Estate planning can require extra care and effort where one spouse is not a U.S. citizen. The same can be said for couples who live, work, or own property in the U.S. but neither is a U.S. citizen. These couples should be well-advised in preparing an estate plan to minimize the potential application of U.S. gift and estate tax.
U.S. Estate Tax
In the U.S., many types of estate planning for married couples rely on the availability of the unlimited “marital deduction” from gift and estate tax. This means that an unlimited amount of assets can be gifted to a U.S.-citizen spouse during life without triggering gift tax, or can pass to a (surviving) U.S.-citizen spouse as an inheritance without triggering estate tax. This feature of U.S. tax law makes it possible in many cases to defer all estate tax on the death of the first spouse.
However, the availability of the unlimited marital deduction is based on citizenship. Mere U.S. residence (even green card status) does not confer the unlimited marital deduction.
Where the surviving spouse is not a U.S. citizen, and therefore an inheritance to the surviving spouse would not qualify for the unlimited marital deduction, it still may be possible to defer estate tax until the second death through the use of a special type of trust called a “Qualified Domestic Trust” (or “QDOT”). A QDOT would hold all the assets of the deceased spouse for the benefit of the surviving (non-citizen) spouse. However, for a QDOT to defer estate tax successfully, it must meet certain conditions imposed under the U.S. Internal Revenue Code including: (i) at least one trustee must be a U.S. citizen or U.S. corporation, (ii) if less than $2,000,000 is transferred to the trust, then no more than 35% of the trust property can be foreign property, (iii) if more than $2,000,000 is transferred to the trust, then either one of the trustees must be a U.S. bank or the trust must post a bond equal to 65% of the value of the transferred property, and (iv) trust principal cannot be distributed to the surviving spouse without the trustee withholding U.S. estate tax from the distribution at the applicable rate (currently 40% federal, plus any applicable state-level estate tax), unless the distribution is made on account of hardship. A withdrawal is made because of “hardship” only if it was made in response to an immediate and substantial financial need relating to the spouse’s health, education, or support, which is difficult to prove.
While the QDOT is certainly useful, certain assets simply cannot be placed in a QDOT under U.S. law, including U.S. retirement plans. An additional limitation is that many foreign jurisdictions either do not recognize trusts or do not allow for (or assess very high tax rates on) property placed in trust, thereby decreasing or eliminating the tax savings and/or careful planning of the distribution of assets under a trust arrangement. These possible limitations should be considered in connection with any QDOT planning.
U.S. Gift Tax
U.S. citizen spouses can make unlimited gifts to each other. That is not the case for gifts to a non-U.S. citizen spouse. Annual gifts to a non-U.S. citizen spouse are limited to a specific dollar amount, currently $185,000 for 2024. If aggregate gifts to a non-U.S. citizen spouse exceed that amount in a single calendar year, then the gifting spouse will use a portion of his or her lifetime exemption from estate tax (provided the gifting spouse is a U.S. citizen or a non-U.S. person domiciled in the United States). If the gifting spouse has no remaining exemption from estate and gift tax, then a gift in excess of the annual limit will trigger federal estate tax at a 40% rate. (Connecticut imposes an additional state-level gift tax at a rate of up to 12%; New York does not impose a state-level gift tax.)
Complexities with Jointly-Held Assets
For couples in the U.S. who hold assets in joint name, there are many rules to navigate when one or both spouses is/are not a U.S. citizen. For example, when U.S. citizen spouses jointly own a home, it is assumed that the home belongs to both spouses equally. This means that only 50% of the home’s value is included in the taxable estate of the first spouse to die. This presumption does not apply if one of the spouses is not a U.S. citizen. Instead, if the spouse who is a U.S. citizen dies first, the entire value of the jointly-owned home will be included in that spouse’s taxable estate (with no marital deduction) unless the non-U.S. citizen surviving spouse can prove that he or she contributed assets toward the purchase of the home. Similarly,
- A taxable gift is deemed to be made if they sell a joint residence and one spouse receives proceeds in excess of his or her pro rata share of contributions to the purchase price.
- Upon the creation of a joint tenancy in tangible personal property, where more than one-half of the consideration is furnished by one spouse, a gift of one-half of the value of such property is deemed to have been made to the other spouse.
- Joint bank and brokerage accounts must be carefully analyzed because a taxable gift can be deemed to be made at the time the account is funded, in certain cases, or when the account is terminated or a withdrawal is made by the non-U.S. citizen spouse.
Other Considerations
- Property Located in a Foreign Country
When individuals own property located in another country, the law of the country where the property is located may affect how it is distributed on death. While wills and trusts are common in the United States, a foreign country may not accept a United States will as valid. Also, many civil law countries do not recognize trusts or treat the trust as an unrelated party and impose the highest inheritance tax rate. Some common law countries may impose taxes on transfers to trusts or impose periodic taxes upon trust property, even for revocable trusts used for standard estate planning and probate avoidance. In addition, some foreign jurisdictions may have “forced heirship” rules that override a U.S. will or testamentary trust. Thus, U.S.-based estate planning may not work in foreign countries where property or beneficiaries are located. It may be necessary to have multiple wills, each one dealing only with the property located in that country and drafted by local counsel. In such case, it is important to take special care to ensure that none of the wills unintentionally revokes any other will from another jurisdiction. - Effect of Treaties
In some cases, treaties between the United States and the non-U.S. citizen spouse’s foreign country of citizenship may provide some relief from U.S. estate tax obligations. Currently, the United States has estate and/or gift tax treaties with sixteen sovereign nations. The treaty rules may establish taxation priority by determining which jurisdiction was the domicile of the decedent, resolve issues of dual-domicile, reduce or eliminate double taxation, and provide additional deductions or credits.
If you would like to discuss the information in this publication and ask any questions on this or other estate planning topics, please do not hesitate to contact your Wiggin and Dana attorney.