Individuals who are residents of the United States but who are not citizens (commonly referred to as “resident aliens“) are subject to the same estate and gift tax rules as U.S. citizens. However, there are two important distinctions to consider when it comes to transfers between spouses who are not both U.S. citizens.
First, direct gifts and direct bequests to a non-citizen spouse do not qualify for the unlimited marital deduction. Instead, a citizen spouse may make a “present interest” gift of up to $152,000 (for 2018) per year to the non-citizen spouse as an “annual exclusion” gift under Section 2523(i)(2), or may use his/her lifetime exemption (currently $11.18 million for 2018) to shelter a transfer from gift or estate taxes.
Second, bequests in trust that would otherwise qualify for the marital deduction (e.g., Qualiﬁed Terminable Interest Property (QTIP) trusts) will not qualify when the beneficiary spouse is not a U.S. citizen. The only exceptions to this rule are if: (1) the surviving spouse becomes a U.S. citizen before the estate tax return is ﬁled or (2) the property passes to a qualiﬁed domestic trust (QDOT) for the beneﬁt of the surviving spouse.
The chart below generally illustrates the major similarities and differences between estate planning for a U.S. citizen as opposed to a non-U.S. citizen.
|Transfer to Non-citizen Spouse||Transfer to Citizen Spouse|
|Annual Gifts to Spouse||$152,000||Unlimited Marital Deduction|
|Annual Exclusion Gifts||$15,000||$15,000|
|Lifetime Exemption Gifts||$11.18 Million||$11.18 Million|
|Unlimited Marital Deduction at death||Not available. Must establish QDOT||Yes|
*During 2018, taxpayers have a lifetime exemption of 11.18M, indexed for chained inflation. Effective January 1, 2026, the lifetime exemption will be reduced to approximately $6.2M-$6.5M, based on inflation adjustments.
For planning purposes, it is important to remember that the citizenship of the spouse who will be the beneﬁciary of a marital trust is the key for determining whether or not a QDOT or other planning technique should be considered to delay estate taxes. For example, in a situation where a husband is a U.S. citizen and the wife is not, the husband’s will or living trust should contain QDOT provisions, whereas the wife’s will or trust can provide for a typical marital trust, or QTIP trust, to receive the unlimited marital deduction.
What is a Qualified Domestic Trust (QDOT)?
A QDOT is a statutorily deﬁned trust allowing married couples with at least one non-citizen spouse to take advantage of the marital deduction while ensuring that estate taxes will be paid on the assets left to the non-citizen spouse.1
The QDOT, however, works differently from the typical QTIP trust. Whereas a QTIP trust for a citizen spouse allows for the deferral of estate taxes entirely until the surviving spouse’s death, the QDOT rules require the payment of estate taxes any time a distribution of trust principal is made during the surviving spouse’s lifetime (subject to an exception for “hardship” distributions).2 Distributions of income are not subject to estate taxes, but any principal left in the QDOT at the surviving spouse’s death will be subject to estate taxes.3
The requirements for a QDOT trust, set forth in Section 2056A and the corresponding Regulations, are as follows:
- Have at least one U.S. trustee (a U.S. citizen or a U.S. corporation);
- Satisfy the general marital deduction requirements of U.S. estate tax law (e.g., qualiﬁed terminable interest rule of Section 2056; during spouse’s lifetime, only beneficiary is spouse; all income paid to spouse at least annually; and power to compel trustee to invest to produce income.)
- Require decedent’s executor to make an election on decedent’s estate tax return to treat the trust as a QDOT;
- Prohibit distributions from trust unless the trustee has the right to withhold U.S. estate taxes from such distributions; and
- In certain circumstances, require a bank to serve as the U.S. trustee or require the U.S. trustee to furnish a bond or letter of credit.4
The Flexible Alternative to a QDOT: The Irrevocable Life Insurance Trust
Because the requirements of a QDOT are complex and may not provide a true deferral of estate taxes if the non-citizen surviving spouse needs principal distributions during his/her lifetime, a spousal lifetime access trust (SLAT) funded with life insurance on the life of the citizen spouse can provide greater flexibility and liquidity for the non-citizen spouse and be drafted and administered in the same way for non-citizens as U.S. citizens. In this way, life insurance helps transfer assets from the citizen spouse to the non-citizen spouse without the restrictions of the QDOT.
Importantly, use of a SLAT funded with life insurance can also provide supplemental income for a non-citizen spouse and access to cash value during the grantor’s lifetime while keeping all the trust assets outside the taxable estate. Moreover, when a rider is included on the life insurance policy to indemnify the spousal beneficiary for chronic illness or long-term care expenses paid for the citizen spouse, the trust can be powerful.
1 These provisions attempt to prevent assets from leaving the U.S. at the death of the citizen spouse. Without special restrictions, a non-citizen spouse could leave the country with a bequest or gift without the U.S. having a chance to collect tax on the transfer.
2IRC §2056A(a). The estate tax paid on distributions will be determined using the rate of tax in effect at the decedent’s death.
3The surviving spouse’s estate exemption generally cannot be used to shelter QDOT assets from estate tax.
4Treas. Reg. §20.2056A-2(d)(1).