What Is a Qualified Domestic Trust (QDT)?

A Qualified Domestic Trust (QDT) is a trust used in estate planning when one spouse is not a U.S. citizen. Its purpose is to allow for the deferral of federal estate taxes. Typically, assets passed to a surviving spouse who is a U.S. citizen are eligible for an unlimited marital deduction, meaning they are not subject to estate tax at the time of the first spouse’s death. This deduction is disallowed if the surviving spouse is not a U.S. citizen.

The reason for this restriction is the concern that a non-citizen spouse could move inherited assets out of the country, beyond the reach of the U.S. estate tax system. A QDT addresses this by holding the assets in a trust that ensures the Internal Revenue Service (IRS) can eventually collect the deferred tax, postponing it until after the non-citizen spouse’s death.

Core Requirements for a Qualified Domestic Trust

For a trust to be recognized by the IRS as a Qualified Domestic Trust, it must satisfy several requirements outlined in the Internal Revenue Code.

• The trust instrument must require that at least one trustee is a U.S. citizen or a U.S. domestic corporation. This U.S. Trustee is responsible for the trust’s administration and tax compliance.
• The trust document must explicitly state that no distribution of the trust’s principal can be made unless the U.S. Trustee has the right to withhold the deferred estate tax from that distribution.
• Additional security arrangements are required for larger trusts. If the QDT’s assets exceed $2 million, the trust must require that either at least one U.S. Trustee is a U.S. bank, or the U.S. Trustee must furnish a bond or letter of credit to the IRS for 65% of the assets’ value. For trusts of $2 million or less, these measures are not mandated if the trust stipulates that no more than 35% of its assets consist of foreign real property.
• The executor of the deceased spouse’s estate must make a formal, irrevocable election on the federal estate tax return, Form 706. Without this election, a trust will not qualify for the tax deferral benefits.

Taxation of QDT Distributions

The tax treatment of payments from a QDT to the surviving non-citizen spouse depends on the nature of the distribution. Payments classified as “income,” such as interest or dividends, are not subject to the deferred QDT estate tax. These income distributions are, however, subject to the surviving spouse’s regular income tax obligations.

In contrast, any distribution of principal from the trust is a taxable event. That amount is subject to the deferred estate tax, calculated based on the estate tax that would have been owed on the first spouse’s estate had the marital deduction not been taken.

An exception exists for principal distributions made due to hardship. A hardship distribution is a payment for an immediate and substantial financial need related to the health, education, maintenance, or support of the surviving spouse. To qualify, the spouse must not have other reasonably available funds. If a principal distribution meets this definition, it is exempt from the QDT estate tax.

Establishing the QDT

A Qualified Domestic Trust can be created and funded through several methods. Before its creation, a qualified U.S. Trustee must be selected and the specific assets that will be transferred into the trust must be identified.

One common method is creating a testamentary QDT, where the trust is established directly within the deceased spouse’s will or a revocable living trust. This approach ensures it is automatically created and funded upon the first spouse’s death.

Alternatively, a QDT can be established after the death of the first spouse. The surviving non-citizen spouse can create a QDT and transfer assets they inherited directly into it. This must be completed before the due date for the federal estate tax return, including any extensions. An existing trust that does not meet the QDT requirements can be reformed through a judicial proceeding to become compliant.

Tax Events and Filing Obligations

Once a QDT is operational, specific events trigger the payment of the deferred estate tax. The primary taxable events are any distribution of principal to the surviving spouse that is not for a documented hardship, the death of the surviving spouse, or the trust ceasing to meet QDT requirements.

The U.S. Trustee is responsible for filing Form 706-QDT, the U.S. Estate Tax Return for Qualified Domestic Trusts. This form must be filed for any year in which a taxable event occurs. For lifetime principal distributions, the form is due by April 15th of the year following the distribution.

Upon the death of the non-citizen surviving spouse, a final taxable event occurs. The entire remaining value of the assets held in the QDT becomes subject to the deferred estate tax. The U.S. Trustee must file a final Form 706-QDT within nine months of the surviving spouse’s death to report the remaining assets and pay the outstanding tax.

A special rule applies if the surviving spouse becomes a U.S. citizen, which can terminate the QDT tax. This can happen if the spouse was a U.S. resident for the entire period between the decedent’s death and becoming a citizen, or if no taxable distributions were made from the trust before the spouse became a citizen. If one of these conditions is satisfied, no further tax is imposed on distributions or the remaining trust assets, provided the U.S. Trustee notifies the IRS by filing a final Form 706-QDT.