Gifting while alive
Gifts between married couples who are both US citizens qualify for the unlimited marital deduction, meaning each gift is not subject to federal gift taxes, as long as the gift is a current interest, which is a gift with no restrictions on the recipient's current use, possession, and enjoyment of the asset transferred. A gift to a noncitizen spouse does not qualify for the unlimited marital deduction, and may be subject to federal gift tax. However, a citizen spouse may gift up to $175,000 per year to a noncitizen spouse.
In addition, a citizen spouse can make lifetime gifts up to the applicable exemption amount ($12.92 million in 2023) to the noncitizen spouse. The applicable exemption amount refers to aggregate, cumulative gifts made over a lifetime and at death. To the extent that a gift to a noncitizen spouse in any given year exceeds the annual gift tax exclusion ($17,000 in 2022), it will diminish the citizen spouse’s lifetime applicable exemption amount. Keep in mind that special rules apply to the joint ownership of property.
Transferring at death
Just as there are special rules for gifting to a noncitizen spouse while alive, there are special rules for transferring assets to a noncitizen spouse at death. A qualified domestic trust (QDOT) can be useful in this scenario.
A QDOT enables transfers at death to noncitizen spouses to qualify for the unlimited marital deduction available to US citizen spouses. This is typically accomplished by establishing a living trust that allocates all or a portion of the deceased spouse's estate tax exemption ($12.92 million in 2023) to a credit shelter trust (CST), with the balance in a QDOT. The executor of the estate must make an irrevocable QDOT election on the estate tax return. This does not happen automatically.
During the surviving noncitizen spouse's lifetime, the trustee of the CST may pay income and principal to the surviving noncitizen spouse, as needed, for health, education, and living expenses. The surviving noncitizen spouse can also receive income from the QDOT. In most cases, the trust should provide that all income is distributable to the surviving noncitizen spouse.
However, distributions of principal from the QDOT generally would be subject to estate taxes at the time of distribution, and this tax is computed as if the distributions were included and taxed in the deceased spouse's estate. The same would hold true for any assets remaining at the surviving spouse's death. A QDOT requires that at least one of the trustees is a citizen of the United States. If the assets exceed $2 million, one of the following must be in place: (1) one of the trustees must be a US bank; (2) the trustee must post a bond to the Internal Revenue Service (IRS) in the amount of 65% of the value of the trust assets to secure payment of the tax; or (3) the trustee must furnish a letter of credit to the IRS in the amount of 65% of the value of the trust assets to secure payment of the tax.
In addition, if a noncitizen surviving spouse becomes a citizen before the deceased spouse's estate tax returns have been filed (generally 9 months after the date of death), they are entitled to all the benefits of a citizen.
A complex challenge
Estate planning for a noncitizen spouse can be significantly more complex than planning for a citizen spouse. Consult your attorney or tax advisor to ensure that your wishes will be carried out appropriately.