Transfers of Assets from a Deceased Spouse at Death.
At death, assets you leave to a surviving spouse who is a United States citizen are not subject to federal estate tax. This is true notwithstanding how much the assets are worth. Lawyers and accountants call this rule the “unlimited marital deduction”. However, the unlimited marital deduction does not apply when the spouse who inherits is not a U.S. citizen, even if the spouse is a permanent U.S. resident. Instead, under current law a U.S. taxpayer can leave assets worth up to the exempt amount ($5.49 million in 2017) to anyone, including his or her non-citizen spouse, without incurring any federal estate tax. Here in New York where I practice, that amount is limited to $5.25 million in 2017. If a non-citizen spouse dies first, assets left to his or her U.S. citizen spouse do qualify for the unlimited marital deduction.
Transfers in the Form of a Gift
If your spouse is a citizen, any gifts you give to him or her during your life are free of federal gift tax. If your spouse is not a U.S. citizen, however, the special tax-free treatment for spouses is limited to $149,000 a year (in 2017). This amount is indexed for inflation. That’s in addition to the amount you can give away or leave to any recipient without owing federal gift/estate tax.
Postponing or Avoiding Federal Estate Tax
For those who are concerned with paying federal estate tax upon leaving property to a surviving non-U.S. spouse, there are two options worth looking into:
If your spouse becomes a U.S. citizen by the time your estate’s federal estate tax return is due, he or she will qualify for the unlimited marital deduction. The return is generally due nine months after death, but the IRS may grant a six-month extension. Because it takes a long time to get citizenship—for most people, there is a waiting period before you can apply, and it takes at least several months after you apply—this isn’t an option for most people.
- Use a QDOT Trust
Your non-citizen spouse can inherit from you free of estate tax if you use a special trust, called a “qualified domestic trust” or QDOT. (Internal Revenue Code section 2056A.) You leave property to the trust, instead of directly to your spouse. Your spouse is the beneficiary of the trust; there can’t be any other beneficiaries while your spouse is alive. Your spouse receives income that the trust property generates; these amounts are not subject to estate tax.
If trust assets themselves (principal) are distributed to your spouse, however, the estate tax will probably have to be paid on that property. (There’s an exception when distributions are made because the spouse has an urgent, immediate need and no other resources.)
A QDOT must be established, and the property must be transferred to it, by the time the estate tax return of the deceased spouse is due. Usually, it’s set up while both spouses are alive, and comes into existence when the citizen spouse dies. The trustee (the person or entity in charge of trust assets) must be a U.S. citizen or a U.S. corporation such as a bank or trust company. If you are interested in a QDOT talk to an experienced estate planning and tax lawyer.
In conclusion, spouses who have a U.S. citizen spouse will likely not have a federal estate tax problem if they leave all their assets to their US spouse. Nor will such taxpayers have a federal estate tax problem if they leave all their assets to a non-U.S. spouse but those assets have a fair value of 5.49 million in 2017. Those having a non-U.S. citizen spouse wishing to leave assets over 5.49 million to such spouse at death should consult with an experienced estate planning – tax lawyer for purposes of minimizing any federal estate tax on such intended transfer.
Mark A. Krohn, a partner, is in charge of the Business Law Team and is also a member of the Trust & Estates Team and is a CPA. He can be reached by phone at our Walden, NY office at 866-303-9595 toll free or 845-764-9656 and by email.