As a general rule, spouses can transfer an unlimited amount of property to each other without paying tax on the transfer.[1] The rule includes transfers made upon death.[2] The so-called “unlimited marital deduction” delays taxation on the transfer of property until it is transferred out of the marital unit. The rule applies to US citizens as well as US residents.[3]
For non-citizen spouses, the unlimited marital deduction does not automatically apply.[4] Congress enacted special provisions for non-citizen spouses because it wanted to prevent a non-citizen surviving spouse from taking property left to him or her upon death back to his/her country of origin and avoid paying tax when transferring the property to a third party in the future.[5]
However, with a Qualified Domestic Trust (“QDOT”) an unlimited amount may be transferred to a non-citizen spouse.[6] Transferring property to a QDOT enables a citizen or domestic trustee to withhold taxes as property exits through the QDOT trust on its way out of the marital unit.
In order to qualify as a QDOT[7]:
- At least one trustee must be a citizen or domestic corporation;
- The citizen/domestic corporate trustee must be able to withhold tax on transfers of principal;
- The trust must comply with all regulations that ensure collection of tax on distributed principal;
- The settlor’s executor must make an election pursuant to §2056A;
- Trust income must be distributed to the non-citizen spouse at least annually;
- Trust principal may not be distributed to anyone but the non-citizen spouse as long as the non-citizen spouse is alive.
If a decedent spouse did not create a QDOT in an estate plan for the surviving non-citizen spouse prior to death, all is not lost. A surviving spouse can transfer property to a QDOT via an irrevocable transfer prior to filing the decedent’s return.
This post is intended to be informational and is not a thorough explanation of estate planning laws or exceptions.
[1]26 USC § 2523
[2]26 USC § 2056(a)
[3] 26 USC § 2001
[4] 26 USC § 2056(d)(1), § 2523(i)(1)
[5] Hellwig, Brant J., and Robert T. Danforth. Understanding Estate and Gift Taxation, LexisNexis, 2015, p. 484
[6] 26 USC § 2056(d)(2)(A)
[7] 26 USC § 2056A