If you are married, protecting your spouse financially in the event of your death or incapacity is no doubt a primary estate planning goal. If your spouse is not a U.S. citizen, protecting him/her becomes both more important and more difficult. In this blog, we explain how a living trust can help you protect your non-citizen spouse.
The Changing Face of Marriage in America
Just a generation or two ago it was relatively unusual for individuals from different backgrounds, much less different countries, to meet each other given the practical limitations of travel. Consequently, it was even less likely to marry someone from another country. Advances in science and technology, however, over the last several decades have caused the world to shrink and national borders to all but disappear. A sharp increase in intermarriage in America is one side effect of those changes. In fact, the United States Census Bureau reports that one in five marriages in the U.S. today includes a spouse born outside the U.S. Of those marriages, about 60 percent of the foreign-born spouses have become naturalized citizens, leaving the remaining 40 percent as non-citizens.
Understanding Federal Gift and Estate Tax
The federal gift and estate tax is a tax that is imposed on an estate after the death of the estate’s owner. Every estate is potentially subject to the tax; however, every taxpayer is also entitled to make use of the lifetime exemption before the tax is imposed. The lifetime exemption was set at $5 million by the American Taxpayer Relief Act of 2012 (ATRA) and is to be adjusted annually for inflation. President Trump enacted changes to the lifetime exemption in 2018 that dramatically increases the exemption amount for several years; however, it will return to the previous amount (adjusted for inflation) in 2026. The portion of an estate tax that exceeds the exemption amount is taxed. If your estate is subject to federal gift and estate tax it can significantly diminish the value of your estate given that the tax rate was also permanently set at 40 percent as part of ATRA.
The Unlimited Marital Deduction and Your Non-Citizen Spouse
In the normal course of events, you may plan to leave your entire estate to your spouse when you die, counting on your spouse to then pass down whatever remains of your combined assets to your children upon his/her death. You can normally do this without worrying about federal gift and estate taxes because of the unlimited marital deduction. The unlimited marital deduction allows a spouse to gift an unlimited amount of assets to a surviving spouse tax-free. The theory behind the deduction is that those assets will eventually be taxed when the surviving spouse passes away. The unlimited marital deduction, however, only works as a tax avoidance strategy if your spouse is an American citizen at the time of your death. If your spouse is a non-citizen, another tax-avoidance strategy must be employed. A common alternative is to create a Qualified Domestic Trust (QDOT).
What Is a QDOT and How Can It Help Protect My Spouse?
A Qualifying Domestic Trust (QDOT) is a specialized trust that allows you to provide for a non-citizen spouse without the help of the unlimited marital deduction. Your spouse will be entitled to the interest from the trust assets but will not own the assets nor can your spouse access the principal held by the trust absent a showing of extreme hardship. An extreme hardship requires your spouse to show an “immediate and substantial” need for money relating to “heath, maintenance, education or support” of either your spouse or someone your spouse is legally obligated to support, such as a child. Upon the death of your surviving spouse, the assets held in the trust will be distributed to the beneficiaries named in the trust, usually children and/or grandchildren. If any federal and/or state estate taxes are due at that time they will need to be paid at the time of distribution. A QDOT allows you to protect your non-citizen, spouse without losing up to 40 percent of your estate assets in the process.
Please download our FREE estate planning checklist. If you have additional questions or concerns about how a Qualified Domestic Trust might fit into your estate plan, contact us at the Northern California Center for Estate Planning & Elder Law by calling (916)-437-3500 or by filling out our online contact form.
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