From the June 2005 issue of Investment Advisor • Subscribe!

June 1, 2005

Estate Planning for a Non-Citizen Spouse

A surviving spouse who's not a citizen can't inherit a partner's estate tax-free without a qualified domestic trust

Marrying Michael last year was one of the most exciting events of my life. We had a small wedding at a clubhouse overlooking beautiful Lake Hazeltine in southern Minnesota. I still remember what our priest said to us after he had pronounced us man and wife: "You will both live a long and happy life as long as you remember this one principle: Rachael, you are always right; and Michael, you are never wrong."

Now that we are passing our honeymoon phase, it has prompted us to contemplate our future life together. When Michael received his green card last month we thought it was the end of our immigration journey. What we didn't know was that it was just the beginning.

My husband is a Canadian citizen. His entire family lives in Canada and he is very proud to be Canadian. At the moment, he does not have plans to become a U.S. citizen. Normally this would not be a problem for anyone. However, if I were to die unexpectedly and had significant assets, it might be a different story.

No Marital Deduction

Under current law, when a spouse of a married couple dies, the surviving spouse qualifies for a federal estate tax marital deduction. This allows for the descendant to leave unlimited amounts of assets to a surviving spouse, either outright or though a marital trust, with no tax imposed. The only prerequisites for this deduction are that the marriage must be valid and intact at the date of death, and the surviving spouse must be a U.S. citizen. That's where we hit a snag. Since my husband is a Canadian citizen, the marital deduction would be denied to him, and what would have normally been passed through tax-free is now subject to taxation.

However, all hope is not lost. There are a few ways to remedy this situation. First, if my husband wanted to obtain U.S. citizenship anytime in life before the federal estate tax return was filed, he would qualify for the marital deduction. I suggest doing this sooner rather than later, since in my experience, immigration paperwork is not always processed in an expeditious manner. If the spouse has already died, you only have nine months to file the estate tax return: Citizenship approval may take longer than nine months.

Secondly, a citizen spouse can transfer up to a certain amount of assets each year ($117,000 in 2005) to the non-citizen spouse free from federal gift tax. To qualify for this exclusion, the gift must qualify under the rules for an annual gift tax exclusion. The gift must also meet the requirements for a marital deduction as if the spouse were a citizen. The non-citizen spouse can use the assets for any purpose. If the non-citizen spouse holds the assets until her death, and such assets are subject to the estate tax in the non-citizen spouse's estate, the applicable exclusion amount can be used to shelter some or all of these assets. This is formally known as the Unified Credit; the total lifetime limit in 2005 is $1.5 million.

The QDOT Alternative

The third way to protect your assets is to establish a QDOT, a Qualified Domestic Trust, which allows a citizen spouse to transfer assets at death to a non-citizen spouse without having to pay federal estate taxes on the transfers. The QDOT does not necessarily have to be created during the life of the citizen spouse, but it must be created before the estate tax return is filed for the deceased citizen. It would be better to explore the option while both spouses are still living, as there may be more choices in the creation of the document.

QDOTs are generally very complicated to set up and administer. At least one of the trustees of the QDOT must be an individual who is a citizen of the United States or a domestic corporation (typically a bank or trust company). The trustee who is the U.S. citizen or domestic corporation has the right to withhold federal estate taxes from any distribution of principal. Although the non-citizen spouse is allowed to receive income from the trust, it is almost impossible for that spouse to remove any principal from the trust without paying federal estate taxes, if, in fact, federal estate taxes were imposed in the year the citizen spouse died. If the non-citizen spouse is paid income by the QDOT, he is responsible for paying federal income taxes, if any, on the income received. Federal estate taxes would not be imposed if the non-citizen spouse qualifies for a hardship exception. As one would expect, the IRS is very strict when it comes to qualifying someone for the hardship exception.

After the death of the surviving non-citizen spouse, the assets remaining in the QDOT are subject to the federal estate tax as though they were included in the estate of the deceased citizen spouse. The assets are not included in the non-citizen spouse's estate. Any appreciation in the value of the assets would also be subject to tax upon the non-citizen spouse's death.

I have already indicated to my husband that he will probably be the first one to die, making this issue moot. However, to protect ourselves from the unlikely and the unexpected, we will be speaking with an experienced and competent estate planning attorney to discuss our options, and draft a QDOT trust if necessary.

Rachael M. Kelly is a Financial Network Investment Corp. (FNIC) financial advisor with Chase Taylor Financial Corp. in Minneapolis. She can be reached by e-mail at

rkelly@chasetaylor.com.

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