858 / How is the availability of the estate tax marital deduction affected when the surviving spouse is not a United States citizen? What is a QDOT?

Generally, there are five kinds of trusts that will qualify for the marital deduction: (1) the “qualified terminable interest property trust,” (2) the “life estate with power of appointment trust,” (3) the “estate trust,” (4) the “special rule charitable remainder trust,” and (5) the “qualified domestic trust.” The first two and the fourth are specific exceptions to the nondeductible terminable interest rule; the third does not come under the rule; the fifth is the only form permitted if the surviving spouse is not a United States citizen. See Q 857.

A marital deduction is usually not available for a transfer to a surviving spouse who is not a United States citizen unless the transfer is to a qualified domestic trust (QDOT) for which the executor has made an election.¹ A QDOT must qualify for the marital deduction under (1), (2), (3), or (4) (above), as well as meet the following requirements.

At least one trustee of the QDOT must be a United States citizen or a domestic corporation and no distribution (other than a distribution of income) may be made from the trust unless that trustee has the right to withhold any additional gift or estate tax imposed on the trust. Additional gift tax is due on any distribution while the surviving spouse is still alive (other than a distribution to the surviving spouse of income or on account of hardship). Additional estate tax is due on any property remaining in the QDOT at the death of the surviving spouse (or at the time the trust ceases to qualify as a QDOT, if earlier). The additional gift or estate tax is calculated as if any property subject to the tax had been included in the taxable estate of the first spouse to die.²

Regulations add additional requirements in order to ensure the collection of the deferred estate tax. If the fair market value (as finally determined for estate tax purposes, see Q 916, but determined without regard to any indebtedness with respect to the assets) of the assets passing to the QDOT exceeds $2,000,000, then the QDOT must provide that at least one of the following is true: (1) at least one U.S. trustee is a bank,³ (2) at least one trustee is a U.S. branch of a foreign bank and another trustee is a U.S. trustee, or (3) the U.S. trustee furnish a bond or security or a line of credit equal to 65 percent of the fair market value of the QDOT corpus. The line of credit must be issued by (1) a U.S. bank, (2) a U.S. branch of a foreign bank, or (3) a foreign bank and confirmed by a U.S. bank.⁴

A QDOT with assets of less than $2,000,000 must either (a) meet one of the requirements for a trust exceeding $2,000,000, or (b) provide that (1) no more than 35 percent of the fair market value (determined annually on last day of trust’s taxable year) of assets consists of real property located outside the U.S., and (2) all other QDOT assets be physically located within the U.S. at all times during the trust term. All QDOTs for the benefit of a surviving spouse are aggregated for purposes of the $2,000,000 threshold. A QDOT owning more than 20 percent of the voting stock or value in a corporation with 15 or fewer shareholders (or 20 percent of the capital interest in a partnership with 15 or fewer partners) is deemed to own a pro rata share of the assets of the corporation (or the pro rata share of the greater of the QDOT’s interest in the capital or profits of the partnership) for purposes of the 35 percent foreign real property limitation. All interests in the corporation (or partnership) held by or for the benefit of the surviving spouse or the surviving spouse’s family (includes brothers, sisters, ancestors, and lineal descendants) are treated as one person for purpose of determining the number of shareholders (or partners) and whether a 20 percent or more interest exists. However, the attribution rules do not apply in determining the QDOT’s pro rata share of the corporation’s (or partnership’s) assets. Interests in other entities (such as another trust) are treated similarly to corporations (and partnerships).⁵

For purposes of the $2,000,000 QDOT threshold and the amount of a bond or letter of credit required, up to $600,000 in value attributable to the surviving spouse’s personal residence and related furnishings held by the QDOT may be excluded. However, the personal residence exclusion does not apply for purposes of determining whether 35 percent of the fair market value of assets consists of real property located outside the U.S. A personal residence is either the principal residence of the surviving spouse or one other residence of the surviving spouse. A personal residence must be available for use by the surviving spouse at all times and may not be rented to another party. Related furnishings include furniture and commonly used items within the value associated with normal household use; rare artwork, valuable antiques, and automobiles are not included.

If a residence ceases to be used as the surviving spouse’s personal residence or a residence is sold, the personal residence exclusion ceases to apply with regard to that residence. However, if part or all of the amount of the adjusted sales price of the residence is reinvested in a new personal residence within 12 months of the date of sale, the exclusion continues to the extent the adjusted sales price is reinvested in the new residence. Also, if a residence ceases to be used as the surviving spouse’s personal residence or a residence is sold, the exclusion can be allocated to another personal residence of the surviving spouse that is held by a QDOT of the surviving spouse. In this instance, the exclusion can be up to $600,000 (less the amount previously allocated to a personal residence that continues to qualify for the exclusion).⁶