There are targeted estate planning tools that can be used to satisfy very specific objectives. One of them is the QDOT, and we will look at this highly effective legal device in this post.
Federal Estate Tax
The acronym “QDOT” stands for a qualified domestic trust. You can use this type of trust to gain estate tax efficiency if you are married to citizen of another country.
This tax is a looming threat to your legacy if you have been very successful from a financial standpoint, because it carries a 40 percent maximum rate. The good news is that there is a rather generous credit or exclusion you can used to transfer a certain amount tax-free.
At the present time, the federal estate tax exclusion is $11.7 million, which is the highest that it has ever been. It came about as a result of a provision that was contained within the Tax Cuts and Jobs Act that was enacted late in 2017.
Prior to its enactment, the exclusion was $5.49 million. This provision is going to expire in 2026, and at that time, the exclusion will go down to the $5.49 million that was in place in 2017.
In fact, this reduction could be implemented sooner if another tax act is passed that addresses the matter. President Biden has expressed his desire to reduce the estate tax exclusion to “traditional levels,” so this is quite possible.
We have a gift tax in the United States as well to stop people from giving gifts to avoid the estate tax. The exclusion is a unified exclusion that encompasses gifts that you give while you are living and the estate will be transferred after you are gone.
Since we have a record high exclusion that is going down in a few years, if you are exposed to federal transfer taxes, you may want to consider lifetime gift giving in the near future.
QDOT Trust
Now that we have shared the necessary background information, we can start to drill down to the point of this post. There is an unlimited marital estate tax deduction that can be used to transfer any amount of property to your spouse free of taxation.
However, there is one caveat: the unlimited marital deduction is not available to noncitizen spouses.
As a response, you could establish a QDOT if you are married to a citizen of another country.
You would fund the trust and name a trustee to act as the administrator. If the trust is funded with more than $2 million, a minimum of one of the trustees must be a United States bank.
If you predecease your spouse, the trustee would make the QDOT election on the estate tax return and distribute the trust’s earnings to your surviving spouse. These distributions would not be subject to the estate tax, but regular income taxes would be applicable.
The trustee could distribute portions of the principal if this latitude is given in the trust declaration, but the estate tax would be levied on those distributions with one exception.
Your surviving spouse can petition the IRS to grant a hardship exemption to allow for tax-free distributions of portions of the principal.
After the death of your spouse, your children or other successor beneficiaries that you name in the trust declaration would inherit the remainder that is left in the trust.
The estate tax would be levied at that time, but there would be one round of taxation instead of two, and the trust’s earning power would be maximized.
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