Gift and Estate Tax Planning for Non-Citizen Spouses
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While non-citizens who reside in the U.S. are subject to U.S. income tax on their worldwide income, and U.S. estate tax for worldwide assets, they do not receive the same treatment as citizens when it comes to U.S. gift and estate taxes. Thus, when one or both spouses in a married couple are not U.S. citizens, special planning may be required to avoid adverse tax consequences for transfers during lifetime or at death.
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 a husband and wife 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 he or she received tax-free without being subject to U.S. gift and estate taxes.
Estate Planning During Life
This year, you may give up to $125,000 of property to your non-citizen spouse without gift tax (the amount is indexed for inflation). If the wealth between you and your spouse is substantially unequal, these gifts will help to equalize your estates. If only one of you is a citizen, gifts from the citizen spouse to the non-citizen spouse will minimize the effect of the marital deduction restrictions at death (discussed below).
Estate Planning At Death
At death, you can give your non-citizen spouse up to the amount of the estate tax exemption amount ($2 million for 2007) free of estate tax. However, gifts over this amount 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, you should first consider your objectives without the complications presented by the citizenship issue. You initially 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, you may wish to ha 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 laws may change: 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).
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; you must name a U.S. citizen or a U.S. bank to act as an additional trustee.
Miscellaneous Matters
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.
Life Insurance
One of the most common issues I see with non-citizens is life insurance. Even if each spouse otherwise has assets under $2 million, large life insurance policies can trigger estate taxes, even at the death of the first spouse. In these cases, the policies should be transferred to an irrevocable life insurance trust. Such an arrangement can save hundreds of thousands of dollars or more!
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.
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.
The bottom line – seek the advice of a qualified attorney when doing your estate plan. Ask the attorney if he or she has experience in planning for non-citizens and the associated tax issues.
