Section 2056 of the Internal Revenue Code ("IRC") provides for what is commonly known as the "marital deduction:" it allows a spouse to pass his or her estate - the property and assets that he or she has at the time of his or her death - to the surviving spouse without the property being taxed at the first spouse's death. Rather, the tax is imposed when the other spouse dies.
There are several trusts that spouses can use to help lower estate taxes. One such trust is the marital deduction trust. Two other trusts that are commonly used by married persons are the:
- "Qualified domestic trust" ("QDOT"), and
- "Bypass Trust "
Both of these trusts have numerous requirements that must be met in order for them to be valid, and each has its own advantages and disadvantages. If you're considering one of these trusts, be certain to read the federal tax laws carefully, or seek the advice of an experienced tax attorney or estate planning attorney.
As mentioned above, the marital deduction works to defer estate taxes on a deceased spouse's estate until the surviving spouse dies. But, what if only one spouse is a U.S. citizen, and when he or she dies, the noncitizen ("non-citizen") spouse decides to take the money back to his or native county? The Internal Revenue Service could never collect the taxes.
For this reason, the marital deduction laws were changed: a marital deduction will not be allowed unless the assets passing to (or for the benefit of) the noncitizen spouse are placed in a QDOT. If the assets are not placed in a QDOT by the time the federal estate tax is to be paid for the deceased spouse's estate, then the entire amount will be subject to immediate tax .
To help the noncitizen spouse get the tax deferral if the deceased spouse didn't create a QDOT, the noncitizen spouse can create her own QDOT after the death of the spouse. The noncitizen spouse can also eliminate the entire problem by becoming a U.S. citizen prior to the filing of the federal estate tax return (including extensions) in the deceased spouse's estate.
If a QDOT trust is required, the QDOT election must be made by the executor - the person who is responsible for making sure that a decedent's will is carried out, or executed, in the way that the decedent intended it to be. In addition, there are a number of conditions and requirements, such as:
- The trust must be a trust for the noncitizen spouse's benefit, and it must provide that any distributions of principal (as opposed to income earned by the trust) will be subject to the trustee withholding the estate tax due on the distribution.
- One trustee must be U.S. citizen or U.S. corporation.
- If the QDOT assets exceed $2 million, then one of the trustees must be a U.S. bank, and if there is an individual trustee, he or she must post a bond or letter of credit to the IRS in the amount of 65 percent of the value of the trust assets to secure payment of the tax.
- If the trust assets are under $2 million, then no bond need be posted and a U.S. bank need not be a trustee, provided that no more than 35 percent of the trust assets consists of real estate located outside the U.S.
Every distribution of principal from QDOT to the surviving spouse during her lifetime or at her death will be subject to payment of estate tax, and this tax is computed as if the distributions were included and taxed in the first spouse's estate
The bypass trust, also called a "family" trust or a "credit-shelter" trust, is designed to provide benefits the trust beneficiaries, normally the surviving spouse or other family members, and to "bypass" or escape taxation in the beneficiary's estate. If you make such a trust, your estate will have to pay the taxes on the property transferred to the trust.
The bypassing of taxes in the beneficiary's estate is based on the idea that the beneficiary did not create the trust and that he or she has no extensive control over it and cannot withdraw the principal. Under these circumstances the assets in the trust will escape taxation in the estate of a beneficiary on the beneficiary's death.
In addition to bypassing taxes in the beneficiary's estate, the bypass trust has other benefits, such as:
- Creditors of the beneficiary can't attack the trust assets to pay for the beneficiaries debts, and
- The trust assets will not go into probate when the beneficiary dies, which not only saves a lot of money in probate expenses, but also ensures that the beneficiary has immediate access to the trust assets without having to wait for the probate court to clear it.
Questions for Your Attorney
- When should I make a QDOT for my noncitizen spouse?
- I understand that my wife and children can benefit from a bypass trust, but is there anyway I can make one and still lower my estate taxes?