The IRS has provided a very valuable deduction for married couples, which allows the couple to avoid estate taxes when the first spouse passes away. This marital deduction means that, when one spouse dies, his or her assets will go to the surviving partner immediately, and no estate taxes are levied. The only condition is that the deduction will only apply if both spouses are U.S. citizens. That means, 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.
What makes a trust a QDOT?
The acronym “QDOT” stands for Qualified Domestic Trust. This particular type of trust was created in 1988, and has become a great way to allow property to pass to a non-U.S. citizen spouse, while remaining qualified for the unlimited marital deduction. When a QDOT trust is established the right way, the surviving spouse receives the estate assets (those funded into the trust) without incurring estate taxes. Then, upon the surviving spouse’s death, the remaining assets can be passed in any manner the couple chooses. What is most important is the fact that estate taxes will not be paid until after the death of the non-citizen spouse. This is the same for couples who are both U.S. citizens.
Are there any restrictions?
As with most things, there are a few restrictions or limitations imposed on QDOT trusts. The individual who is 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. These requirements are meant to ensure that, at the end of the day, the IRS will receive the estate taxes.
It is also important to note that, any income earned from the trust is subject to federal income tax. Any distributions made from the principal of the trust, incur estate taxes immediately. In fact, the trustee is required to withhold a sufficient amount of money in order to pay the taxes. There are some situations where the principal‘s distributions are not taxed, such as for health care, education and support of the surviving spouse and children. However, a showing of substantial financial is required, in order for those exceptions to apply.
Alternatives to a QDOT trust
A QDOT trust is aimed at couples who have citizenship issues. Regrettably, there are few alternatives. The best choice, if at all possible, is for the surviving spouse to become a U.S. citizen before estate taxes are due. Otherwise, a QDOT cannot be avoided. That is because, spouses cannot simply transfer their estate to a 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 have an unlimited sum of assets before your death.
If you have questions regarding QDOT trusts, or any other estate planning needs, please contact the Schomer Law Group either online or by calling us at (301) 337-7696.