In the United States when U.S. citizens get married to one another they receive the benefit of an unlimited marital deduction on federal estate and gift taxes. Arguably, one spouse could gift or bequeath a billion dollars to the other spouse with no gift or estate tax imposed. In contrast, transfers from a U.S. citizen to a noncitizen spouse do not enjoy the unlimited marital deduction benefit. The IRS assumes the noncitizen surviving spouse might return to their home country at some time before their death and avoid U.S. estates taxes. When one or both spouses are non-US citizens, estate planning can be tricky with dire financial consequences should it be handled improperly. One of the most important considerations for non-citizen spouses is where the decedent and surviving spouse reside at the time of death. But first let’s discuss U.S. citizens living abroad.
U.S. Citizen Living Abroad
American expats living abroad who inherit U.S. assets from a U.S. resident, will be subject to international estate treaties between the U.S. and country of domicile. you’re probably wondering whether an inheritance tax might apply to you. If you’re living in Australia, there is a bilateral U.S. estate and gift tax treaty. In Germany, you must have been deemed domiciled for ten years before being subject to inheritance tax. In South Korea, there is no inheritance tax on U.S. assets bequeathed by a U.S. citizen, but you may be subject to a gift tax if you bring the asset into the country.
A person achieves domicile by living in a jurisdiction without the intention of leaving at a later date and requires a move outside the country to sever the domicile. For example, a person with a green card would establish a domicile until they decided they no longer wished to live in the United States.
International Estate Treaty Guidance
US Citizen Leaving Assets to Non-Citizen Spouse
Remember, with the current high federal estate tax exemption, in 2023 a U.S. citizen can gift up to $12.92 million dollars during their lifetime or at their death to anyone, including a non-citizen spouse. It does not matter where the non-citizen spouse lives. Annual gifts to non-citizen spouse are limited to $175,000.00. But given the high federal exemption, the federal estate and gift tax only becomes an issue for US citizens if they leave more than $12.92 million in assets.
US Resident Leaving Assets to Non-Citizen Spouse
A green card holder residing in the U.S. is treated like a U.S. Citizen for estate tax purposes. There is no unlimited marital deduction, but a U.S. resident can leave up to $12.92 million in assets to anyone regardless of where the beneficiary lives.
Non-Resident Leaving Assets to US Citizen Spouse
Any non-resident owning U.S. property can leave their U.S. spouse an unlimited amount of assets using the unlimited marital deduction. This is because the IRS will one day be paid because of the spouse’s citizenship.
Non-Resident Leaving Assets to US Resident
A non-resident alien leaving U.S. based assets to a non-citizen spouse—no matter where the surviving spouse lives—the federal estate tax exemption is only $60,000.00. The 40% estate tax on a non-resident who is not a U.S. citizen depends on what is considered a U.S. asset – real estate for example is always a U.S. asset.
What is a Qualified Domestic Trust
A QDOT allows the marital deduction for property passing to a non-citizen surviving spouse. It does not avoid estate tax, just defers it until the surviving spouse’s death. The overall purpose is to ensure that the IRS will eventually be able to tax property for which a marital deduction is claimed. The requirement that the surviving spouse place property in a QDOT ensures that if the marital deduction is allowed, the property will still ultimately be subject to death tax.
A QDOT, like a qualified terminable interest property trust (“QTIP”), mandates that all income be paid to the surviving spouse and that no other person have an interest in the trust during their lifetime. However, QDOTs have additional requirements and limitations, such as:
At least one Trustee must be a domestic corporation or a U.S. citizen.
The trust must be subject to and administered under the laws of a particular state or the District of Columbia.
Property placed in the QDOT must pass from the decedent to the surviving spouse in a form that would have qualified for the marital deduction if the surviving spouse was a U.S. citizen.
The trustee must have the right to withhold the estate tax and pay it to the IRS.
The biggest drawback from a QDOT is that unlike an income distribution, which are tax free, any distributions of principal to the surviving spouse are taxable events. When a distribution from principal occurs, the U.S. trustee must file an annual statement with the IRS and pay federal estate tax on the distribution. This estate tax trigger can be waived under limited circumstances when a “hardship” can be proven.
What Happens if the Surviving Spouse Leaves the US?
When death or a distribution from principal occurs, the U.S. trustee must file an annual statement, and federal estate tax is imposed. The law imposes security requirements to ensure the payment of the estate tax. The IRS imposes different security requirements depending on if the assets in the trust exceed $2 million dollars, whether the trustee is a U.S. Bank, and what percentage of the trust property is located within the United States. These requirements ensure the IRS get its due on the surviving spouse’s death.
Do You Need a QDOT?
For high-net-worth international couples, noncitizens with U.S. property or those planning for when the estate tax exemption is lowered, a Qualified Domestic Trust (“QDOT”) is often the best alternative. A QDOT can even be set up after the U.S. Citizen spouse passes away. A trust created for the spouse which fails to meet all of the requirements can be amended to qualify as a QDOT. Additionally, under certain circumstances, an executor can, with the permission of the surviving spouse, make an irrevocable election to a QDOT.
A QDOT would not be needed if the surviving spouse becomes a U.S. citizen before the deceased spouse’s estate tax return is filed. This is usually nine months from date of death, but can be extended six months. Multinational spouses should seek out an experienced estate planning attorney and accountant, as the rules are complex and always changing.
What Do You Have To Report?
It’s a good idea to report your inheritance to the IRS even if you don’t think you owe any foreign inheritance taxes. If you’re a surviving spouse who isn’t a U.S. citizen, you must pay taxes on the inherited amount as per federal estate tax rules since the unlimited marital deduction rule doesn’t apply.
If the spouse who was a U.S. citizen gifted the non-U.S. citizen during their life, whether by making them a joint owner of a bank account, real estate, or stocks, those gifts are also subject to federal gift tax since the unlimited marital deduction doesn’t apply in that case either. The citizen spouse can gift up to $159,000 per year to a non-U.S. citizen spouse, but an experienced tax professional must assist with the documentation, timing, and nature of the gift from the U.S. citizen spouse to the non-citizen spouse.
If you’re looking for an estate planning lawyer in the NYC area, we can help. Benjamin Kats Esq. P.C. is an experienced, knowledgeable lawyer with a reputation for providing a comforting experience. Contact us today to make an appointment for a free estate planning consultation.