Transfer Tax Consequence for Non-Citizen (or Non-Resident Alien) Spouse
I. Inter-Spousal Succession at Death
1. Unified Credit and Portability.
In 2019, US citizen and US domiciliary are allowed to take a basic exclusion amount of $11,400,000 for their estate tax purpose. Since 2010, unused estate tax basic exclusion amount of a deceased spouse has been allowed to be transferred to the surviving spouse’s exclusion amount upon certain conditions (Portability Rule). Thus, the surviving spouse, when s/he died, may use the unused exclusion amount of the first deceased spouse.
However, the estate tax code does not allow the unified credit for Non-Resident Alien and instead provides a special credit against the Estate tax only by $13,000 (meaning $60,000 of exemption amount, in December 2018) Id.§2102(b)(1) for Non-Resident Alien. Accordingly, if Non-Resident Alien spouse died first, survived by US citizen spouse, there is no portability available since there is no deceased spouse’s unused exemption amount. The code only allows above $13,000 credit and this is not a “basic exclusion amount”. Furthermore, if US citizen spouse died first, survived by Non-Resident Alien, there is still no portability allowed since Non-Resident Alien is not entitled to any exclusion amount to be added. Non-Resident Alien spouse is permitted only to use above $13,000 credit when he or she died.
2. Marital Deduction.
In general, unlimited marital deduction is allowed for the property passing from the decedent to the surviving spouse. 26 U.S.C.§2056(a). Thus, by taking advantage of the marital deduction, the married couples can defer estate tax until the death of the surviving spouse.
However, according to §2056(d)(1)(A), the unlimited marital deduction is not available where the surviving spouse is not a US citizen unless there is a QDOT established explained below. It does not matter whether the surviving spouse is a US resident (e.g., having Green Card).
The assets will be 100% included in the US spouse’s estate upon his or her death even if the decedent and surviving spouse retained joint ownership with the right of survivorship. Id. §2056(d)(1)(B), §2040(b). In contrast, if the married couples have the property as a community property, then only a half of the property will be included in the US spouse’s estate.
Note that the unlimited marital deduction is still available for the decedent having a US citizen surviving spouse.
There are some special rules to be mentioned here.
26 U.S.C.§2056(d)(3) gives a credit to the estate tax, when the surviving spouse died, by the amount of estate tax paid by the first decedent spouse if: the property passes to the surviving spouse of the first decedent spouse; the marital deduction would have applied if the surviving spouse was a US citizen; and the surviving spouse died and the estate of the surviving spouse is subject to the US estate tax. The credit follows the rules under §2013, meaning if the value of the assets appreciates during the surviving spouse’s holding period, there will still be a tax to pay on the appreciation.
Under §2056(d)(4), the surviving spouse will be deemed a US citizen at date of the first decedent’s death if a) the surviving spouse becomes a citizen before the estate tax return is filed, and b) such spouse was a resident of the U.S. at all times between the date of death and the date of becoming a US citizen.
3. QDOT
Notwithstanding the above, married couples with non-US citizen spouse may take the marital deduction by using a Qualified Domestic Trust (QDOT, Id.§2056A). The QDOT is a statutorily defined marital trust allowing non-US citizen spouse to take advantage of the marital deduction.
To qualify for the QDOT, the structure of the trust must follow the general requirements for the other marital trust such as Qualified Terminable Interest Property Trust (QTIPs Id.§2056(b)(7)). In addition, the trust must have at least one trustee being a US individual or US corporation (Id.§2056A(a)(1)(A)), and must provide that no distribution may be made from the trust unless such trustee has the right to withhold from distributions enough to pay the taxes imposed (Id.§2056A(a)(1)(B)). The trust must meet requirements of the regulations (Id.§2056A(a)(2)), and an election must be made on the estate tax return (Id.§2056A(a)(3)).
The QDOT rule makes sure that estate tax will be imposed when the non-US citizen surviving spouse dies, or when the property inside the trust is distributed to the surviving spouse (Id.§2056A(b)(1)).
In the meantime, this estate tax exposure will not be applied after the surviving spouse becomes a US citizen a) when such spouse had been a US resident at all times after the death of the first spouse, or b) when there had been no taxable distribution of the property before s/he becoming a US citizen (Id.§2056A(b)(12)).
QDOT or Treaty Election
The executor may elect either QDOT or Treaty benefits, but not both. The United States may have treaties with another country that overrides the section and allows the marital deduction. Meanwhile, the deduction permitted under the treaty may be equal to the amount which bear the same ratio of the decedent’s property that is in the US.
II. Lifetime Inter-Spousal Gifts
1. Annual Gift Exclusion.
Annual gift exclusion of $15,000 (per one donee) is available for all (US person & NRA) donors. However, the split gift (26 U.S.C§2513(a)(1)) is only available if both spouses are US citizens or residents.
2. Unlimited Marital Deduction.
If the donee is a US citizen, the unlimited marital deduction will be available. However, if the gift is to non-citizen spouse, no unlimited marital deduction will be available.
3. Special Gift Exclusion.
Inter-spousal gift to a non-citizen spouse will qualify for the special annual gift exclusion amount of $152,000 (instead of marital deduction) in 2018.
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