Estate Planning and Administration When One Spouse is a Non-U.S. Citizen or is a Nonresident Alien
By Cowles Liipfert
It is becoming more frequent for one spouse to be a non-citizen of the United States. A different set of rules applies to non-citizen spouses than to US citizens, even if the non-citizen spouse has resided in the US for many years, and even if he or she has children who are US citizens.
When it comes to basic estate planning, residents who are non-citizens should have documents similar to those of citizens. The estate of a resident spouse who is a non-citizen must be administered in the United States, just like the estate of a US citizen, and the same rules generally apply to estate tax returns for non-citizens as for citizens. Both spouses should have wills, durable powers of attorney for financial matters, health care powers of attorney, declarations of desire to die a natural death, and sometimes revocable trusts, just like spouses who are both U.S. citizens.
A US citizen can leave property to someone who is not a US citizen or a resident, the same as he or she can leave property to US citizens. This applies not only to wills, but also to joint bank accounts, retirement accounts, life insurance, etc. However, there are some tax issues and complications about which married couples, one of whom is a non-citizen, should be aware – especially if they have high net worth, but in some instances when they have moderate wealth.
PROPERTY TRANSFERRED TO A NON-CITIZEN SPOUSE
The most notable differences between estate planning and estate administration, where there is at least one non-citizen spouse – as contrasted with estates with two spouses who are both US citizens – concern gift and estate taxes. A US citizen or resident may make unlimited transfers of assets – either during life or at death – to a spouse who is a US citizen, without gift or estate tax consequences, but if one spouse is a noncitizen, (a) transfers to the non-citizen at death generally do not qualify for the estate tax marital deduction, and (b) lifetime transfers to a US citizen or resident to a non-citizen spouse without gift tax consequences are limited per year to $155,000 in 2019, indexed for inflation in the future – which is generous, but is not unlimited.
The simplest and best way to deal with tax issues arising out of the fact that one spouse is not a US citizen would be for the non-citizen to apply for US citizenship. He or she does not necessarily have to give up citizenship in his or her native country. The US allows dual citizenship, but some countries do not. A person with dual citizenship gets all the tax benefits of being a US citizen.
In the planning process for a married couple, one of whom is a non-citizen and does not want to apply for citizenship, the tax benefits of making gifts to the non-citizen spouse within the annual gift tax exclusion limit, should be considered as a possible useful tool.
Because the threshold for estate tax is so high ($11.4 million in 2019 and indexed for inflation) it is not important for most of us to utilize the estate tax marital deduction in our planning, but (a) for couples with high net worth, estate taxes may be a very important consideration, and (b) the current lifetime exemption is scheduled to expire in 2025, and it is possible that the laws could be re-written before that date, so it is advisable to consider addressing those possible eventualities in one’s estate planning.
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 has an extremely net worth. If the surviving spouse is a non-citizen, on the other hand, the transfers from the decedent to the surviving spouse will not automatically qualify for the estate tax marital deduction, and other steps must be taken, if the deceased spouse has a large estate, to avoid unnecessary estate tax.
Those assets may be made to qualify for the estate tax marital deduction, even after the death of the US citizen or resident spouse, if (a) the surviving spouse becomes a U.S. citizen on or before the filing deadline for the decedent’s federal estate tax return (within nine months after the date of death unless a six-month filing extension is obtained, in which case the filing deadline would be 15 months after the date of death, instead of nine months), or, (b) in the alternative, those assets are put into a Qualified Domestic Trust (QDOT) for the benefit of the surviving spouse prior to that estate tax filing deadline, and a QDOT election is made on a timely-filed estate tax return for the decedent.
Because there may be unexpected delays in an application for citizenship, a QDOT trust agreement should be drafted in favor of the noncitizen spouse, even if the spouse has applied for citizenship, and if the citizenship application has not been approved some time prior to the filing deadline, the assets should be transferred to the QDOT. If the QDOT is created and funded in a timely manner, and if the appropriate tax election is made on the Form 706, US Estate Tax Return for the decedent’s estate, the QDOT assets would qualify for the unlimited marital deduction.
If a surviving spouse becomes a US citizen after the QDOT has been created and funded, the trust assets may later be distributed to the spouse and the trust terminated, if the terms of the trust agreement so allow.
BEWARE “TAX TRAP” WHEN A DECEASED SPOUSE IS A NONRESIDENT ALIEN
Because the lifetime gift and estate tax exemption applicable to a U.S. citizen or resident is so high ($11.4 million in 2019), many people (including many attorneys) are not aware that a different set of rules is applicable to “US-situated” assets belonging to nonresident aliens, including spouses of U.S. citizens, and they may have to pay extremely high estate taxes, if a nonresident alien spouse dies first and leaves his or her “US-situated” assets in a manner which does not qualify for the estate tax marital deduction.
An estate tax return (Form 706-NA) must be filed if a nonresident alien’s “US-situated” assets exceed $60,000 in value – a much lower threshold than one might expect. “US situated” assets include real estate, tangible personal property (i.e., “things” like jewelry, furniture, collectibles and home furnishings) in the United States, and securities of U.S. companies. Certain countries have treaties with the U.S. government, which may impact the taxation of those assets.
Please note that lifetime taxable gifts made by a nonresident alien are taken into consideration in determining whether or not the tax filing threshold for an estate tax return has been met, as lifetime taxable gifts are included in the taxable assets belonging to a deceased nonresident alien. That is, gift tax and estate tax are unified for nonresident aliens in much the same manner as for US citizens and residents, but with a much lower exclusion amount.
Property left by a nonresident alien spouse to a spouse who is a US citizen will qualify for the estate tax marital deduction on the Form 706-NA, Federal Estate Tax Return for Nonresident Aliens, but property left to a non-citizen spouse must be put into a Qualified Domestic Trust (QDOT) and all the QDOT requirements must be met, in order to qualify for the estate tax marital deduction on the estate tax return for a nonresident alien decedent. If the deceased spouse is a nonresident alien, there is a good possibility that the other spouse will be a US resident only, instead of being a US citizen, so special care should be taken in order to qualify property left to a non-citizen spouse for the estate tax marital deduction. .
A determination as to which assets are “US-situated” assets and which are not, is often difficult to determine – that is, which assets may be subject to US estate tax for the estate of a nonresident alien. For example, currency which is physically located in the United States is subject to estate tax, but cash deposits in US banks are not subject to estate tax. Go figure?? It is possible that bonds would be taxable if owned directly by the decedent, but would not be taxable if owned by a partnership which is not subject to US estate tax.
Consequently, we recommend that you consult with an experienced tax professional concerning possible estate tax on US-situated assets for a nonresident alien.
This material is intended for informational purposes only and should not be construed as legal or tax advice, and is not intended to replace the advice of a qualified tax professional.