Estate Tax and Non-citizen Surviving Spouses

     In the age of growing globalization, advisors increasingly must be aware of the potential that one or both of married clients may not be a United States citizen. With estate planning, citizenship particularly is important when dealing with the marital deduction against Federal  Estate Tax. While normally all assets transferred to a surviving spouse are exempt from Federal estate taxation, this deduction is disallowed if the surviving spouse is not a United States citizen.

     However, assets transferred to a Qualified Domestic Trust (QDT) allow the noncitizen spouse to make use of the marital deduction. A QDT functions much like any other trust for a spouse in the decedent's living trust. However, a QDT must have at least one trustee who is a citizen of the United States and provide that no distribution (other than the distribution of income) may be made from the QDT unless a trustee who is a citizen of the United States has the right to withhold from such distribution the tax imposed. The typical result when using a QDT is for the surviving spouse to receive all of the income from the trust automatically with the principal of the trust being distributed after the death of the surviving spouse. If the trust provisions for the spouse do not qualify as a QDT prior to the death of the taxpayer, the statute allows the trust to be reformed by a judicial proceeding as long as that judicial proceeding is commenced before the tax return is filed. Thus, through a court ruling, the trust is judicially modified so that it qualifies as a QDT.

     If the noncitizen spouse prefers not to have the trust assets restricted by the terms of the QDT, the statute also allows the noncitizen spouse, to become a citizen and therefore be qualified for the marital deduction.  The noncitizen surviving spouse must be a continuous resident of the United States following the death of the citizen spouse. The spouse must also become a citizen before the day the Federal Estate Tax Return is due. However, it is important to note that when an estate tax return is filed late in order for the surviving spouse to complete citizenship proceedings, the late return is treated as if it was filed on the actual filing date and the noncitizen spouse does not receive the protection of the marital deduction. If the noncitizen spouse seeks the protection of the statute, the Estate  must file for extensions until the  completion of the citizenship proceeding.

     Even if the Estate files for and receives an extension allowing time for the completion of citizenship proceedings, it is important to file quickly after the completion of those proceedings. The Court of Federal Claims has recently upheld the IRS's imposition of a penalty on an estate when the estate delayed nine months between the surviving spouse achieving citizenship and the filing of the final Estate Tax Return.

    While it is always wise to determine if either of the parties are non-citizens when discussing estate planning and drafting documents, the Internal Revenue Code still allows for solutions in the event appropriate planning is not completed before death. It is important for clients to consult with an expert on the subject of taxation to avoid unintended consequences.