Estate and gift taxes are commonly referred to as transfer taxes, as they tax the gratuitous transfer of assets between individuals. The estate and gift taxes work in tandem to account for the property transfers over the life and estate of an individual through the lifetime gift tax exclusion. At $5,430,000 in 2015 (adjusted for inflation), the lifetime transfer tax exclusion is the total value of assets that can be gifted during one’s lifetime and/or left in a taxpayer’s estate without the payment of transfer tax. Gifts greater than the annual exclusion amount of $14,000 in 2015 (adjusted for inflation) must be reported on a gift tax return and reduce one’s lifetime gift tax exclusion.
Typically gifts between spouses qualify for the unlimited marital deduction. This deduction allows spouses to gift any amount to one another without reporting the gifts, reducing their lifetime exclusion amount, or paying gift taxes. However, if one spouse is not a citizen of the United States the deduction is subject to an annual limit of $147,000 in 2015 (adjusted for inflation). Any amounts gifted by a citizen spouse to a noncitizen spouse greater than $147,000 in a year must be reported on a gift tax return and will reduce one’s lifetime exclusion amount.
A citizen spouse may transfer any remaining amount of lifetime transfer tax exclusion to a noncitizen spouse in the citizen spouse’s estate. Any property exceeding this amount is taxable unless it is paid to a Qualified Domestic Trust (QDoT), in which case the property is treated as though it is part of the unlimited marital deduction. A QDoT does not eliminate estate tax, but rather defers it. Any income passed out to the noncitizen spouse is taxed as ordinary income and any principal distributions are subject to estate taxes of 40%. To qualify for the marital deduction, property must be directly transferred to the trust, the executor must make a timely QDoT election, and at least one trustee must be a US citizen or domestic corporation. In addition, the trust documents must give the US trustee the power to withhold estate taxes from principal distributions paid to the noncitizen spouse. Due to the fact that the noncitizen spouse can create a QdoT without any provision in the citizen spouse’s estate plan for such a trust, a QdoT can be a powerful tool in post-mortem estate planning.
To learn more about QDOTs and how you might be able to employ one to defer tax in your estate plan, please feel free to contact us at any time.