Mo Vidwans
So much importance is stressed about estate planning and investments and so many aspects of financial planning are discussed with client’s best interest in mind that sometimes one very important question does not get asked. That question has the potential to derail the whole conversation and giving the entire estate planning process a totally different perspective. And the question is: Are both spouses US citizens?
Why is this question so important? Most of today’s estate planning process (and for that matter laws on the books) is designed with the assumption that both spouses are US citizens. If that is not the case, then a totally different set of rules applies and I have to say some of the rules are not advantageous to the non-citizen spouse, in fact they are outright expensive. It is always a good idea to convert the Green Card status to the citizenship status as soon as possible. Granted that (after five years of Green Card) you have to give a test for which you have to study but there is much help available and it becomes a simple matter of putting in some concerted efforts and keeping some devoted time to do that.
What are the differences?
The fear Congress has expressed and the reason why it is done is that the non-citizen spouse can take the entire estate after the death of the first spouse and reside in another country, supposedly from where the spouse came from.
Under US Law, assets left to a surviving spouse are not subject to federal estate tax, no matter how much the assets are worth, if the surviving spouse is a US citizen. This rule is called “the unlimited marital deduction.”
This marital deduction does not apply when the spouse who inherits it isn’t a US citizen, even if the spouse is a permanent US resident (Green Card holder). As mentioned above, the federal govt. doesn’t want someone who isn’t a US citizen to inherit a large amount of money, pay no estate tax and then leave the country.
Still keep in mind that you can leave assets worth up to the exempt amount ($11.58M in 2020) to anyone, including non-citizen spouse without owing any federal estate tax. And if the non-citizen spouse dies first, assets left to spouse who is a US citizen do qualify for the unlimited marital deduction.
You probably noticed that the current estate tax exemption makes this a problem only for wealthy. These current rules expire and have a sunset date by end of 2025. In 2026, however, the exemption is scheduled to revert back to $5.49M (unless Congress and the President interject and decide to make new laws) so estate planning will become more complex for mixed-nationality couples. Without the marital deduction which all citizens enjoy, these couples have less attractive options.
Become a citizen
Either before any spouse dies or definitely afterwards, become a US citizen. It is much easier to become a citizen, if both spouses are alive. This is so because there is much less pressure of time and emotionally the spouse is in much better shape to prepare and pass the tests. The federal estate tax return is due nine months after death but the IRS may grant a 6-month extension which aggregates to a 15-month grace period. Hence after the American spouse’s death, the survivor has just 15 months to become a citizen, move the money into a trust or pay estate taxes. That typically is not enough time to complete the citizenship process, although it is possible to gain another 12 months by paying a penalty to IRS.
Use a QDOT trust
If citizenship doesn’t appeal or work out immediately, a qualified domestic trust (QDOT) is an alternative. Your non-citizen spouse can partially enjoy your assets free of estate tax if you use this special trust. The assets go into this trust for the surviving spouse who can receive the income from the trust, without paying estate taxes but cannot spend the principal without showing hardship or paying estate tax on the principal that exits the trust.
A QDOT must be established, and the property must be transferred to it, by the time the estate tax return of the deceased spouse is due. It is best if it is set-up while both spouses are alive and comes into existence when the citizen spouse dies. The trustee, a person or US Corporation such as bank or a trust company, must be a US citizen or US corporation. These trusts generally must comply with some complicated legal rules.
Once the non-citizen spouse becomes a citizen, he/she can unwind the trust and take the inheritance estate-tax free under the marital deduction.
Other possibilities
If neither citizenship, nor a QDOT is an option, there are other ways. United States has treaties with many countries (but not all) which may allow the foreign citizen to inherit outright, at least in part, without paying US estate taxes. Survivor has to choose either a treaty provision or a QDOT but not both.
Generally, financial planners would advise to split the total estate between the spouses but in this case, with a non-citizen spouse, more property should be titled in the name of non-citizen spouse, including annual gift from the citizen spouse. The more the foreign spouse owns the less estate tax will be due.
If a US citizen gives gift to the foreign spouse in ways that would otherwise be eligible for the marital deduction, taxes are due on everything above $155,000 annually; this amount goes up every year.
This is another case for not having a joint account or ownership, like real estate.
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Mo Vidwans is an independent, board-certified financial planner. For details visit www.vidwansfinancial.com, call +1 (984) 888-0355 or write to [email protected].
