There are many acronyms used in the legal field to shave down wordy descriptions, and the estate planning niche is not immune to this phenomenon. We have a number of different devices that are part of this alphabet soup, and one of them is the qualified domestic trust or QDOT.
In this post, we will explain the value of this advanced estate planning tool that can be very useful for some high net worth families.
Federal Estate Tax Parameters
To understand the value of a qualified domestic trust, you have to absorb some information about the federal estate tax and its potential impact on your legacy. This death levy carries a 40% maximum rate which is enough to get anyone’s attention. We are talking about almost half of the legacy that you are going to pass along to the next generation and beyond.
The rate of the tax is the bad news, but there is also some news that will be comforting to most people. All families are not subject to this tax, because there is a credit or exclusion that allows you to transfer a certain amount before it would be applied. At the time of this writing in 2019, the federal estate tax exclusion is $11.4 million.
We should point out the fact that this exclusion is subject to inflation adjustments on an annual basis, so you may see a somewhat higher figure next year.
Plus, the entire structure is subject to change via legislative mandate, so this is something to keep an eye on. For example, prior to the tax cuts that went into effect in 2018, the exclusion was right around half of what it is at the present time, so nothing is permanently etched in stone.
If you are thinking that you will simply give gifts to your loved ones before you pass away to get around the estate tax, the Internal Revenue Service is one step ahead of you. There has been a federal gift tax in place since 1932, and it is unified with the estate tax.
As a result, the $11.4 million exclusion that we have in place this year is a unified exclusion. It encompasses large lifetime gifts along with the estate that will be passed along after you are gone.
Now that we have set the stage appropriately, we can start to ease into the subject that we are focusing on here. The estate tax is potentially applicable on asset transfers to everyone, including close relatives, with one exception. There is an unlimited marital deduction that allows you to transfer any amount of property to your spouse free of taxation.
However, this deduction is only allotted to citizens of the United States. If you are an American, and you are married to someone who is a citizen of another country, you would not be allowed to use this deduction as an estate tax efficiency measure.
This being stated, you could utilize a qualified domestic trust as the next best thing. To provide a brief explanation, you would fund the trust, and your spouse would be the initial beneficiary. If you pass away first, the trustee whom you empower would be able to distribute the trust’s earnings to your spouse in an estate tax-free manner.
Your spouse would also be able to utilize property that is held by the trust for the rest of his or her life, and you could give the trustee the latitude to distribute portions of the principal. Distributions of this nature would be subject to the estate tax unless a hardship exception was granted by the IRS.
When the trust is established, you name secondary beneficiaries to assume ownership of the remainder in the trust after the death of your spouse. When that time comes, the transfer would take place, and the estate tax would be a factor. The deferred, single round of taxation would invariably save your family a great deal of money in the long run.
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