Estate planning can be especially tricky if your spouse isn’t a U.S. citizen.
Strategy: Apply your ingenuity. For instance, you might use a special trust to shift income or some other technique.
Find the tax solution that best meets your needs.
Here’s the whole story: The two main gift and estate tax breaks for married couples are the unlimited marital deduction privilege and the unified estate and gift tax exemption.
As the name implies, no federal estate or gift tax is due on any transfer between spouses under the unlimited marital deduction. Currently the exemption can effectively shelter transfers of up to $5 million (indexed to $5.49 million in 2017) to nonspouse beneficiaries. The tax break is available for lifetime transfers or bequests, but lifetime gifts reduce the available estate tax shelter.
However, if your spouse is not a U.S. citizen, the unlimited marital deduction doesn’t apply. Instead, you must use the estate tax exemption to cover assets transferred at death.
To avoid dire results, you might establish a qualified domestic trust (QDOT) and name your spouse as beneficiary of the trust. As a result, your spouse can receive income free of estate tax. At least one trustee of the QDOT must be a U.S. citizen.
Caveat: Any principal withdrawn from a QDOT by your noncitizen spouse is taxed as if it were removed from your taxable estate. This can push your estate into a higher tax bracket. Also, there are certain limitations on investments made by QDOTs. Therefore, you may decide to shift more assets into the name of the noncitizen spouse, subject to the estate and gift tax exemption.
Another possibility is to have your spouse become a U.S. citizen if he or she is inclined to do so. The QDOT may be structured so that it ceases to be effective when your spouse formally obtains citizenship.
Tip: A noncitizen spouse can petition a court to set up a QDOT if predeceased by a citizen spouse.