Qualified Domestic Trust (QDOT)

[Kathleen Reynolds]

#2998

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On November 10th, 1988, the Technical & Miscellaneous Revenue Act of 1988 (TAMRA) was put into effect. Before this, U.S. citizens and residents were allowed to transfer assets during their lifetime or upon death to a surviving spouse with no Estate or Gift tax implications. TAMRA prohibits non-citizen surviving spouse’s opportunity to return to their country of citizenship to avoid United States Federal Estate Taxation. TAMRA eliminated the Federal Marital Deduction when assets are inherited by non-citizen spouses, except in certain circumstances.

For a surviving spouse who has not obtained U.S. citizenship, the denial of the Marital Deduction can be severe. Section 2056A of the IRC allows transfers of assets to a Qualified Domestic Trust (QDOT). The QDOT is a way to preserve marital assets by utilizing the Marital Deduction. This technique requires the assets to be placed in a Trust. However, several requirements need to be considered.

The QDOT must be created before the Estate Tax filing of the deceased spouse. Some exceptions allow up to 15 months to file the Estate Tax return for the deceased spouse, but this is typically completed within 9 months of the date of death.

When the surviving spouse dies, the QDOT will be subject to Estate Taxes and the Net Trust assets will pass to the beneficiaries under the Trust Agreement, which is usually the children of the two spouses.

Income earned by the trust is subject to Federal (and State if applicable) Income Tax. Distributions can be made to the surviving spouse from “income earned”, but the spouse will be required to pay income taxes. Distributions made from trust principal, require §2056A estate taxes to be calculated and withheld by a Trustee. Exceptions to §2056A Estate Taxes are made for principal distributions concerning health, education or support of the surviving spouse or child.

Requirements of a QDOT:

• Administration governed by a U.S. state (including Washington D.C.).
• Qualifies as an Ordinary Trust via §301.7701-4(a).
• Qualifies as an Appointment Trust, QTIP Trust, Charitable Remainder Trust, or an Estate Trust.
• At least one Trustee has to be a U.S. citizen or a U.S. corporation.
• If QDOT is more tha $2,000,000, then at least one Trustee must be a U.S. bank.
• Trust Distributions (except for income) can only be made if the §2056A Estate Tax is withheld by a Trustee.
• In the event of a hardship, a §2056A may not be imposed on distributions from the principal.

There are few alternatives to this strategy. The best strategy is to to have the non-US citizen gain citizenship while both spouses are alive.

Entering Data

• Growth Rate of First Estate after First Death- Enter the growth rate to be used. This will appreciate the first to die’s estate value (net estate tax). The growth will occur from the death year of the first to die, till the death year of the second to die. This growth rate will not impact the separate estate value of the second to die. That value entered should be the value expected in the year of the second death.
• Inflation Rate for Exclusion- When an entered death year is beyond the last published exclusion value, this input will be used to determine the exclusion.
• Sunset in 2026?- Current law stipulates that estate tax calculations will sunset in 2026. This allows you to continue to use current rates beyond 2025.

First Death (US Citizen)-

• Taxable Estate- Enter the taxable estate as of the year of death, for the first to die. This value will appreciate by the growth rate (net estate taxes) till the second death.
• Year of Death- Enter the year of death for the first to die. The first to die is assumed to be the US citizen. By default, this input needs to be less than or equal to the second death year.
• Adjusted Taxable Gifts- Enter prior Adjusted Taxable Gifts made by the US citizen after 1976.
• Unified Credit Used- Enter Unified Credit used on the Adjusted Taxable Gifts. If no gift tax was paid, then use the maximum amount, by clicking on the computer icon.

Second Death (non-US Citizen)-

• Separate Estate at Death- Enter the taxable estate as of the year of death, for the second to die. This value will NOT appreciate by the growth rate, so the entered value should reflect the value as of the death year.
• Year of Death- Enter the year of death for the second to die. By default, this input needs to be greater than or equal to the first death year.
• Year of Death- Enter the year of death for the second to die. By default, this input needs to be greater than or equal to the first death year.
• US Resident- Select if the surviving spouse is a US resident. Nonresident noncitizens are treated differently, then residents.
• Unified Credit Used- Enter Unified Credit used on the Adjusted Taxable Gifts. If no gift tax was paid, then use the maximum amount, by clicking on the computer icon. If the surviving spouse is not a US resident, then this input will not appear.

Results

Summary Tab: This report shows 3 different scenarios: a) No QDOT created, b) QDOT created with all assets from First Estate and c) Bypass Trust created, with remaining assets placed into a QDOT. The summary report shows the different tax implications based on the scenario.

Graph: This tab shows the 3 different scenarios graphed based on total estate tax and totals going to beneficiaries.

Flowcharts: This tab allows you to see a snapshot of how the assets flow from one estate to the other, highlighting amounts going to a Bypass Trust and QDOT. You can view these in the PDF report that is created.

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