. citizen spouse qualifies for a $100,000 annual exclusion, provided assets go directly to the spouse or to a qualifying trust, and the gift would qualify for the marital deduction if the donee were a U.S. citizen. This $100,000 deduction is not available for distributions from a QDOT.

The unified credit ($211,300 minus tax on $650,000 of assets transferred) also is available to present interest gifts made by U.S. citizens or RAs. An NRA is not entitled to the unified credit and is only subject to gift tax on present interest gifts of tangible real and personal property that is located in the United States.

These are some thoughts to consider about qualified domestic trusts. Your Deloitte & Touche financial advisors also can provide information and should be consulted before any action is taken.