Transfers between U.S. Citizen Spouses -— The Marital Deduction
U.S. citizens may delay the imposition of either the U.S. gift tax or estate tax on transfers between citizen spouses. If both spouses are citizens, either may transfer assets to the other spouse and receive a tax deduction for the entire value of the property transferred.
The first spouse to die may therefore leave his or her entire estate to the surviving U.S. citizen spouse without triggering estate tax (which becomes payable on the death of the second spouse). Estate tax otherwise owed by the first spouse to die may thus be delayed (by devising the deceased’s estate to the surviving spouse); this concept is known as the “unlimited” marital deduction. Transfers may be accomplished during life or at death and either by outright gift or through gifts in trust (for the benefit of the other spouse).
A U.S. citizen or resident may also “port” his or her individual exclusion amount (currently $12,060,000) to the surviving spouse. Any exclusion amount not used by the first spouse to die (by lifetime and testamentary non-spousal gifts) may be transferred (or “ported”) to the qualifying surviving spouse. The total amount of property currently excluded from the estate tax ($12,060,000 times 2, or $24,120,000) may therefore be “pooled” by U.S. spouses (and applied against the taxable estate of the second spouse to die).
Certain limitations are imposed on the marital deduction for property transferred to a non-U.S. citizen spouse (even if the recipient spouse is a U.S. resident).
The unlimited marital deduction (sheltering spousal bequests by a U.S. citizen or resident) is restricted for transfers to a surviving non-citizen spouse. A surviving non-citizen spouse may not generally receive a bequest (from a citizen or resident deceased spouse) tax-free.
The restriction is intended to limit the risk of the surviving non-citizen spouse (even if a U.S. resident) leaving the United States with the decedent’s taxable estate. Titling (during marriage) marital assets (especially assets not located in the United States) in the name of the non-citizen spouse should be considered if the intention is for the survivor to leave the United States. A non-resident non-citizen (NRNC) surviving spouse is subject to estate tax only on U.S. situs assets.
Qualified Domestic Trusts
U.S. citizens or residents may defer estate tax on testamentary transfers to a non-citizen spouse through a special trust. The grantor spouse must leave his or her estate to a “qualified domestic trust” (QDOT), to receiving the marital deduction. The fiduciary of the estate must make the QDOT election on the deceased spouse’s estate tax return. In the absence of an estate tax treaty, only through the QDOT may U.S. estate tax (on assets held by a U.S. citizen or resident spouse) be deferred until the death of a surviving non-citizen spouse.
Transfers to QDOTs qualify for the marital deduction. Distributions from a QDOT of trust principal are subject to the estate tax. To qualify for the marital deduction, the deceased’s property must pass either (i) directly to a QDOT before filing the deceased’s estate tax return, or (ii) from the non-citizen recipient spouse (to the QDOT) within nine months of the decedent’s death.
Regulations limit who may qualify as a potential QDOT trustee (generally to individuals and entities tied to the United States). Trustee distributions are also restricted, to ensure tax payments (with certain exclusions for QDOTs with minimal assets and for QDOTs holding the personal residence of the non-citizen spouse).
If the surviving non-citizen spouse becomes a U.S. citizen before the deceased’s Estate Tax return is filed, direct bequests to the survivor will qualify for the marital deduction. If the surviving spouse later becomes a U.S. citizen, all QDOT assets may then be distributed directly to the survivor (free of Estate Tax, through the marital deduction).
To qualify for the marital deduction, the QDOT must (i) be executed under U.S. law, (ii) have at least one trustee that is a U.S. citizen or U.S. corporation, and (iii) not allow for distributions unless the trustee has the right to withhold tax on transfers to the surviving (non-citizen) spouse. The executor of the first spouse to die must elect to treat the trust as a QDOT and pass property directly to the QDOT. Certain other mandatory trustee powers must be included, to ensure U.S. tax compliance.
Any distributions of principal from the QDOT to the surviving noncitizen spouse are subject to the estate tax at the time of distribution. Any principal remaining upon the death of the non-citizen spouse will also be subject to estate tax (as part of the estate of the first spouse to die).
Treasury regulations permit a modified “portability” election to be made (to allow a surviving non-citizen spouse to utilize the deceased’s unused estate tax exemption). The modified portability credit (applied through the QDOT) delays imposition of estate tax until the death of the second (non-citizen) spouse. Upon the death of the non-citizen spouse, the first spouse’s unused Estate Tax exemption is applied. The determination of the amount of exemption (left by the first spouse to die) involves a series of valuation procedures. The formula is influenced by the appreciation or depreciation of assets in the QDOT.
Rules of administration exempt the QDOT from “foreign trust” status (and the associated onerous reporting requirements).
Asset allocation (based on location and value) and strategic use of the QDOT must be carefully considered for U.S. individuals potentially leaving assets to a non-citizen spouse.
 IRC §2523(a) and (i); §2056(a).
 IRC §2056(a). Under this code section, a deduction is allowed for “any interest in property which passes or has passed from the decedent to his surviving spouse” (emphasis added).
 IRC §2010(c)(3)(A), (B).
 IRC §2010(c)(4).
 IRC §2056(d)(1).
 IRC §2056(d)(2)(A); §2056A.
 Treas. reg. §20.2056A-2.
 Treas. Reg. §20-2056A-2(a).
 IRC §2056A(a)(1)B).
 IRC §2056A(a)(3).
 Treas. Reg. §20.2010-2(a)(5).
 IRC §7701(a)(30), IRC §7701(a)(31).
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