The advantages of having a Living Trust are outlined in our article on this web site, Wills and Trusts which the reader should review before reading this article. Living Trusts can save probate fees, can allow non public transfer of assets after death, and can save executor’s fees. In a typical million dollar estate, the savings can be in the tens of thousands of dollars.
For a married couple, a massive tax savings is achieved if the marital deduction is utilized completely. Recall that anything going to a spouse is estate tax free until the second spouse to die finally dies. But to qualify for that marital deduction the gift must be outright to the spouse.
This can be a problem for many people who want to make sure that whatever their spouse does not use during his or her life is made available for the children. As one client put it, “If my husband marries Sophia Loren after I die, I don’t want her getting all my money, I want it to go to my children!”
The only way to do that is to use a trust in which the spouse gets all the income during his or her life, and perhaps the right to invade corpus (principle) if there is real need, and upon the spouse’s death the remainder goes to the children. But the problem with that plan is that the estate tax authority held that the gift to the spouse, to qualify for the marital deduction, must be outright, not in trust.
Congress solved that problem by allowing a special trust…a QTIP trust…to be created. (QTIP stands for “qualified terminable interest trust”). A QTIP provides that the spouse MUST receive all the income, at least quarterly, for the spouse’s life and may or may not allow invasion of corpus…and still qualified for the martial deduction. QTIP trusts are used in the majority of estate plans nowadays.
But a problem remained: non citizens were not allowed to use QTIPS even though they lived in the United States or owned property here.
The solution? The QDT or “QDOT” Trust, explained below.
LIVING TRUSTS FOR NON-CITIZENS
Purpose: The purpose of a Qualified Domestic Trust (known as a QDT or QDOT) is to preserve the marital deduction when the surviving spouse is not a United States citizen and whose assets are likely to be subject to the federal estate tax if the marital deduction is not available. The marital deduction allows transfers of unlimited amounts of assets between spouses at death. The result is that the surviving spouse does not have to pay any tax on the estate of the first spouse to die, provided the surviving spouse is a citizen of the United States.
Note that the marital deduction only postpones the federal estate tax on the estate, and, in some cases, may cost a couple additional taxes if there are no other provisions to reduce estate taxes. Such tools are discussed in the articles on Wills and Trusts, above.
But while the marital deduction is only a postponement of taxes, that postponement can be for decades and given the uncertainty of the estate tax as a law, may act to practically eliminate the taxes forever. Clearly anyone who can should take full advantage of that particular tool.
No marital deduction is allowed if the surviving spouse is not a U.S. citizen and does not become a citizen by the time that the estate tax return is filed. Thus, an estate of, for instance, one million dollars which would have no estate tax whatsoever if the surviving spouse was a citizen would easily have three hundred thousand dollars in tax if the surviving spouse was a non citizen…due nine months from date of death!
However, the marital deduction can be still be used if the assets are transferred to a Qualified Domestic Trust (QDT). This is important for estates that exceed the applicable exclusion amount ($1.5 million during 2004), because the marital deduction is often used to postpone or avoid estate taxes for estates that are larger than $1.5 million. Without the marital deduction, larger estates of non-U.S. citizens will have to pay taxes that estates of U.S. citizens would not have to pay until the surviving spouse died.
REQUIREMENTS FOR QDT
To qualify as a QDT, a trust must meet the following requirements:
1. At least one trustee must be a U.S. citizen or a U.S. corporation.
2. No distribution can be made from the trust, except for income, unless the trustee who is the U.S. citizen or corporation has the right to withhold estate taxes from the distribution.
3. The trust must meet Treasury regulations regarding the collection of any tax.
4. The executor must elect on the estate tax return to treat the trust as a QDT.
After the death of the surviving spouse, the assets in the QDT are subject to the estate tax as though they were included in the estate of the first spouse to die. These assets are not included in the surviving spouse's estate.
CONCLUSION
It has been written that the most important tax advantage made available to couples is the marital deduction and, indeed, when civil unions are discussed one of the first issues brought up is the inability of gay couples to obtain the marital deduction with resultant massive additional taxation. The same danger applies to non citizens but obtaining good legal advice and the correct trust instrument can ensure this valuable tool is made available. Key provisions must be incorporated into the instrument and, of course, if citizenship is later obtained the Trust should be altered, if the Settlor wishes, to conform more closely with the standard QTIP Trust.