Entire books could be written on estate tax planning for non-citizens. Here is a short analysis of the relevant issues involved with an estate plan for a non-citizen when married to a US citizen. The examples in this analysis involve a husband who is an Oregon resident a US citizen with a taxable estate for federal tax purposes 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, there is exposure that the 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 US court can exercise primary supervision over trust administration (the “court test”), and (ii) US persons control all substantial trust decisions (the “control test”). 26 CFR 301.7701-7(a)(1). The term “US person” means any US 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 as co-trustee on a standard 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 non-citizen spouse is named as a trustee on a revocable trust, the trustee resignation provisions should be drafted so that if the non-citizen spouse ceases to be a US resident taxpayer (or US person), she will be deemed to have resigned effective immediately upon the date that she ceases to be a US resident taxpayer.
General Background Regarding Death Taxes
Oregon residents are potentially subject to both the federal estate tax and the Oregon estate transfer tax. The federal estate tax comes into play when a decedent passes away with more than $5,490,000 in assets. The Oregon estate transfer tax comes into play when a decedent passes away with $1,000,000 or more in assets.
Gifts Involving a Non-Citizen Spouse
The first $14,000 given to a donee is excluded from a donor’s taxable gifts for each calendar year. Regarding gifts made to a non-citizen spouse, the first $149,000 is excluded. In other words, a US citizen spouse can make a gift of up to $149,000 annually (adjusted for inflation) to a non-citizen spouse without utilizing his unified credit or needing to file a gift tax return.
When a US citizen spouse’s wealth is disproportionately large compared to the wealth of the non-citizen spouse, one option is for the US citizen to gift a substantial amount of assets to the non-citizen spouse. The goal is to drop the taxable estate of the US citizen spouse beneath $5,490,000. 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 US citizen spouse adds his non-citizen spouse’s name to a deed and the amount gifted to his spouse exceeds $149,000, the US 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 Deductions
Married couples who are both US 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 US government is concerned that the property transferred upon the US citizen spouse’s death will escape the deferred federal estate tax because of the unlimited marital deduction and the possibility that the property may be removed from US estate tax jurisdiction 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:
- At all times, at least one trustee must be either an individual US citizen or a domestic corporation (the “domestic trustee”);
- 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
- The trustee must file an appropriate election for the trust to be treated as a QDOT. IRC 2056A.
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 shall require that at least one trustee of the QDOT must be an individual US 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, $1,000,000 can pass free of the estate transfer tax. At the death of the first spouse, the surviving non-citizen spouse would likely take an Oregon Special Marital Property (OSMP) election on the amount in excess of $1,000,000. There is no requirement that the surviving spouse be a US citizen to make an OSMP election. This has the same effect of deferring estate transfer taxes until the surviving spouse passes away.
Issues Regarding Assets Located in 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.
When one spouse is a non-citizen, there can be a lot of unfavorable tax consequences if the US citizen spouse passes away first. However, with careful estate tax planning, there are other measures the married couple can take to effectuate beneficial tax planning.