Estate Planning for Non-US Citizens

Non- U.S citizens (nonresident aliens and green card holders) could be a subject to a more challenging estate planning environment when they own U.S. assets. Instead of the $12,060 estate and gift exemption amount (as of 2022) to which U.S. citizens and permanent residents are entitled, a nonresident individual is entitled to an exemption of only $60,000 for estate tax purposes for their U.S. property.

For a good overview of How the U.S. Estate Tax Applies to U.S. citizens vs. non-citizens and domiciliary, you can refer to this article.

Permanent residents of the U.S., while entitled to the entire estate tax exemption for the U.S. estate tax, are subject to U.S. estate tax on their worldwide assets, including assets held in the home country. Thus, nonresident aliens and green card holders may also be subject to estate tax in their country of citizenship, raising the issue of double taxation.

In the context of a married couple where one of the spouses is not a U.S. Citizen, the estate planning landscape is significantly affected. The general rule is that U.S. citizens or U.S. residents can pass an unlimited amount of assets between each other without paying any estate or gift tax, through what is called the unlimited marital deduction. However, in case of the receiving spouse being a non-U.S. citizen or U.S. resident, the IRS requires special provisions to be included in the revocable trust for the unlimited marital deduction to apply. These special provisions are necessary to create a qualified domestic trust, or “QDOT,” which can result in significant tax savings. With a QDOT, at the first spouse’s death, assets go to the trust instead of to the surviving noncitizen spouse.

A QDOT allows a noncitizen surviving spouse of a deceased taxpayer to take advantage of the unlimited marital deduction on estate taxes for any assets that are placed into the trust.

 Under IRS section 2056A, a surviving spouse is eligible for a 100% marital deduction of any estate taxes owed on assets. To be a QDOT, a trust agreement must have the following provisions:

1. Provide that the laws of a U.S. state or the District of Columbia govern its administration;

2. Qualify as an ordinary trust under Regs. Sec. 301.7701-4(a);

3. Have terms that qualify it as a power of appointment trust, a qualified terminable interest property trust (QTIP trust), a qualified charitable remainder trust (qualified CRT), or an estate trust;

4. Require at least one trustee to be a U.S. citizen or a U.S. corporation; and

5. Provide that no distributions (except distributions of income) may be made from the trust unless the trustee has the right to withhold the Sec. 2056A estate tax.

Other requirements come into play depending on the value of the QDOT:

6. If the property transferred to the QDOT has a value that exceeds $2 million, at least one trustee must be a U.S. bank, the trustee must post a bond with the IRS equal to 65% of the fair market value of the property transferred to the trust, or the trustee must furnish the IRS with a letter of credit of 65% of the fair market value of the property transferred to the trust.

7. If the property transferred to the QDOT has a value that is $2 million or less, then either no more than 35% of the trust property determined annually on the last day of the trust’s tax year will consist of foreign real property, or the trust will meet the bank, bond, or letter of credit rules above.

It is important to note that the federal estate tax on the value of those assets funded into the QDOT is deferred until the noncitizen surviving spouse takes money out of the QDOT or passes away. At that point, the QDOT assets are added back to the estate for tax purposes, and the deferred estate tax bill comes due. However, if the surviving spouse becomes a citizen, he or she can then take all the assets in the QDOT, and the deferred tax bill will disappear.