Advanced Underwriting Consultants

Question of the Day – October 7

Ask the Experts!

The professionals at Advanced Underwriting Consultants (AUC) answer the tax and technical questions posed by producers.  Here’s the question of the day.

Question: I am working with a couple where one of the spouses is not a U.S. citizen.  What special federal estate tax rules do I need to be worried about?

Answer: The 1988 Tax Act eliminated the marital deduction for estate owners whose surviving spouses are not U.S. citizens. At-death transfers from a citizen to a non-U.S. citizen spouse do not have the same tax treatment as transfers between two citizen spouses since the unlimited estate tax marital deduction is unavailable.

There are two exceptions to the general rule. The marital deduction is available:

(1) if the surviving spouse becomes a citizen before the decedent spouse’s estate tax return is filed and she was a U.S. resident at all times after decedent’s death; or

(2) if the property passing to the surviving spouse is transferred to a Qualified Domestic Trust (QDT).

The deceased spouse’s unified gift and estate tax credit – currently equivalent to an exemption of $5,000,000 in 2011 – can be applied against any at-death transfers that fail to qualify for the marital deduction.

A QDT is a trust meeting the following requirements:

  • The trust is created and maintained under the laws of the United States, any state or the District of Columbia.
  • The trust meets the regular marital deduction requirements; that is; it is either a general power of appointment trust, an estate trust, a qualified terminable interest property (QTIP) trust, or a special rule, charitable remainder trust.
  • At least one trustee is an individual who is a United States citizen or a domestic corporation.
  • The trust instrument provides that no distributions of trust principal will be made unless the trustee withholds the estate tax due on the distribution.

Distributions of trust income from a QDT to a surviving spouse are subject to a special estate tax on distributions from a QDT in the following circumstances:

1. On distributions of trust principal to the surviving spouse during her lifetime. Distributions of principal made on account of hardship are not subject to the special estate tax. A distribution is made on account of hardship if made in response to an immediate and substantial financial need relating to health, maintenance, or support. The spouse first must exhaust other reasonably available resources prior to requesting a hardship distribution.

2. On trust assets remaining at the death of the surviving spouse.

3. On trust assets remaining at the time the trust fails to qualify as a QDT, e.g. when there is no longer a U.S. trustee.

The estate tax due is the tax, which would have been collected, had the distribution been included in the decedent’s estate.

Have a question for the professionals at AUC?  Feel welcome to submit it by email.  We may post your question and the answer as the question of the day.