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Navigating Estate Planning with a Non-U.S. Spouse

Posted on: July 25th, 2022

Navigating Estate Planning with a Non-U.S. Spouse

It’s important for married couples to do at least some basic estate planning so their assets are transferred as they wish—and hopefully do so in ways that minimize or avoid unnecessary taxes. For many couples, estate planning can potentially be as straightforward as creating a will. 

But that simplicity can quickly fly out the window if one of the spouses is not a U.S. citizen. If that describes your situation and you have significant wealth, there are numerous issues and rules around estate planning (and other types of wealth planning) that you need to be aware of in order to make smart financial decisions—and avoid potentially costly mistakes.

Here’s a closer look at some of the key concerns that U.S./non-U.S. married couples may encounter and how those issues impact their financial planning.

Different marital exemptions

With married couples who are both U.S. citizens, all assets owned by the first spouse to die can be transferred to the surviving spouse and—importantly—no estate taxes are owed on that transfer. That’s because the two people have essentially been seen for tax purposes as a single unit. This is called the unlimited marital exemption because there is no ceiling on the amount of wealth that can go from one spouse to the other, estate-tax free. 

Trouble is, this unlimited exemption doesn’t exist among married couples where one spouse is not a U.S. citizen. Instead, if the U.S. spouse dies first, the assets that go to the surviving non-U.S. spouse may be subject to estate taxes immediately. 

The reason: The U.S. government doesn’t want to leave the door open to allow the surviving non-U.S. spouse to move back to his or her home country and die there without ever paying any U.S. taxes. So to make sure it gets its share, the government taxes the transfer upon the U.S. spouse’s death. 

Important: This rule applies only when the U.S. spouse dies first. If, instead, the non-U.S. spouse were first to pass away, the surviving spouse—a U.S. citizen—would be allowed to take advantage of the unlimited marital exemption by inheriting the non-U.S. spouse’s assets estate tax-free.

Of course, these estate tax concerns depend largely on a couple’s wealth. As of this writing, the estate tax exemption is $12.06 million, and $24.12 million for married couples. Estates under those limits won’t face federal estate tax bills. That said, there’s been chatter that the exemption may be cut back down to its 2017 level of just $5.49 million (and approximately $11 million for married couples) or even lower. As always, it’s smart to consult with a tax professional for the latest.
The upshot: What looks like a bulletproof estate today may not be in a few years.

Different joint property rules

Property may be viewed differently among married couples with a non-U.S. spouse compared with couples with two U.S. citizens—and that difference can potentially lead to a larger taxable estate for a couple with a non-U.S. spouse.

For example, take a married couple—both U.S. citizens—who own property jointly. In that case, the joint property is assumed to belong to each spouse equally. That means upon the first spouse’s death, only 50 percent of the value of the property is included in the deceased spouse’s gross estate—regardless of who contributed what. In stark contrast, joint property involving a couple with one non-U.S. spouse is not necessarily viewed as a 50-50 split. Unless the non-U.S. spouse can provide documentation that he or she contributed to the purchase of the property, 100 percent of the value of the jointly owned property that passes to the non-U.S. citizen spouse is generally fully includible in the deceased spouse’s estate.

 
Bottom line: If the U.S. spouse dies first, the full value of a jointly owned $500,000 home or $1 million investment account would be exposed to estate taxes—not just 50 percent of those values (again, unless the non-U.S. spouse has documentation about his or her contributions).

Different gifting and gift tax rules

A married couple consisting of two U.S. citizens can transfer or gift an unlimited amount of money (or jewelry or other types of gift items) to each other during their lifetime without incurring taxes. But—you guessed it—that’s not the case if the spouse of the person making the gift is not a U.S. citizen. Instead, the U.S. spouse is limited to annual gifts up to $164,000 (in 2022). Gifts in excess of that amount will incur gift tax consequences, requiring the U.S. spouse to report the gift on a tax return. The “excess” gifting beyond that annual exclusion will reduce the spouse’s remaining lifetime unified credit from gift, estate and generation-skipping transfer taxes. 

Why does this matter? It can make good financial sense for some wealthy individuals to place significant assets in their spouse’s name. If that describes you, but you have a non-U.S. citizen spouse, the gifting limits could mean it takes you several years to achieve what other married couples might accomplish practically overnight. Therefore, your asset transfer planning timeline should be adjusted accordingly.

Options to consider

Does all this mean that blended U.S./non-U.S. married couples always must pay more in estate taxes, or pay them more rapidly than U.S.-U.S. couples? Not necessarily. Steps can be taken to reduce the tax bite, or at least delay it.  

Perhaps the most obvious move is for the non-U.S. spouse to become a U.S. citizen. As such, the surviving spouse would qualify for the unlimited marital deduction—meaning estate taxes wouldn’t be owed when the first spouse died. Having U.S. citizenship also means the couple could transfer or gift an unlimited amount to each other during their lifetime without incurring taxes. That said, gaining citizenship can be a highly complex and time-consuming endeavor—the ins and outs of the process go far beyond the scope of this report—and citizenship shouldn’t be pursued simply to avoid or delay taxes, as there are multiple needs, goals and concerns that should be weighed as part of the decision-making process.

One financial strategy to consider if you have a large estate is to set up a specific type of trust called a qualified domestic trust, or QDOT. A QDOT won’t help you avoid estate taxes entirely, but it can help you defer them until after the surviving non-U.S. citizen spouse dies instead of after the death of the first spouse. 

With a QDOT, assets from the deceased U.S. citizen spouse go directly to the trust instead of to the non-U.S. spouse. (Alternatively, the surviving non-U.S. spouse could place assets left to him/her outright into a QDOT within a certain amount of time after the death of the first spouse.) Therefore, the trust—not the surviving spouse—owns the assets. This move allows the noncitizen surviving spouse to make use of the marital deduction on estate tax for any assets that are placed into the QDOT. 

The surviving noncitizen spouse receives annual income generated by the trust’s assets to fund current expenses, and that income is subject to income taxes (but not estate taxes). But if the trustee distributes principal from the QDOT to the surviving non-U.S. spouse, the amount of that distribution will be subject to estate taxes. (An exception: No estate tax is due if principal is distributed in circumstances that fall under the IRS’s hardship exemption.)

After the noncitizen spouse’s death, the assets that remain in the QDOT will be subject to U.S. estate tax—and the balance goes to the trust’s remainder beneficiaries (usually the couple’s children).

The advantage, of course, is that the tax bill was deferred potentially well into the future while the surviving spouse benefited during his or her lifetime from the trust assets. 

Keep in mind that certain rules have to be met for a QDOT to be considered legal. For example:

  • After the first spouse dies, the executor must make an irrevocable election on the estate tax return (which must be filed within nine months of the first spouse’s death, even if no tax is due) to treat the trust as a QDOT.
  • The QDOT documents must state that all income is distributable to the surviving noncitizen spouse only. 
  • The trustee of the QDOT must be a U.S. citizen.
  • If the property transferred to the QDOT has a value that exceeds $2 million, at least one trustee must be a U.S. bank. (Alternatively, a trustee can post a bond with the IRS equal to 65 percent of the fair market value of the assets transferred to the trust at death.)

Conclusion

Ultimately, there are numerous financial and wealth planning issues that affluent U.S./non-U.S. citizen married couples must navigate. Estate planning—which can potentially involve significant sums—can be an excellent place to start. Armed with clarity about which rules do, and do not, apply in this situation, couples can begin crafting strategies and making decisions that may be ideal for them.


This report was prepared by, and is reprinted with permission from, VFO Inner Circle.  AES Nation, LLC is the creator and publisher of VFO Inner Circle reports.

Disclosure: The opinions expressed in this commentary are those of the author and may not necessarily reflect those held by Kestra IS or Kestra AS. The material is for informational purposes only. It represents an assessment of the market environment at a specific point in time and is not intended to be a forecast of future events, or a guarantee of future results. It is not guaranteed by Kestra IS or Kestra AS for accuracy, does not purport to be complete and is not intended to be used as a primary basis for investment decisions. It should also not be construed as advice meeting the particular investment needs of any investor. Neither the information presented nor any opinion expressed constitutes a solicitation for the purchase or sale of any security. Securities offered through Kestra Investment Services, LLC (Kestra IS), member FINRA/SIPC. Investment advisory services offered through Kestra Advisory Services, LLC (Kestra AS), an affiliate of Kestra IS.

Fusion Wealth Management is not affiliated with Kestra IS or Kestra AS. https://www.kestrafinancial.com/disclosures

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