This memorandum discusses generally the U.S. gift tax and estate tax issues to consider for a married couple when either one or both spouses are not citizens of the United States.
In general, the U.S. gift tax and estate tax laws permit unlimited tax-free transfers of property between spouses if the transferee spouse (i.e., the spouse receiving property) is a U.S. citizen. This "marital deduction" often is said to reflect the view that married partners represent a single economic unit, and only transfers from that unit to third parties (e.g., children) should be subject to gift and estate tax. But the marital deduction is not allowed if the transferee spouse is not a U.S. citizen, even if the non-citizen spouse is a permanent resident of the United States. Although widely criticized, this rule is based on a concern that the non-citizen spouse might move to another country and thereafter transfer property they received tax-free without being subject to U.S. gift and estate taxes.
Estate Planning During Life
Each year, you may give up to $100,000 of property to your spouse without gift tax even if your spouse is a non-citizen. You might want to undertake a series of annual gifts. For example, if the wealth between you is substantially unequal, these gifts will tend to equalize the wealth between you. If only one of you is a citizen, gifts from the citizen to the non-citizen spouse will minimize the effect of the marital deduction restrictions at death (discussed below).
Estate Planning At Death
At death, gifts to your non-citizen spouse can qualify for the marital deduction and avoid estate tax only if the property is held in a special trust for the non-citizen spouse's benefit, sometimes called a "qualified domestic trust" or "QDOT trust."
In planning your estate, we suggest that you first consider your objectives without the complications presented by the citizenship issue. You first should decide whether to make your gifts outright to your spouse or in a trust for your spouse's benefit with the property eventually to pass to other named beneficiaries. Once you have made this decision (outright versus trust), you can decide how best to qualify your spouse's gift for the marital deduction.
Outright Gift to Non-citizen Spouse
If your estate plan includes an outright gift to your spouse, we suggest that your will make this outright gift even if your spouse is not a U.S. citizen. If your spouse is a non-citizen, your will also should include an option for your spouse to "disclaim" part or all of the outright gift; if your spouse then disclaims, or refuses, the gift, the property would instead pass to a QDOT trust for your spouse's benefit. This structure gives your spouse several choices:
- The citizenship problem may go away: Between now and the time of your death, the citizenship problem may go away. Congress might change the rules applicable to non-citizen spouses.
- Your spouse may become a citizen: Before or after your death, your spouse may avoid the marital deduction problem by becoming a U.S. citizen before the due date for filing your estate tax return (normally 9 months after your death, but often extended to 15 months). Thus, the problem may go away if your surviving spouse elects to obtain U.S. citizenship before or even after your death.
- Your surviving spouse may prefer to pay the tax: The surviving spouse may prefer to pay the tax and have unrestricted ownership of the assets. This will not make sense for most people, but might be appropriate for a spouse who plans to leave the United States, e.g., to return to his or her native country.
- Your surviving spouse may establish a separate QDOT: The U.S. estate tax rules permit your surviving spouse to establish his or her own QDOT trust with terms selected by the surviving spouse, as long as the QDOT trust is established and the property transferred to it by the due date of your U.S. estate tax return (9 months after death, or 15 months with an extension). This option allows your spouse to customize the trust to accommodate the requirements of the U.S. tax laws at that time.
- Your spouse may disclaim to the QDOT trust under your will: Finally, your spouse may reject all of the above options and choose to disclaim the outright gift so that it passes to the QDOT trust for your spouse's benefit under your will. This structure allows the use of this trust but does not require it, thus preserving planning flexibility for your spouse.
Gift in Trust for a Non-Citizen Spouse
You may plan to use a trust for your gift to your spouse. For example, you may use a trust so that, at your spouse's later death, the trust property passes to your named beneficiaries (e.g., your children) rather than having your spouse control the disposition of your property. If you plan to use a trust, there are relatively few requirements to convert an ordinary trust to a trust that satisfies the QDOT rules. The primary requirement is that your spouse cannot be the sole trustee, and you must instead name a U.S. citizen or a U.S. bank to act as an additional trustee.
The IRS May Require a Security Arrangement
When you give property to a QDOT trust for your non-citizen surviving spouse, the Internal Revenue Service may impose special arrangements on that trust to ensure that the estate tax will be paid at the surviving spouse's death. The requirements differ depending on the value of the trust and the value of foreign real property in the trust; you may need a U.S. bank as trustee or the trustee may need to furnish a bond or other security.
Retirement Plan Benefits
Planning for the distribution of retirement plan benefits may raise additional complications if those benefits are to qualify for the marital deduction. We can suggest options for dealing with retirement plan benefits on a case-by-case basis.
Foreign Real Property
It is unclear how the QDOT rules apply to real property located outside the United States. It may be impossible for foreign real property to be transferred to a QDOT trust and qualify for the marital deduction. This matter is still the subject of some debate by the IRS and tax practitioners, and no definite conclusions may be drawn.