Non-Citizen Spouses

     As a natural consequence of international travel, study and commerce, more U.S. citizens are marrying foreign nationals. These marriages specifically enrich both families and generally enrich the great "melting pot" which is the United States of America. However, without proper planning, such marriages also could unnecessarily enrich the IRS!
     When a marriage is between U.S. citizens, each spouse may give away during life or pass at death an unlimited amount of assets to the other spouse. This is called, appropriately, the unlimited marital deduction. However, the gift and estate tax rules governing transfers from a U.S. citizen spouse to a non-citizen spouse are different. And the failure to comply with these rules can be rather expensive.

Lifetime Giving

     A U.S. citizen may give $133,000 each year to their non-citizen spouse free of gift taxes. Any amount exceeding that protected annual threshold is subject to gift taxes. This rule is clear and easy to understand. The rules for post-mortem transfers, on the other hand, are complex, especially for estates exceeding the applicable estate tax exemption amount (e.g., $3.5 million for 2009).

Post-Mortem Transfers

     General rule: If the estate of a U.S. citizen passing to their non-citizen surviving spouse exceeds the applicable estate tax exemption amount, then the amount in excess will not qualify for the unlimited marital deduction. General exception: If the non-citizen surviving spouse becomes a U.S. citizen before the federal estate tax return is due (within nine months of death), or if the estate passing to the non-citizen spouse is held in a Qualified Domestic Trust (QDOT), then estate taxes will not be triggered on the excess at the death of the U.S. citizen spouse. [Note: Up to $600,000 of the value of the personal residence and its contents may be excluded when determining whether the applicable estate tax exemption has been reached.]

QDOT Requirements

     The underlying purpose of the QDOT exception is to ensure the collection of the estate tax at the death of the non-citizen spouse (who otherwise could remove the assets from the United States and deprive the IRS of its eventual inheritance).
     The QDOT requirements are set forth in IRC Sec. 2056A(a) and related Treasury Regulations, and they include the following:

• At least one trustee of the QDOT must be a U.S. citizen or a domestic corporation.
• While QDOT trust income distributed to a non-citizen spouse is not subject to QDOT tax, distributions of principal will be subject to federal estate taxes (unless made due to a qualifying hardship).
• The U.S. trustee must be able to withhold taxes due on any trust principal distributions.

     Bottom line: The lifetime or post-mortem transfer of wealth to a non-citizen spouse can be an unnecessarily taxing experience. Appropriate legal counsel, however, can mitigate the taxing consequences.