Generally, if you are domiciled in the United States (US) at death, your estate is subject to US estate taxes. The determination of domicile is subjective. If you are a permanent resident, however, and have a green card, you will undoubtedly be considered domiciled in the US. But does that mean that you are treated the same as a US citizen? The answer is No. Although, just like a US citizen, a permanent resident is subject to estate taxes on all of his or her worldwide assets; unlike a US citizen, if a non-citizen inherits property from their spouse (regardless of whether or not that spouse was a US Citizen) they do not receive the benefit of the unlimited marital deduction on the assets they receive.
Elimination of The Marital Deduction for Non-Citizens
The marital deduction was originally established to assist families by considering husbands and wives as a single-family unit. Accordingly, it was felt that only transfers to third parties should be taxed, thereby deferring any potential estate tax until the death of the surviving spouse. Congress later realized, however, that should a non-citizen spouse decide to return to his or her country of origin after the death of their spouse, they would be able to avoid estate tax on any property held outside of the US. Accordingly, Congress decided to eliminate the marital deduction on estates passing to non-citizens. Loss of the marital deduction can be devastating to an estate, particularly if the amount of the estate exceeds the exemption amount ($5,490,000 in 2017). In that event, a 40% estate tax would be imposed on the excess.
How Estate Planning using a Qualified Domestic Trust can Help
Fortunately, Congress provided exceptions to the general rule that disallows the marital deduction for the non-citizen spouse beneficiary. The most obvious of these is for the non-citizen surviving spouse to become a US citizen prior to the date by which the decedent’s estate tax return is filed. For many, a more feasible estate planning alternative is to establish a Qualified Domestic Trust (“QDOT”). Similar to the typical marital deduction trust often used in estate planning, transferring assets from the decedent spouse to a QDOT allows the inheriting non-citizen spouse beneficiary to receive the benefit of the unlimited marital deduction and avoid estate tax at the first death. Unlike the typical marital trust, however, if the trustee distributes principal to the non-citizen spouse beneficiary, the distribution will be treated as if it never qualified for the marital deduction and an estate tax will be incurred. Consequently, if income distributions are insufficient to meet the cash needs of the inheriting non-citizen spouse, other estate planning vehicles (such as purchasing life insurance naming the non-citizen spouse as beneficiary) should be considered.
Other challenges occur when the value of the assets in the QDOT are greater than $2 million. In that event, the QDOT must either (i) name a US bank or trust company as trustee, or (ii) provide for the posting of a bond or letter of credit in the amount of 65% of the value of the QDOT.
QDOT’s can be complicated. Although they can be of substantial benefit, they are not necessarily the right choice for every non-citizen beneficiary. You should have a thorough discussion with an experienced estate planning attorney before considering a QDOT as part of your estate plan.
Consult a Qualified Estate Planning Attorney
Clifford M. Cohen has been practicing law for nearly 40 years and is also a member of the Trusts and Estates Section of the D.C. and Montgomery County Bar Associations. For assistance with everything related to estate planning and elder law, contact Cliff for your free consultation today. He’ll do what he can to create the best possible outcome for your situation.