Published in the Estate Planning and Administration Section of the Oregon State Bar, April, 2018
Entire books could be written on estate tax planning for non-citizens. Here is a short analysis of some of the most relevant issues involved with an estate plan for a noncitizen when married to a U.S. citizen. The examples in this analysis involve a husband who is an Oregon resident and a U.S. citizen with a taxable estate for federal tax purposes, and whose wife is a non-citizen.
Issues Regarding a Green Card Holder Serving as Trustee of a Revocable Trust
If a non-citizen serves as trustee, the Internal Revenue Service (“IRS”) may deem the trust a foreign trust. When a trust becomes a foreign trust, each asset in the trust is subject to a capital gains tax on the excess of the fair market value of the asset over its adjusted cost basis. The IRS will also impose a special tax on any accumulated undistributed net income. A trust is considered domestic if (i) a U.S. court can exercise primary supervision over trust administration (the “court test”), and (ii) U.S. persons control all substantial trust decisions (the “control test”). 26 CFR § 301.7701-7(a)(1). The term “U.S. person” means any U.S. citizen or alien admitted for permanent residence in the United States. IRC § 6010. As long as the non-citizen spouse maintains her green card status and continues to live in the United States, there are no issues with her serving as trustee or co-trustee of a typical revocable trust. However, if she moves back to her home country and continues to serve as trustee, the trust will become a foreign trust, resulting in very unfavorable tax consequences.
Practice Tip – If the non-citizen spouse is named as trustee or co-trustee of a revocable trust, the trustee resignation provisions should be drafted so that she will be deemed to have immediately resigned as trustee if she ceases to be a U.S. resident taxpayer (or U.S. person). General Background Regarding Death Taxes Oregon residents are potentially subject to both the federal estate tax and the Oregon estate transfer tax. Under current law, the federal estate tax comes into play if a decedent passes away with more than approximately $11.18 million in assets (adjusted for inflation). The Oregon estate transfer tax comes into play when a decedent passes away with over $1 million in assets. Estate Planning and Administration Section April 2018 Page 9 Gifts Involving a Non-Citizen Spouse Gifts to U.S. citizen spouses qualify for the unlimited marital deduction and gifts of less than $15,000 per year to other beneficiaries can qualify for the gift tax annual exclusion. However, gifts to a non-citizen spouse do not qualify for the unlimited marital deduction but may qualify for a $152,000 annual exclusion. This allows a U.S. citizen spouse to make a gift of up to $152,000 annually (adjusted for inflation) to a non-citizen spouse without utilizing his unified credit or needing to file a gift tax return. When a U.S. citizen spouse’s wealth is disproportionately large compared to the wealth of the non-citizen spouse, one option is for the U.S. citizen to gift a substantial amount of assets to the non-citizen spouse. The goal is to drop the taxable estate of the U.S. citizen spouse below $11.18 million. However, the estate would likely still be taxable for Oregon purposes. In other words, even if the wealth is equalized between the spouses and there’s no federal estate tax exposure, the estate will likely still be subject to Oregon estate transfer taxes if the couple remains in Oregon. In addition, if the couple ceases to reside in Oregon but continues to own real estate or tangible personal property in Oregon, the estate will still be subject to Oregon estate transfer taxes.
Practice Tip – If a U.S. citizen spouse adds his noncitizen spouse’s name to a deed and the amount gifted to his spouse exceeds $152,000, the U.S. citizen must file a gift tax return to report the transfer. The unified credit may be available to cover any taxes resulting from this transfer.
Federal Issues Regarding the Marital Deduction
Married couples who are both U.S. citizens have an unlimited marital deduction available upon the death of the first spouse. IRC § 2056(a). This unlimited marital deduction is not available if the surviving spouse is a non-citizen. The U.S. government is concerned that the property transferred to the non-citizen spouse will escape the deferred federal estate tax because of the possibility that the property may be removed from the jurisdiction of the U.S. estate tax before the death of the non-citizen surviving spouse. An exception to the marital deduction limitation is available if the property passes to the surviving non-citizen spouse in a qualified domestic trust (“QDOT”). IRC § 2056A. There are three requirements for a QDOT: (1) At all times, at least one trustee must be either an individual U.S. citizen or a domestic corporation (the “domestic trustee”); (2) No distribution (other than income) may be made unless the domestic trustee may withhold taxes and the QDOT must meet the requirements of regulations prescribed by the IRS to ensure the collection of any such taxes (the tax rate is the same as the federal estate tax); and (3) The trustee must file an appropriate election for the trust to be treated as a QDOT. Id.
Practice Tip – If a non-citizen is named as a trustee on a revocable trust and it’s expected that a QDOT will be created upon her spouse’s death, the trust provisions should require that at least one trustee of the QDOT must be an individual U.S. citizen or a domestic corporation and that no distribution may be made from the trust unless the domestic trustee has the right to withhold from such distribution the taxes imposed on the distribution.
Oregon Issues Regarding Marital Deductions
In Oregon, $1 million can pass free of the estate transfer tax. At the death of the first spouse, the surviving noncitizen spouse would likely take an Oregon Special Marital Property (“OSMP”) election on the amount in excess of $1 million. There is no requirement that the surviving spouse be a U.S. citizen to make an OSMP election. This has the same effect of deferring estate transfer taxes until the surviving spouse passes away. ORS 118.013 allows property transferred outright to a spouse to qualify for the OSMP election. If a couple’s assets are all jointly owned or will pass via transfer-on-death or beneficiary designations, then an OSMP election may be taken on these assets. As a reminder, if all of the assets pass to the surviving spouse and an OSMP election is taken on all the assets, the estate of the surviving spouse will have to pay taxes on any amount in excess of $1 million. Ideally, joint assets should be transferred to a trust so that the surviving spouse can disclaim $1 million to avoid estate transfer taxes on these assets at the surviving spouse’s death. Alternatively, the trust can be set up as an A-B split so that half of the joint assets are placed into an irrevocable trust and not included in the surviving spouse’s taxable estate.
Issues Regarding Assets Located Outside of the United States
We can only give legal advice pertaining to assets located in states in which we are licensed to practice. Clients should be advised to obtain legal counsel in the jurisdiction in which the non-citizen spouse has assets in and other countries in which that spouse is a citizen. Conclusion When one spouse is a non-citizen, there can be a lot of unfavorable tax consequences if the U.S. citizen spouse passes away first. However, with careful estate tax planning, there are measures the married couple can take to effectuate beneficial tax planning.