When planning your estate – regardless of you and your spouse’s respective countries of citizenship – addressing the potential tax consequences under various scenarios needs to be a top priority. If you are a US resident and your total estate exceeds a certain value (currently $5.45 million), the Internal Revenue Service (IRS) can claim as much as 40 percent of the excess based solely upon the fact that you have passed away. There are a variety of other estate and gift tax considerations as well, and to preserve your wealth for your spouse, children, and other family members, you need to carefully plan ahead. This includes planning not only for the current value of your estate, but for any future increase in value as well.
Many of these taxes can be significantly mitigated – if not avoided entirely – with some basic estate planning. We have previously discussed the benefits of tools like the revocable living trust, and a comprehensive estate plan will use trusts, beneficiary designations, and other tools to prevent the IRS and other tax authorities from staking a claim to a significant portion of your financial legacy. While these tools are generally available to individuals across the board, there are special tax rules that require special attention when your spouse is a non-citizen of the United States.
Sorry, the Unlimited Marital Deduction Does Not Apply
Understanding the Unlimited Marital Deduction and Its Importance During Estate Planning
Under current US tax law, most married couples enjoy the benefit of what is known as the “unlimited marital deduction.” The unlimited marital deduction means that all assets that you leave to your spouse when you die – regardless of their total value – get to transfer tax-free. So, if you have assets that would be subject to taxation if transferred to your children, a charity, or another family member or third party, you can avoid the tax completely by transferring those assets to your spouse instead.
This is important for a number of reasons beyond the obvious issue of giving money to the government when you don’t have to. For example, consider this: What if your children don’t have enough liquidity to pay the tax when it comes due? Suppose you give your children a collection that is worth thousands, hundreds of thousands, or millions of dollars. Are they going to have the cash available to pay the tax due to the IRS? If not, what will they do? Sell your prized possessions?
While taxes certainly should not be your only consideration when planning your estate, they certainly should remain top of mind. This takes on additional importance when your spouse is a non-citizen.
Non-Citizen Spouses Are Not Eligible for the Unlimited Marital Deduction
Remember how we said “most” married couples are entitled to benefit from the unlimited marital deduction? This is because there is one major exception: If your spouse is a non-US citizen, the unlimited marital deduction does not apply when you die. If the value of your estate exceeds the federal estate tax threshold, spousal transfers that would be tax-exempt for other couples will not be tax-exempt for you.
A Lifetime Gift to Your Spouse? Sorry, We Tax That Too
One common method of avoiding estate taxes (and the burdens of probate) is to make gifts during your lifetime. The idea is simple: If you do not own an asset when you die, (i) you have nothing to probate, and (ii) the government has nothing to tax. Of course, giving your property away before you die means living without it. But, there are ways to address this issue; and, you may own property that you are easily willing to part with now instead of waiting to gift it when you pass away.
Oh, wait, you are married to a non-US citizen? Then, you need special rules. While most lifetime gifts between spouses are non-taxable, if you are married to a non-citizen, the IRS is going to tax your lifetime gifts to your spouse, too. If you give your spouse gifts exceeding $148,000 (adjusted annually for inflation) in any one year, the excess will be subject to federal gift taxation. Importantly, if you and your spouse jointly own real estate located in the United States, when your non-citizen spouse inherits your interest in the property upon your death, this will be considered a “gift” subject to tax on any value above the $148,000 threshold.
Ways to Avoid Estate and Gift Taxes When Married to a Non-US Citizen
With these special tax rules in mind, if you are married to a non-US citizen, what can you do to minimize your estate and gift tax liability?
1. Plan to Make Lifetime Gifts Over a Period of Years
One option is to start executing a plan to transfer your assets to your spouse during your lifetime. The $148,000 threshold for federal gift taxation applies on an annual basis. So, as long as you transfer less than $148,000 each year (or more if the IRS increases the threshold over time) and you haven’t waited too long to build your estate plan, you can transfer a significant portion of your assets to your non-citizen spouse via gifts on a tax-free basis.
Of course, one of the cons of this approach is that it can raise serious questions and concerns in the event that you or your spouse file for divorce. Once you give property to your spouse, can you seek to recover all or a portion of it through the divorce process? This is a legitimate consideration, and one that you may be able to address through the use of a prenuptial or postnuptial agreement.
2. Use a Qualified Domestic Trust (QDOT)
Another option is to use the estate planning tool known as a qualified domestic trust (QDOT). A QDOT is a form of irrevocable trust that is specifically intended to address the estate tax issues associated with marrying a non-US citizen. With a QDOT, you transfer your assets to the trust during your lifetime, and then your spouse (who is named as the beneficiary in the trust’s documentation) becomes entitled to the assets automatically upon your death.
However, the important caveat here is that QDOTs defer federal estate taxes – they do not prevent federal estate taxation entirely. So, when your non-citizen spouse passes away, his or her beneficiaries will most likely be left with the tax burden that was previously avoided.
3. Find Out if Your Spouse is Eligible for US Citizenship
A third option to consider is this: Is your spouse eligible to become a US citizen? There are strict eligibility requirements for US citizenship, and your spouse may or may not wish to become a US citizen; but, if citizenship is an option, among the numerous benefits is the ability to avoid the tax issues we’ve covered above.
Speak with an Experienced Attorney about Building Your Estate Plan
If you would like more information about planning your estate with a non-citizen spouse, we encourage you to contact us for an initial consultation. We would be happy to help you assess your options, and we can tailor an estate plan to your unique circumstances that minimizes your tax obligations while ensuring that your final wishes will be carried through. To get started with the estate planning process, call Jiah Kim & Associates at (646) 389-5065 or schedule a consultation online today.
This blog post is written for educational and general information purposes only, and does not constitute specific legal advice. You understand that there is no attorney-client relationship between you and the blog publisher. This blog should not be used as a substitute for competent legal advice from a licensed professional attorney in your state.