The IRS has provided married couples a very valuable deduction that allows couples to avoid paying estate taxes when the first spouse dies. This marital deduction means that, when one spouse dies, his or her assets will pass to the surviving spouse automatically. No estate taxes are imposed. The only catch is that the deduction only applies when both spouses are U.S. citizens. On the other hand, if the surviving spouse is not a U.S. citizen, then estate taxes will be due immediately. A QDOT trust is an important estate planning tool that will allow non-citizen spouses to receive the assets tax free.
Definition of a QDOT trust
The acronym “QDOT” refers to the Qualified Domestic Trust. This specialized trust, created in 1988, is a great way to allow property to pass to a spouse who is not a U.S. citizen, while still qualifying for the unlimited marital deduction. When a QDOT trust is created properly, the surviving spouse will receive the estate assets (which were funded into the trust) without incurring estate taxes. Then, upon the surviving spouse’s death, the remaining assets can be passed in any way the couple wishes. The key is, estate taxes will not be paid until after the death of the non-citizen spouse, just as it would normally with U.S. citizens.
Are there any restrictions?
There are a few limitations. First, the person in control of the trust (the trustee) must be a U.S. citizen. If the estate is worth more than $2 million, one of the trustees of the QDOT trust must be a U.S. bank. This requirement is meant to ensure that the IRS will ultimately receive the estate taxes.
It should also be noted that, any income earned from the trust will be subject to federal income tax. Also, any distributions made from the principal of the trust, will incur estate taxes immediately. The trustee is actually required to withhold sufficient funds to pay the taxes. There are some situations where distributions of the principal are not taxed, such as for health care, education and support of the surviving spouse and children. However, a showing of substantial financial need must be made for the exception to apply.
Is there any alternative to creating a QDOT trust?
A QDOT trust can be very useful for couples who have citizenship issues. Unfortunately, there aren’t many alternatives. The most obvious solution is that the surviving spouse becomes a U.S. citizen before the estate taxes are due. If that is not an option, though, a QDOT will be required. Spouses cannot simply transfer the estate to their non-citizen spouse before death, because any transfers over a certain amount will be subject to a gift tax. On the other hand, if your spouse is a citizen, he or she could accept an unlimited amount of assets before your death.
If you have questions regarding QDOT trusts, or any other estate planning needs, please contact Sexton, Bailey Attorneys, PA online or by calling us at (479) 443-0062.