03/31/2016

Qualified Domestic Trust

A Qualified Domestic Trust (QDOT) is used to defer federal estate tax when a U.S. citizen dies and leaves a large amount of money to a spouse who is not a U.S. citizen. If you are a citizen, and your spouse is not, and you expect that family assets of several million dollars may pass to your non-citizen spouse, a QDOT maybe on your estate planning list.

 Why the need a special kind of trust if you’re married to a noncitizen? For federal estate tax purposes, citizens get a big tax break that noncitizens don’t. When both members of a married couple are U.S. citizens, the first spouse to die can leave any amount of money to the survivor, free of estate tax. This is called the unlimited marital deduction.

The marital deduction does not apply if the surviving spouse is not a citizen. A noncitizen survivor must pay estate tax just like anyone else who inherits. If the taxable estate exceeds the $5.45 million exemption amount, for deaths in 2016, federal estate tax may be due.  To avoid paying estate tax at the death of the first spouse, couples have two main options:  have the non-citizen become a US Citizen or create a QDOT trust.

With a QDOT, if the citizen spouse is the first to die, assets go to the trust instead of outright to the surviving noncitizen spouse. The survivor receives benefits such as income from the trust assets, but doesn’t own them. When the second spouse dies, assets pass to other beneficiaries named in the document containing the trust terms. If the estate is valuable enough, estate tax is paid then, as if the assets were in the estate of the first spouse to die. Trust assets are not included in the estate of the second spouse to die.

There are detailed IRS rules to follow in setting up and administering the QDOT. For example, the trustee with control over the trust assets, must be a U.S. citizen. If the amount of trust assets exceeds $2 million dollars, one of the trustees must be a U.S. bank or the trustee must put up a bond for the trust’s value. After the first spouse dies, the executor must elect to qualify for the marital deduction on the federal estate tax return filed for the deceased spouse’s estate.  The return must be filed nine months after the death, and the QDOT election is irrevocable.

The surviving spouse is entitled to receive any income earned by trust assets, and typically, all income is distributed to the survivor at least annually. These distributions are subject to income tax, but not estate tax.  However, if the trustee gives the surviving spouse any of the trust principal, estate tax may be due. No estate tax will be due, however, if money is distributed in circumstances that fall under the IRS “hardship exemption”. If the spouse has an immediate and substantial need for money for heath, maintenance, education or support, a principal distribution may qualify for the hardship exemption.

As a final note, a QDOT can be created under a last will and testament, in a revocable living trust or as a stand-alone trust.