There are various methods available to married couples that can help them reduce their estate tax burdens. The marital deduction trust is one of these mechanisms, as it allows spouses to pass their estates to the surviving spouse without that property being subject to taxation at the time of the first spouse’s death.
When the surviving spouse is not a United States citizen, more complex planning is required. Typically, the citizen-spouse will want to have a Qualified Domestic Trust (QDOT) to hold the assets for the benefit of the non-citizen spouse.
What is a Qualified Domestic Trust (QDOT)?
The weakness of the standard marital deduction is that it only applies to marriages between two U.S. citizens. If one spouse is a noncitizen, he or she does not qualify for the marital deduction because of Internal Revenue Service (IRS) concerns about collecting taxes on the estate should that spouse decide to return to his or her native country.
This is where the QDOT comes in. Assets placed in a QDOT pass tax-free, even to noncitizen spouses. The noncitizen spouse may also create a separate QDOT after the death of his or her spouse—or become a U.S. citizen before filing a federal estate tax return.
There are several conditions associated with the creation of a QDOT, including the following:
- The trust must be for the benefit of a noncitizen spouse. Any distributions of principal from the trust are subject to the trustee withholding estate tax due on distribution.
- One trustee must be an American citizen or an American corporation.
- If assets in a QDOT exceed $2 million, one of the trustees must be an American bank. If there is an individual trustee, that person must post a letter of credit to the IRS for 65 percent of the trust assets’ value to secure payment of the tax.
- If assets in a QDOT fall below $2 million in value, there is no need to post a bond and a bank does not need to be a trustee, so long as less than 35 percent of those trust assets consist of real estate outside the United States.
A QDOT can be extremely complex to create, and fund, so be sure to consult an experienced estate planning attorney to receive the guidance and advice you need when working to protect your hard-earned assets and property.
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