What is a QDOT?

QDOTs

A QDOT (Qualified Domestic Trust) is a trust for the benefit of a surviving non-citizen spouse that defers the federal estate tax following the death of the first spouse. A Qualified Domestic Trust defers the federal estate tax because it qualifies for the unlimited marital deduction. A QDOT usually defers the federal estate tax until the death of the surviving spouse. However principal distributions can also trigger the tax. QDOTs are specifically permitted pursuant to Internal Revenue Code §2056A.

Why Does the Tax Law Treat Non-Citizen Spouses Differently?

Most people just assume that they can give or leave a spouse money without any tax consequences. This is because it public policy to try and treat a husband and wife as one unit for tax purposes. When it comes to an estate tax, the government generally feels it can wait until the death of the surviving spouse to collect any taxes that may be owed. The IRS codifies this right in I.R.C. §2056 by granting an unlimited estate tax deduction to a surviving spouse. There is also a corresponding unlimited gift tax deduction for gifts to a citizen spouse in I.R.C. §2523.

However, the rules are different if you are married to a person who is not a citizen. The government is afraid that a surviving non-citizen spouse may return to his or her home country after one spouse dies. If that happens, it will be difficult for the IRS to actually collect the estate tax.

In order to reconcile these two competing interests, the concept of a QDOT was created.

Requirements of a QDOT

In order for a trust to qualify as a QDOT, it must meet the following requirements:

  1. A QDOT must qualify for the marital deduction as provided for in Internal Revenue Code §2056.
    • The most common way to achieve this goal is for the Trust to pay all the net income to the surviving spouse annually. (Another option is to grant the surviving spouse a general power of appointment over trust property.)
    • The surviving spouse can be the only lifetime beneficiary of a QDOT.
  2. At least one trustee of the QDOT must be a citizen of the United States.
  3. A Bank with a US branch may be required to serve as trustee depending upon the size and types of assets involved.
    • A “large QDOT” is a QDOT with assets in excess of $2,000,000. A large QDOT requires:
      • At least one of the trustees must be a U.S. bank or a trust company; or
      • The U.S. trustee (an individual trustee) must furnish a bond or letter of credit equal to 65 percent of the fair market value of the assets in the trust.
    • A “small QDOT” is a QDOT with assets of $2,000,000 or less. A small QDOT requires:
      • No more than 35 percent of the trust assets can be real property located outside the United States; or
      • The requirements for a “Large QDOT” be met.
    • Note: Up to $600,000 of the principal value of a US based primary residence (and furnishings) may be excluded from the calculations for purposes of determining whether a trust should be treated as a “Large QDOT”.
  4. The trustee must have the right to withhold the estate tax and pay it to the IRS.
  5. The laws of a US state or the District of Columbia must govern the trust.
  6. The executor of the deceased spouse’s estate must elect to have the trust treated as a QDOT on a timely filed federal estate tax return.

Planning Considerations

Estate planning for clients who are married to a non-citizen spouse can be very complex. A surviving non-citizen spouse is not entitled to an unlimited gift tax deduction or an unlimited marital deduction. Portability is typically wasted. Moreover, simply re-titling U.S. assets from the name of one spouse to the name of both spouses can trigger horrible tax problems.

When should a QDOT be Created

If you have significant assets, we recommend creating a QDOT as part of an overall estate plan that includes life insurance trusts and credit shelter trusts. However, technically, a QDOT does not need to be created in the decedent’s Will (or in a revocable living trust). The surviving non-citizen spouse may create the QDOT provided it is funded prior to the due date for the federal estate tax return (including extensions).

Be careful not to fund a QDOT unnecessarily

If you fund a QDOT before using up a decedent’s estate tax exemption, you will lose the remaining exemption of the first spouse to die. Accordingly, it is best to consider the following strategies:

  1. If the two spouses do not have significant funds, then most likely no estate taxes will ever be due. In this scenario, it may not be wise to set up any QDOT structure. Currently, the federal estate tax exemption is $11.7 million. However, there are rumors of it dropping down. Therefore, for right now, many would suggest that if a couple has less than $2M of assets and it is unlikely to grow much beyond that, there is probably no need to do a QDOT.
  2. If the two spouses have significant assets, it will be imperative to utilize the tax exemptions of both spouses as much as possible. This may entail creating life insurance trusts, credit shelter trusts, disclaimer trusts, and/or a QDOT.
  3. If the two spouses have a moderate asset level, but above $2M, I would suggest putting failsafes in place that allow for the creation of credit shelter trusts and a QDOT if needed.
  4. It is generally not advisable to fund a QDOT until credit sheltered trusts are fully funded.

Be mindful that distributions from a QDOT can cause an Estate Tax

When principal distributions are made from a QDOT (either to a surviving spouse or to the remainder beneficiaries upon the death of the surviving spouse) it triggers an estate tax. A QDOT does not eliminate the estate tax on the death of the first spouse, it merely defers it. Accordingly, it would be wise to ensure that a surviving non-citizen spouse uses the QDOT to own a primary residence, for income, and for emergency funds. The surviving spouse should not plan to tap into the principal as a regular source of funds.

Lifetime Gifting

Normally, a spouse can give the other spouse an unlimited amount of money if they are citizens. In addition to an unlimited marital deduction for estate tax purposes, citizen spouses are also entitled to an unlimited marital deduction for gift to tax purposes. (See I.R.C. §2523(a))

The IRS limits tax free gifts to a non-citizen spouse to $100,000, indexed for inflation. See I.R.C. §2523(i). For 2021, the limit is $159,000. Note that this is higher than the $15,000 annual gift exclusion that you can gift to anyone under I.R.C. §2503(b).

To avoid the difficulties associated with QDOTs, it would be wise to ensure that both spouses have adequate assets in their own name. This may difficult to accomplish since the potential tax on a large gift to a non-citizen spouse disincentivizes pre-funding too many assets into the name of the non-citizen spouse. However, with patience and time, you can transfer significant funds into the name of a non-citizen spouse by using the annual I.R.C. §2523(i) exclusion amount. We also recommend leveraging life insurance and other planning tools such as ILITs.

Dealing with Retirement Assets (IRA/401k/ROTH) and Joint Property

A QDOT Rollover IRA should be considered for the decedent’s IRA and 401(k) assets to avoid an immediate income tax and estate tax. Treas. Reg. §20.2056A-4(c) provides for alternatives on handling non-assignable annuities and other such assets.

For joint property owned by the decedent and the non-citizen spouse, the surviving spouse may wish to consider using qualified disclaimers or funding part of a QDOT with 50% of the joint asset.

What if the Surviving Spouse Becomes a Citizen

It is imperative to learn of the client’s citizenship and status to accurately plan and determine if any treaties apply.

  1. If the surviving non-citizen spouse becomes a citizen prior to the filing of the estate tax return, there will be no need for a QDOT.
  2. If the surviving spouse becomes a citizen after the assets are transferred to the QDOT, distribution of property from the QDOT will not be taxed if:
    • the surviving spouse either was a U.S. resident from the date of death of the decedent or no taxable distributions were made from the QDOT prior to the surviving spouse becoming a citizen; and
    • the United States trustee notifies the IRS that the surviving spouse has become a U.S. citizen.
    • Note: Special rules apply if the QDOT had already made taxable distributions. See Treas. Reg. § 20.2056A-10

As a practical matter, we strongly encourage surviving non-citizen spouses to consider becoming a US citizen to minimize the tax and administrative complexities.

Tax Consequences

  1. The assets transferred into the QDOT are eligible for the unlimited marital deduction.
  2. The QDOT is generally taxed as a simple trust for income tax purposes. This means that when the trust earns income, it MUST be distributed to the surviving spouse. The surviving spouse is then required to pay the income tax on that income based upon the surviving spouses own tax rates.
  3. Each distribution of PRINCIPAL from the QDOT triggers the federal estate tax. (This may be waived if the surviving non-citizen spouse can prove a hardship.)
  4. Income distributions from a QDOT are not subject to the estate tax.
  5. The Trustee must file Form 706-QDT annually. Form 706-QDT reports the amount in the trust as well as the distributions made from the trust.
  6. A non-citizen spouse cannot use the applicable exclusion amount to shelter any distributions of principal from a QDOT. Assets in a QDOT assets are never considered part of the non-citizen spouse’s gross estate. They are part of the deceased spouse’s estate for estate tax purposes.

Portability

In 2012, President Obama signed a law allowing a surviving spouse to port the unused estate tax exemption of a deceased spouse. The unused estate tax exemption is officially known as DSUE (Deceased Spouse’s Unused Exemption). While a surviving non-citizen spouse is entitled to port the DSUE of their deceased spouse, complex recapture rules potentially make this an effectively useless benefit. (See Treasury Regulation 2.2010-2(c)(4) and Example 3 under (c)(5).)

Same Sex Spouse Issues

Since 2013, the IRS has treated same sex spouses the same as heterosexual spouses. If the marriage is legally recognized in the US, there should not be a difference when it comes to this topic. However, those who have entered into a registered domestic partnership, civil union, or other similar formal relationship recognized under state law that is not denominated as a marriage will NOT qualify to set up a QDOT.

23 thoughts on “What is a QDOT?

  1. I was of the understanding that a QDOT was only necessary for estates over $2M and that a U.S. citizen could transfer up to $2M (current estate tax exemption) to his/her non-citizen spouse tax free. Is that not correct? Thank you.

  2. You are correct Expat One. I think you ask the question because I discuss small and large QDOTs. It comes into play as follows:

    1) If a decedent has $3,500,000, the first $2,000,000 can go to the non-citizen spouse tax free. The remaining $1,500,000 may be placed in a small QDOT.
    2) If a decedent has $5,000,000, the first $2,000,000 can go to the non-citizen spouse tax free, but the remaining $3,000,000 must go in a large QDOT.

    Hope this helps.

  3. My nonresident alien spouse and I jointly own a house and other assets like joint bank accounts. I was the $ source of some assets. Your wrote “Joint property owned by the decedent and the non-citizen spouse will follow the rules established under I.R.C. §2040(a)” saying my estate will include these items. Can I give $100,000 worth of assets each year to my spouse? For a $300,000+ house, how can I do this?

  4. Need2know:

    Did you mean nonresident alien spouse or resident alien spouse? If he/she is not living in America, then he/she is a nonresident alien. Immigration permission is irrelevant to the IRS.

    For calendar year 2008, you may gift up to $128,000 to a non-citizen spouse. Again, it is irrelevant if the spouse is a resident or non-resident alien. For threshold limits, see: http://www.irs.gov/pub/irs-drop/rp-07-66.pdf

    For a house, the easiest way to accomplish this is to redo the deed putting your spouse on the deed and then file a Form 709 federal gift tax return. The Form says that you do not have to file if you give less than the annual exclusion amount, but you should still file it if you want to prove the gift was made.

    If you stay under the annual exclusion amount, there will be no federal tax consequences. Unless you are in a state that taxes gifts, there will be no cost for the transaction other than hiring someone to do the deed or return for you.

  5. Your January 6 example is very interesting.

    Where is the legal support for this?

  6. What about life insurance and Life Insurance Trusts? Should life insurance still be placed in a LIT, and then a QDOT be established w/in 12 months of the US citizen spouse’s passing, or should life insurance be placed directly in a QDOT, which would require a QDOT being established and maintained for the US citizen spouse’s lifetime?
    Thanx!

  7. Dear Walsh,

    Sorry for the slow feedback – it got lost in the Thanksgiving shuffle.

    The ILIT and QDOT are two totally separate and distinct animals. If a person has a taxable estate that includes life insurance, an ILIT is the first thing to do. After that, if the estate still is taxable, then a separate QDOT can be created for the amount over the federal estate tax.

    I don’t think I need to say this – but if a spouse has already died, it is too late to do an ILIT…

    If you are telling me that a US spouse died within 3 years of a policy being transferred into a ILIT, making it includible in the decedent’s taxable estate, then the amount of the QDOT would certainly go up as a result.

  8. According to the fed gift tax form #709, I do not need to file it for my planned gift of $100,000; but you recommend filing the form anyway to prove gift was made? If I give gift in January 2009 before filing 2008 tax forms, can I claim the gift for tax year 2008? Thank you.

  9. Would my non-citizen spouse have to pay any taxes (including income tax) if she inherited about $2Million from my IRA?

  10. Anonymous said…

    Would my non-citizen spouse have to pay any taxes (including income tax) if she inherited about $2Million from my IRA?
    —————–

    Dear Anonymous,

    I get to answer this with a lawyer’s favorite answer… it depends:

    1) It depends on whether the IRA is rolled over into your spouse’s name or withdrawn (income tax);
    2) It depends when the spouse dies or died (the estate tax is constantly changing – the exemption amount just went up to $3.5 million from $2 Million);
    3) It depends what state you are in (there may be state estate taxes).

  11. I'm a U.S. citizen with a non-resident alien spouse. She is "beneficiary upon death" of my Roth IRA. If I die first, is she subject to federal estate tax on the Roth, or to federal income tax on qualifying Roth distributions?

    Thanks

  12. Dear TaxedToDeath,

    I assume that you live in a country other than the United States, otherwise you would have a Resident alien spouse rather than a non-resident alien spouse.

    If you do not live in the US, the answer is really quite tricky because it depends upon where you live and whether there is an estate tax treaty with the country in which you reside.

    If you live in the US, then yes, the US can tax the ROTH as part of your estate (assuming the federal estate tax comes back into existence).

    The good new is that since you have already paid income tax on the ROTH, there would not be an additional federal income tax on the withdrawals, regardless of who withdraws from it.

  13. In New York and New Jersey- With respect to a QDOT, is it possible to pay the Trustee Commissions out of the trust's principal rather than property distributed to the spouse to avoid the additional tax?

  14. Dear Anonymous,

    Trustee commissions are charged on both income and principal and they must be allocated accordingly.

    So yes, it would be a deduction, but whoever receives the commission would have to report it as income.

  15. I would like to include a provision in the QDOT whereby a small portion of the net income can be distributed to our children, the rest to my non-resident alien spouse. Will that affect anything?

  16. Dear Anonymous,

    You can NOT name the children as an income beneficiary of a QDOT because then it will not be entitled to the marital deduction. Remember, the way an estate plan works is that a person's estate is divided into two portions, the bypass portion (currently $5,000,000) and then anything in excess of the bypass portion, known as the marital share. For citizens spouses, this can simply be put into a marital trust. For non-citizen spouses, you must set up the QDOT. Since it is for the benefit of spouses only, naming a child as a partial beneficiary will ruin the tax benefits. The children can have all or a part of the first $5,000,000.

  17. I am a US Citizen but was born in Puerto Rico. This is also true for my spouse. I believe that although I am a US Citizen while alive, that the moment I pass away I'm considered a Foreign National by the United States and am therefore subject to estate tax on every asset I own in the US. I have considered using a QDOT to pass assets to my spouse in order to get the marital deduction.

    1) Would the QDOT have to be funded prior to my death?

    2) Is there a certain amount of estate exempted from estate tax for a foreign national?

    3) Would the transfer of assets through a QDOT to my spouse circumvent Puerto Rico Civil Code requirements to distribute 50% of my estate at death?

    Thanks!!

  18. Dear PRTaxFrustration,

    I'm sorry, but unfortunately I am not licensed in Puerto Rico and I have very little knowledge of the laws with respect to it. I strongly recommend that you find a local attorney with an advanced tax degree. Good luck.

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