If you’ve been reading our articles for some time, you’re aware that there is an unlimited marital deduction, meaning that there are no U.S. estate taxes charged at the death of the first spouse. For this reason, many believe that there is no need for advanced estate planning unless clients have larger estates. However, the unlimited marital deduction only applies to U.S. Citizens, meaning that if one or both spouses are foreign nationals, the unlimited marital deduction does not apply, and special planning is required.
For U.S. Citizens or Resident Aliens in 2015, the lifetime gift and estate exemption is $5.43 million, and all worldwide assets are included for the valuation of your estate. For Non-Resident Aliens, there is no lifetime gift exemption. In addition the lifetime estate tax exemption is approximately $60,000, and all U.S. held assets are subject to estate taxes, with the exemption of death benefits of a U.S. life insurance policy, U.S. Bank deposits, and U.S. government bonds and treasury notes.
For example, if two U.S. Citizens are married, there is no tax due upon the first death, due to the unlimited spousal deduction. Upon the death of the second spouse, there are no federal estate taxes due, as long as the estate is valued below $10.83 million combined exemption ($5.43 million x2).
If a U.S. Citizen is married to a foreign national, and the U.S. citizen passes away first, they can transfer up to $5.43 million federal estate-tax free, as the non-citizen spouse is not eligible for the unlimited marital deduction. However, if the non-citizen passes away first, the citizen surviving spouse is eligible for the unlimited marital deduction.
In many cases, a Qualified Domestic Trust (QDOT) is used to provide a deferral of estate taxes for the life of the surviving spouse, but the assets inside of the QDOT will be subject to estate taxes when distributed to meet any hardship needs of the surviving spouse. Moreover, when the surviving spouse passes away, the assets and appreciation in the QDOT will be subject to estate taxes. Generally, a QDOT is a fairly complicated trust, requiring a U.S. Trustee, with a fairly limited benefit.
While there is no marital deduction for gifting assets to a non-citizen spouse, you may make annual gifts up to $147,000, indexed for inflation, to your spouse. This is typically best taken advantage of by setting up an irrevocable life insurance trust, and purchasing a life insurance policy, which would cover any future U.S. Estate Taxes. This is typically seen as a more efficient estate planning option than a QDOT, as the life insurance death benefit is not subject to income or estate taxes, and can be used to pay any estate tax liability, instead of deferring it. Proper estate planning for non-citizens is a complicated, but critical process. With proper planning in place, you can avoid a huge estate tax liability, and ensure that your assets pass on to your heirs as you intend them to.