Qualified Domestic Trusts (QDOT)

There is an unlimited marital deduction against gift or estate taxes if property passes from the donor to his surviving spouse, but not if the donee is not a United States citizen. The purpose of the marital deduction is to defer the estate tax until the death of the surviving spouse but not to allow the elimination of the estate tax. The justification for the marital deduction is that it will provide support for the surviving spouse and the transferred property will be includable in her estate. However, if the surviving spouse is not a United States citizen, then there is a good possibility that the United States will not be able to collect an estate tax from the estate of the noncitizen spouse.

However, the law does provide an exemption amount for annual gifts, which is adjusted annually for inflation, that can be given free of gift or estate tax to a noncitizen spouse. This exemption amount is in addition to the lifetime gift exemption that applies to gifts to others. ^{IRC §2523(i)}

The law also provides a special type of trust, called a qualified domestic trust (QDOT) that allows the noncitizen surviving spouse to receive all income from the trust, and under certain circumstances, some principal. However, some countries have treaties with the United States that allows a different treatment of the noncitizen spouse. The QDOT qualifies for the unlimited marital deduction, and thus, no estate taxes are due on the trust property when the citizen spouse dies. ^{IRC 2056(d)}

However, when the surviving noncitizen spouse dies, the QDOT assets are subject to estate tax. A QDOT must meet the following requirements to qualify for the marital deduction:

• the surviving spouse is entitled to all trust income;
• the QDOT must be elected by the executor of the grantor's estate on the estate tax return.

The following additional requirements are to ensure that the U.S. government gets its tax money:

• at least 1 of the trustees must be either a United States (US) citizen or US corporation (because they will, then, be subjected to U.S. laws);
  • so the noncitizen surviving spouse cannot be the sole trustee;
• the trust must comply with applicable IRS regulations, and provide a means of ensuring that estate taxes will eventually be paid, such as posting a bond or providing a letter of credit, if the trustee is an individual and if the QDOT principal exceeds the exemption amount.
  • If estate taxable assets exceeds $2,000,000 in value, then the trust document must reference Treasury Regulation §20.2056A-2(d) and specify at least 1 of the following requirements:
    • At least 1 US trustee is an IRC §581 bank;
    • a US trustee must furnish either a bond or an irrevocable letter of credit from the bank equal to 65% of the fair market value (FMV) of the trust assets in favor of the IRS
  • If the estate taxable value is $2,000,000 or less, regardless of any debt owed, then the following conditions must be satisfied:
    • No more than 35% of the FMV of trust assets can consist of real estate located outside of the United States
    • The trust must satisfy all requirements if assets exceed $2,000,000
  • The estate taxable value in determining the above requirements can be reduced by up to $600,000 of real property, including furnishings, if it is used by the surviving spouse as a personal residence, the property is owned directly by the QDOT, and it satisfies the other rules for the marital deduction.

Estate taxes must be paid on any principal distributed to the spouse unless it is for hardship, which the IRS defines as an immediate need relating to health, maintenance, education, or support that cannot be met with any other reasonable means.

If the decedent spouse did not provide for a QDOT in his estate plan, then the surviving spouse can ask the IRS to reform the estate plan so that it meets the guidelines of a QDOT.

The trustee or other filer designated by the executor of the decedent's estate must file Form 706-QDT, U.S. Estate Tax Return for Qualified Domestic Trusts to report on certain distributions from the QDOT, certain annuity payments paid out of the trust principal, and to report the value of the property remaining in the QDOT when the surviving spouse dies.

It is also possible for the noncitizen spouse to become a United States citizen so that she can qualify for the unlimited marital deduction, even after the citizen spouse has died, but she must become a citizen either before the estate tax return is filed, which is usually 9 months after the death, or before any distribution of principal is made to the noncitizen spouse. If successful, then the surviving spouse will receive the full marital deduction, obviating the need for the QDOT. The trustee must file Form 706-QDT to inform the IRS that the surviving spouse has become a US citizen.