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Laws, work-arounds, QDOT’s: Estate planning for non-citizen spouses

Every year, the United States grants lawful permanent residence to about one million foreign-born people. Like American citizens, alien residents, aka green card holders, may live and work permanently anywhere in the U.S. They may attend public schools and universities, join at least some branches of the Armed Forces, and after a while they usually become eligible for citizenship. In terms of estate planning, however, things aren’t quite perfect. While registered aliens may purchase, bequeath and inherit property in the U.S., one important privilege doesn’t apply to them: the unlimited marital tax deduction.

What does this mean, and will it affect you? If you are wealthy and married to a non-citizen, yes. The law limits the value of the property that you can pass on to your spouse tax-free to $5.43 million.

Let’s, once again, take a hypothetical example. Dylan is married to Simone, a registered alien. Dylan dies with an estate valued at $8.53 million, and Simone is the exclusive beneficiary. Thanks to the federal estate tax exemption, $5.43 million pass without taxes coming due. For the remaining $3.1 million, Simone is out of luck simply because she is not a citizen. The federal estate tax with a top rate of 40 percent kicks in.

Are there work-arounds for this scenario? With planning, yes. The obvious solution would have been for Simone to become a U.S. citizen in a timely manner, meaning before the due date for filing the federal estate tax return for Dylan’s estate. Had Simone, for whichever reason, resisted that idea, Dylan could have passed on at least a small part of the estate to Simone incrementally, by taking advantage of the annual gift tax exclusion. (The limit is set at $14,000 for the 2015 tax year. This amount does not count toward the lifetime gift tax exemption of $5.43 million mentioned above.)

Dylan and Simone could also have provided for the assets to go into a qualified domestic trust (QDOT.) While this tool, in itself, doesn’t allow for the estate tax to be avoided or even reduced it does defer its payment. With a QDOT, taxes on Dylan’s estate would not come due until Simone either takes money out of the trust or dies. Plus, there’s a nice twist to the QDOT route: Simone could still avoid the IRS by applying for U.S. citizenship. Even if she legally becomes an American long after Dylan’s death, naturalization will render the deferred tax bill null and void.

By Kevin J. Moore