Estate Tax Exemption for a Non Citizen Spouse

The U.S. federal estate tax applies to the transfer of a person’s assets after death. However, a lifetime exemption allows a large portion of an estate to be passed on tax-free; for 2025, this amount is $13.99 million per person. This figure is indexed for inflation but is scheduled to decrease in 2026 without new legislation.

For married couples, the unlimited marital deduction permits the tax-free transfer of assets to a surviving spouse, deferring any potential estate tax until the second spouse’s death. A major exception to this rule occurs when the surviving spouse is not a U.S. citizen.

The Unlimited Marital Deduction and Non-Citizen Spouses

The unlimited marital deduction is denied if the surviving spouse is not a U.S. citizen. This restriction stems from the government’s concern that a non-citizen spouse could leave the country with inherited assets, placing them outside of U.S. tax jurisdiction.

If this happened, the deferred estate tax would never be collected. This policy is a protective measure for the U.S. tax base, ensuring that assets benefiting from the marital deduction are eventually subject to U.S. estate tax.

The Qualified Domestic Trust (QDOT) as a Solution

To address the non-citizen spouse issue, Congress created the Qualified Domestic Trust (QDOT). This mechanism allows assets to be transferred to a non-citizen spouse while still qualifying for the marital deduction. A QDOT works by placing assets from the deceased’s estate into a specially structured trust.

This allows the estate to claim the marital deduction and defer the estate tax. The surviving spouse can receive income from the trust, but the assets remain within the U.S. tax system’s reach. The QDOT is a tax deferral tool, not a tax elimination tool. The estate tax deferred at the first spouse’s death will be imposed on the assets remaining in the QDOT upon the surviving spouse’s death or on certain principal distributions made during their lifetime.

Key Requirements for Establishing a QDOT

For a trust to be recognized by the IRS as a QDOT, it must satisfy several strict requirements outlined in the Internal Revenue Code. Failure to meet these rules can result in the loss of the marital deduction.

• U.S. Trustee: At least one trustee must be a U.S. citizen or a U.S. domestic corporation. This U.S. trustee is responsible for ensuring compliance with tax laws.
• Withholding Rights: The U.S. trustee must have the legal right to withhold estate tax from any distribution of principal made to the non-citizen spouse. This ensures the tax is paid when a taxable distribution occurs.
• Security Arrangements: To guarantee tax collection on larger trusts, additional security is required. For QDOTs with assets over $2 million, the trust must either have a U.S. bank as a trustee or the U.S. trustee must furnish a bond or letter of credit for 65% of the trust’s asset value. For trusts of $2 million or less, the instrument must state that no more than 35% of the assets can be foreign real property.
• QDOT Election: The executor of the deceased’s estate must make an irrevocable election on the federal estate tax return. This formal declaration confirms the trust meets all QDOT qualifications and must be made on a timely filed return.

Taxation and Distributions from a QDOT

Specific tax rules govern when the deferred estate tax is collected from a QDOT. The two main taxable events are any distribution of trust principal to the surviving spouse and the death of the surviving spouse, at which point the remaining property is taxed.

However, not all distributions are taxable. Payments of income, like interest and dividends, can be made to the spouse without triggering the tax. An exception also exists for principal distributions made on account of “hardship,” defined as an immediate financial need for health, maintenance, or support that cannot be met from other available sources.

The QDOT tax is calculated at the highest estate tax rate applicable to the first spouse’s estate. The U.S. trustee is responsible for filing the appropriate tax forms to report taxable distributions and pay any tax due.

Alternative Planning Considerations

While the QDOT is the primary tool for deferring estate tax for a non-citizen spouse, other strategies can impact estate planning.

Surviving Spouse Becomes a U.S. Citizen

The QDOT rules can be avoided if the surviving spouse becomes a U.S. citizen. If citizenship is obtained before the federal estate tax return is filed, the estate can claim the standard unlimited marital deduction without a QDOT. An existing QDOT can also be terminated tax-free if the surviving spouse becomes a U.S. citizen later, provided certain residency conditions are met.

Lifetime Gifting

Lifetime gifting can reduce the size of a potential estate. While gifts between citizen spouses are unlimited, a higher annual gift tax exclusion applies to gifts made to a non-citizen spouse. For 2025, a U.S. citizen can give up to $190,000 per year to their non-citizen spouse tax-free. This strategy allows for the gradual transfer of wealth, reducing the assets subject to estate tax.

Estate Tax Treaties

The U.S. has estate and gift tax treaties with several foreign countries that can modify standard tax rules. A treaty might offer a separate marital deduction, a tax credit, or other provisions affecting assets passed to a non-citizen spouse. It is important to check for a treaty with the non-citizen spouse’s country of citizenship, as it may offer planning opportunities beyond the QDOT.