Planning for Non-Citizen Spouses in Large Estates

Planning for Non-Citizen Spouses in Large Estates

By Alan G. Orlowsky

A married couple has special Estate Planning challenges if one spouse is not a citizen of the United States. Federal estate tax law requires that a spouse be a U.S. citizen in order to qualify for the unlimited marital deduction. The primary reason for this law is that the IRS does not want a surviving non-citizen spouse to leave the United States with property that has never been taxed.

The citizen spouse’s estate still has the individual estate tax exemption or applicable exclusion amount ($5,250,000 for 2013), and even though the surviving spouse is not a U.S. citizen there is no federal estate tax on this amount. The problem comes for married couples with large estates that exceed the applicable exclusion amount. The estate of the citizen spouse will have to pay federal estate taxes on everything over that exemption amount unless the surviving non-citizen spouse becomes a citizen before the deceased spouse’s estate tax return is filed, or if the non-citizen spouse is the beneficiary of a special trust called a Qualified Domestic Trust (QDOT).

A QDOT allows the deceased spouse’s estate to postpone paying federal estate tax if the trust meets certain requirements. With a QDOT, at the first spouse’s death, assets go to the trust instead of to the surviving non-citizen spouse, and the spouse can receive income distributions. When the surviving non-citizen spouse dies, the assets in the trust pass to other beneficiaries named in the trust document such as the couple’s children. That is when the estate tax is paid, as if the assets were in the estate of the first spouse to die, not as part of the second spouse’s estate.

In order for a QDOT to work, specific rules must be followed. For example, the trustee who controls the trust must be a U.S. citizen. If trust assets exceed $2,000,000 (very likely in the large estate situation we’re describing), the trustee has to be a U.S. bank or domestic corporation willing to be bonded for most of the value of the trust. The executor of the deceased spouse’s will, or trustee of his or her trust, must make an election on the deceased spouse’s estate tax return to have the trust treated as a QDOT.

 As mentioned, the non-citizen spouse is entitled to distributions of income earned by trust assets, and although the distributions are subject to income tax, they are exempt from estate tax. However, distributions from trust principal to the non-citizen surviving spouse are not allowed – unless the U.S. trustee is given the right to withhold estate taxes on any distributions of principal.

There are also exceptions to the taxation of principal distributions if those distributions fall under the IRS hardship exemption. If the spouse has an “immediate and substantial” need for money relating to “health, maintenance, education or support”—either his own, or that of someone he legally obligated to support—a distribution of trust funds may qualify for a hardship exemption. However, the non-citizen surviving spouse would have to prove that he or she doesn’t have other available assets to meet those needs. 

If you have any questions about planning for Non-Citizen Spouses and how we can help please contact the Law Office of Orlowsky & Wilson by calling 847-325-5559 or visit our website www.orlowskywilson.com for more information. 

The Qualified Personal Residence Trust

The Qualified Personal Residence Trust
By Alan Orlowsky

Let's Talk About.......The Qualified Personal Residence Trust

A Qualified Personal Residence Trust (QPRT - pronounced "Q-Pert") is a trust that holds a personal residence for a term of years, allowing you, in effect, to give away your residence at a discount and "freeze" its value for federal estate tax purposes - all while continuing to live in it. Each person can set up no more than two QPRTs: one for the primary residence and one for a vacation home or condominium.

A Qualified Personal Residence Trust takes advantage of certain provisions of federal law that allow you to make a gift to the trust of your personal residence, for the ultimate benefit of the remainder beneficiaries at a discounted value. Assume that the remainder beneficiaries are your children - the most common situation for most QPRT planning. Either your principal residence or a vacation home can be transferred into a QPRT. This removes the asset from your estate, reducing potential estate taxes at your death.

For gift tax purposes, the original transfer will be treated as a gift to the children, but not a gift of the current fair market value. Instead, it's a gift of the value of your children's future right to the residence at the end of the QPRT term (called the "remainder interest"). You must file a gift tax return at the time the residence is transferred to the trust.

The value of the remainder interest is derived by first determining the fair market value of the entire property, and then subtracting the value of the right you retain to live in the residence (your "retained interest"). In general, the longer the term of the trust, the longer you get to live in the property and the larger the value of your retained interest. As the value of your retained interest increases, the value of your children's remainder interest decreases. This results in a smaller taxable gift by you.

If you haven't previously used your lifetime federal gift tax exemption amount, the amount of gift tax due may be offset by that amount, thus possibly eliminating the need to pay any gift tax on the transfer of the residence to the QPRT. Of course, if the residence is appreciating quickly, the potential savings can be even greater in a shorter period of time.
If you live to the end of the specified period, the residence, including all post-gift appreciation, passes to the children free of any additional federal estate or gift taxes.

However, one disadvantage is that if you die before the end of the period, the value of the residence, as of the date of death, will still be include-able in your estate for federal estate tax purposes. The result in that case is the same as if you had never created the QPRT. Therefore, for maximum benefit and results, you need to outlive the term of the trust.
A second disadvantage of the QPRT is that if the house continues to be a part of the trust after the initial term ends, it will pass to the remainder beneficiaries with your original income tax basis.


If you have questions about this post or about a particular legal situation,  click here to contact our office to set up a time to discuss this with you or contact Alan Orlowsky directly by calling 847-325-5559.