George is an American citizen and his wife, Sofia, is a citizen of Colombia. George and Sofia, who have two adult children and five grandchildren, need estate planning guidance. Are there any special considerations?
The short answer is “yes.” But the long view is that the couple may still be able to meet their main estate planning objectives.
When both spouses are U.S. citizens
When both spouses in a legal marriage are U.S. citizens, the family may benefit from various estate tax breaks that were enhanced by the Tax Cuts and Jobs Act (TCJA). This includes the:
Unlimited marital deduction. A transfer from one spouse to another — whether it’s during life or after a spouse’s death — is exempt from federal gift and estate tax. An unlimited amount of assets can be transferred.
Gift and estate tax exemption. The federal exemption covers amounts that are bequeathed to nonspouse beneficiaries such as your children. The generous estate tax exemption of $5 million was doubled to $10 million by the TCJA, subject to inflation indexing, for 2018 through 2025. The amount for 2019 is $11.4 million. Under the unified gift and estate tax exemption, a spouse may also benefit from a lifetime gift tax exemption of $11.4 million in 2019. However, using the lifetime gift tax exemption erodes the available estate tax exemption.
Annual gift tax exclusion. This exclusion shelters from tax any gifts made during your lifetime, without affecting your lifetime gift tax exemption. In 2019, you can give $15,000 per recipient without using any of your lifetime exemption. The exclusion is doubled to $30,000 per recipient if you and your spouse properly “split” the gift. Plus, certain gifts are further excluded. For instance, you may make unlimited payments for medical expenses, so long as they’re paid directly to the provider, and for tuition, so long as they’re paid directly to the institution.
When one spouse isn’t a U.S. citizen
Estate planning can become considerably more complicated when one or both spouses aren’t U.S. citizens. First, it’s important to ascertain the status of both spouses. The IRS defines a U.S. resident for federal gift and estate tax purposes as someone who’s domiciled in the United States at the time of death. One becomes domiciled in a place by living there, even briefly, with a present intention of making that place his or her permanent home.
Whether you’ve established domicile in the United States depends on several factors. The factors include time spent in the country vs. time spent abroad; the locations and relative values of your residences and business interests; visa status; community ties; and locations of family members.
If you’re a noncitizen who’s a resident of the United States, the IRS treats you similarly as it would a U.S. citizen. That means you’re entitled to the same federal gift and estate tax exemption and annual gift tax exclusion, including the tax benefit of gift-splitting. However, for a noncitizen who isn’t a U.S. resident (a nonresident alien), the estate tax exemption plummets from $11.4 million to a comparatively miniscule $60,000 for amounts going to anyone other than a U.S. citizen spouse.
Thus, having U.S. property holdings can result in a large estate tax bill when a nonresident alien dies and leaves property to anyone other than his or her surviving U.S. citizen spouse. For this purpose, taxable property includes real estate and tangible personal property (such as cars, boats and works of art) located in the United States.
Determining the location of intangible property — such as stocks, bonds and partnership interests — creates additional complications. For example, if a nonresident alien gives a family member stock in a U.S. corporation, the gift is exempt from U.S. gift tax. But a bequest of that same stock at death is subject to estate tax. Conversely, a gift of cash on deposit in a U.S. bank is subject to gift tax, while a bequest of the same cash would be exempt from estate tax.
Transfers to a noncitizen spouse
Let’s return to the example of George, the U.S. citizen and his noncitizen spouse Sofia. Notably, the unlimited marital deduction doesn’t apply to transfers to a noncitizen spouse, regardless of whether the noncitizen spouse is a U.S. resident. Instead, George must use his estate tax exemption to cover assets transferred at death, up to $11.4 million. Furthermore, the lifetime gift tax exemption for gifts to a noncitizen spouse is limited to just $155,000 in 2019.
But all isn’t lost. One solution is for George to establish a qualified domestic trust (QDOT) and name his wife as beneficiary (see “QDOTs 101”). Another possibility is for Sofia to become a U.S. citizen if she’s willing to do so. In fact, tax laws provide that, subject to certain requirements, a QDOT will no longer be effective when your spouse formally obtains citizenship.
Turn to your advisor
If you or your spouse is a noncitizen, consult your estate planning advisor to evaluate the potential impact on your estate plan and to discuss strategies for avoiding unintended tax consequences.
Sidebar: QDOTs 101
A U.S. citizen may establish a qualified domestic trust (QDOT) and name his or her spouse as the beneficiary. As a result, the spouse receives assets estate-tax-free. However, QDOTs must meet certain requirements designed to ensure that the assets stay in the United States and ultimately are subject to estate taxes.
For example, if you leave an inheritance to a citizen spouse, he or she can avoid estate taxes by spending the money or giving it away (using his or her own exemption or annual exclusion). But when a noncitizen spouse withdraws principal from a QDOT, the general rule is that it’s immediately subject to estate taxes as part of your estate. There are, however, exceptions that may exempt the withdrawal from the estate tax.