Estate Planning When One Spouse is a Noncitizen

5 July 2019

By: Cowles Liipfert

It is becoming more frequent for one spouse to be a noncitizen of the United States.

Sometimes a noncitizen is reluctant to give up his or her native citizenship, and people are often not aware of the possibility of having dual citizenship in both the native country and in the United States.  Also, a noncitizen spouse may not know that it makes any difference whether he or she has United States citizenship, in which case he or she never gets around to obtaining U.S. citizenship.

When it comes to basic estate planning for most of us, it doesn’t matter whether you or your spouse are noncitizens.  Both of you should have wills, durable powers of attorney for financial matters, health care powers of attorney, HIPAA Releases, and sometimes revocable trusts, just like spouses who are both U.S. citizens.

One question which you may have is whether you can leave property to someone who is not a U.S. citizen?  The answer is yes – noncitizens can inherit property just the same as citizens. Consequently you can leave your assets to a noncitizen spouse, and he or she may be designated to receive joint bank accounts, retirement accounts, etc., just the same as a U.S. citizen.  However, there are some tax rules that individuals with high net worth need to be aware of.

Preliminarily, most people do not need to worry about federal estate and gift tax.  These taxes affect only very wealthy individuals.  For a death in 2019, for example, there is no tax on the estate of a Decedent whose taxable estate is less than $11.4 million. A Decedent with a taxable estate which exceeds $11.4 million (in 2019) needs to be aware that he or she will have likely estate taxes at death, and bequests directly to their surviving spouse will not qualify for a “marital deduction” for his or her estate.

When both spouses are U.S. citizens, the first spouse to die can leave any amount of money or other assets to the surviving spouse, either outright or in a “marital trust,” completely free of estate tax.  By utilizing the unlimited marital deduction, a couple can completely avoid federal estate taxes at the first spouse’s death, even if the deceased spouse is worth an extremely large amount – like $100 million, for example.  Any property on which an estate tax marital deduction is claimed at the death of the first spouse does become part of the taxable estate of the surviving spouse, and when the surviving spouse dies, will be subject to the US estate tax laws at the time of his or her later death.

If the surviving spouse is a noncitizen, however, the unlimited marital deduction generally does not apply to assets passing directly to him or her, whether by direct bequest or devise, by beneficiary designation or by survivorship under joint ownership.  However, assets may be qualify for the estate tax marital deduction at the first spouse’s death (a) it the surviving spouse becomes a U.S. citizen on or before the filing deadline for the Decedent’s federal estate tax return (nine months after the date of death unless a filing extension is obtained), or, in the alternative, those assets are put into a Qualified Domestic Trust (or QDOT) for the surviving spouse before that estate tax filing deadline.  Because there may be unexpected delays in an application for citizenship, a QDOT should be created for the spouse and the assets transferred to the QDOT if the citizenship papers are delayed.  The QDOT would qualify for the unlimited marital deduction, if created and funded in time.

That is, to qualify property left by a U.S. citizen to a noncitizen spouse for the estate tax marital deduction, there are two options: (1) the surviving spouse can obtain U.S. citizenship before the filing deadline, or (2) a QDOT trust can be created for the surviving spouse, and funded before the filing deadline.  If the spouse receives U.S. citizenship after the QDOT has been funded, the QDOT can distribute the trust assets to the spouse.  Because of the administrative and legal complexities of QDOT trusts, attorneys should encourage their clients to pursue citizenship or dual citizenship.

Also, the executor of the deceased spouse’s estate must file a federal tax return in a timely manner and must elect to qualify the property left to the surviving spouse for the deceased spouse’s estate tax marital deduction.  That is, the executor must make a “QDOT election” on the federal estate tax return for the estate of the first spouse to die.  Federal estate tax returns are required to be filed within nine months after a decedent’s death, unless extended.

A QDOT gives the surviving spouse a right to life income from the trust, but that spouse is not the legal owner of the trust assets.  When the surviving spouse dies, however, if the QDOT has not been earlier terminated, the remaining trust assets will be included in his or her taxable estate, after which the remaining trust assets will pass to the other beneficiaries under the QDOT trust agreement, often the couple’s children.

If the QDOT were not terminated, the income from the QDOT would be distributed to the  surviving spouse and would be subject to income tax on the surviving spouse’s personal income tax return.  The trust would be required to file a federal fiduciary income tax return each year for the QDOT trust, and to give a Schedule K-1 showing the taxable income distributed to the surviving spouse.

Distributions of income to the surviving spouse would not be subject to estate tax on the deceased spouse’s estate, but if distributions of trust principal are made during the administration of the QDOT trust, estate tax will generally be due for the estate of the deceased U.S. spouse on those distributions.  There are exceptions if the principal distribution qualifies for a “hardship exemption,” which gives some leeway for distributions to the surviving spouse or for someone whom the spouse is legally obligated to support, but is the distributions do not qualify for the hardship exemption, an amended estate tax return would have to be filed and additional estate taxes paid for any such distributions.

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