Estate Planning Considerations for the Non-Citizen Spouse

When you are planning your estate and your spouse is not a US citizen, there is something very important to consider.

Marital Deduction

Property that passes from the decedent spouse to the surviving spouse by reason of the decedent spouse’s death passes free of federal estate tax. This is due to the marital deduction. The amount of the marital deduction is unlimited and therefore not subject to any ceiling. It has the effect of postponing the federal estate taxation of property that passes from the decedent spouse to the surviving spouse until the surviving spouse’s death to the extent that the property is not expended by the surviving spouse during his or her lifetime. However, this estate tax deferral opportunity is somewhat limited when the surviving spouse is not a US citizen.

Qualified Domestic Trusts (QDOT)

The marital deduction applies when the surviving spouse is a US citizen and property passes outright to him or her (or in certain trusts for the benefit of the surviving spouse discussed below). Conversely, the marital deduction does not apply when the surviving spouse is not a US citizen and property passes outright to him or her. It applies only when the property passing to the surviving spouse passes in a qualified domestic trust, or “QDOT”. Therefore, a QDOT can become a powerful estate planning tool.

General Power of Appointment Marital Trusts (GPOA)

In addition to complying with a unique set of rules and regulations (some of which are discussed below), a QDOT must be a marital trust that would otherwise qualify for the federal estate tax marital deduction if the surviving spouse were a US citizen. The most common trusts for this purpose are a general power of appointment marital trust, or “GPOA Trust”, and a qualified terminable interest property marital trust, or “QTIP Trust”. In both of these trusts, the remaining trust assets are included in the surviving spouse’s estate upon his or her death, thereby postponing the federal estate taxation until the death of the surviving spouse.

A GPOA Trust is created for the sole benefit of the surviving spouse during his or her lifetime. Its terms provide the surviving spouse with an income interest for life. The surviving spouse is granted a broad power to direct the distribution of assets remaining in the trust at his or her death; this power is known as a general power of appointment.

Qualified Terminable Interest Property Marital Trust (QTIP)

Like a GPOA Trust, a QTIP Trust provides the surviving spouse with an income interest for life. However, the surviving spouse will not have the power to direct the distribution of the remaining trust assets at his or her death. Instead, the remaining trust assets will be distributed in accordance with, and to the beneficiaries named, in the trust instrument. In other words, the decedent spouse, as the trust creator, controls the disposition of the remaining trust assets at the death of the surviving spouse.

Requirements for Marital Deduction

A GPOA Trust or QTIP Trust for the benefit of a surviving non-citizen spouse will not qualify for the marital deduction unless it also meets certain requirements that qualify it as a QDOT. These requirements help ensure that the US will be able to collect QDOT estate taxes during the surviving spouse’s lifetime if principal distributions are made to the surviving spouse and upon the surviving spouse’s death or disqualification of the trust as a QDOT.

A fundamental QDOT requirement is that at least one trustee be a US trustee. A US trustee is an individual who is a US citizen or a domestic corporation. A domestic corporation is a corporation organized under the law of any state or the District of Columbia. Therefore, the surviving non-citizen spouse may be a trustee as long as a US trustee is serving with him or her.

If the value of the QDOT assets exceeds $2 million (not including a personal residence with a value of up to $600,000), a QDOT trustee must be a US bank unless the US trustee meets certain bond (i.e., a bond in favor of the IRS in an amount equal to at least 65% of the fair market value of QDOT assets without regard to any indebtedness on such assets) or letter of credit requirements.

QDOT Estate Tax

Generally, a QDOT estate tax is imposed in three circumstances: during the lifetime of the surviving spouse if and when principal is distributed to him or her; upon the death of the surviving spouse on the then remaining trust assets; and upon disqualification of the trust as a QDOT. In fact, if the QDOT is to distribute principal during the surviving spouse’s lifetime, the QDOT must give the US trustee the right to withhold from the distribution the QDOT estate tax imposed on the distribution.

In the case of a distribution of QDOT principal to the surviving spouse during his or her lifetime, the QDOT estate tax is based on the fair market value of the principal distributed and the amount that the US trustee withholds from the distribution to pay the QDOT estate tax. However, the QDOT estate tax does not apply to income distributed to the surviving spouse or to hardship distributions of principal. A hardship distribution of principal is a distribution made for an immediate and substantial financial need relating to the health, education, maintenance and support of the surviving spouse or of any person the surviving spouse is legally obligated to support.

A QDOT estate tax is imposed on the fair market value of the remaining QDOT assets at the surviving spouse’s death or at the time of the disqualification.

The QDOT estate tax equals the Federal estate tax that would have been imposed on the decedent spouse’s estate if the decedent spouse’s estate were increased by the value of property distributed in the case of a lifetime distribution of principal, or the value of the property remaining in the QDOT at the time of the surviving spouse’s death or the disqualification, as the case may be, increased by the aggregate value of all property distributed in all prior distributions, and decreased by the Federal estate tax which would have been imposed on the decedent spouse’s estate had it been increased by the aggregate value of all property distributed in all prior distributions.

How Commonwealth Can Help

Planning for a non-citizen spouse is complicated, and the rules and regulations governing QDOTs are complex. It is strongly recommended that you consult with your attorney and tax advisor when you are planning for a non-citizen spouse. Nevertheless, if you are considering a QDOT as part of your estate plan, Commonwealth Trust Company, a Delaware Trust Company, can serve as the US trustee. Furthermore, if the value of the QDOT exceeds $2 million, the bond or letter of credit requirement can be avoided if Commonwealth Trust Company is appointed as Trustee because Commonwealth Trust Company qualifies as a US bank for purposes of the QDOT rules. Moreover, the QDOT can be a Delaware Directed Trust under Delaware law and thereby give the non-citizen spouse, or another person, a meaningful role in the trust investment decision-making process.

Commonwealth Trust Company is pleased to provide this article as a guide. Commonwealth Trust Company is not engaged in the practice of law and is not providing legal advice by the provision of these materials. Commonwealth Trust Company recommends that clients seek the opinion of their attorney regarding the specific legal and tax issues addressed in this article.