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The importance of marital status cannot be understated in transfer tax planning. The US Transfer Tax System is designed to allow spouses to pass assets to one another in life and upon death without the imposition of transfer taxes. However, the spouse receiving the assets must be a US citizen for the transfer to qualify for an unlimited martial deduction. It is critical to determine the citizenship of your married clients.
Prior to 1988 it was the citizenship of the decedent spouse that determined the availability of the marital deduction. However, there was concern that if a spouse died leaving an estate to a non-citizen spouse, the surviving spouse would return to his or her country of origin and die a nonresident alien. If that were to occur no US federal estate tax could be imposed except upon assets held in the United States. Who knows the extent to which this actually happened, but the perception that this was occurring gave rise to the Technical and Miscellaneous Revenue Act of 1988 ("TAMRA"). Under TAMRA Congress denied the marital deduction to all non-citizen spouses, creating instead a web of requirements one must cross to garner benefits the law still allows.
After TAMRA, the surviving spouse's citizenship governs the availability of the federal estate tax marital deduction. The marital tax deduction is generally disallowed if the surviving spouse is not a US citizen, even if the deceased spouse is a US citizen or a resident alien, unless two elements are established. First, the transfer still has to be qualified for the marital deduction had the surviving spouse been a US citizen. Second, the surviving spouse must become a US citizen before the date on which the federal estate tax return is made or the property must pass from the decedent to the surviving spouse in a Qualified Domestic Trust ("QDOT") for which an election has been made.
If the surviving spouse were to become a US citizen prior to the time the federal estate tax is deemed made, the marital deduction is determined as if the surviving spouse were a US citizen at the first spouse's death. It requires more than merely applying for citizenship before the return is made; citizenship must be granted prior to the time the return is made. The federal estate tax return is deemed "made" as of the last date that it could have been filed (including extensions) unless the return is filed late. If the return is filed late, the "made" date is the date of actual filing. Additionally, the surviving spouse must reside in the US at all times after the decedent spouse's death and before attaining US citizenship.
Alternatively, if the surviving spouse does not become a US citizen before the date on which the federal estate tax return is made, the property can pass to the surviving spouse in a QDOT for which an election has been made.
Property can pass to a surviving spouse in a QDOT in one of three primary ways. First, a direct transfer to a QDOT which had been established by the pre-deceased spouse will qualify. This is the ideal scenario if there had been sufficient lifetime planning. Unfortunately, that is not always the case and the planning begins anew post-mortem.
Second, by a direct transfer to a trust that is not a QDOT, but that is reformed in a timely manner. Any reformation must comport with the instrument establishing the trust or by a judicial proceeding effective under local law. The trust can be revocable by a surviving spouse or be subject to a general power of appointment, but no one can have a power to amend the trust in such a way as to disqualify it as a QDOT. If it is a non-judicial reformation, it must be completed by the time required for filing the federal estate tax return. If it is a judicial reformation, then it simply must be commenced on or before the return due date, regardless of the date that the return is actually filed.
Third, the property can qualify by a transfer to the surviving spouse, followed by a transfer or irrevocable assignment by the surviving spouse to a QDOT. The property must be either transferred or assigned irrevocably to a QDOT before the federal estate tax return is filed. The property must be transferred or assigned before the administration of the estate is completed. If there is no administration, the transfer must be completed within the one-year anniversary of the due date for filing the decedent's estate tax return, including all extensions. A QDOT recipient could be created by the deceased spouse, the executor of the deceased spouse or even a surviving spouse/surviving spouse's legal representative.
When we meet with clients to discuss estate planning, we typically ask for all manner of personal information including, marital status, children, grandchildren, finances and health. However, some of the most basic details can be missed. If we fail to ask our clients whether they are United States citizens we are missing an opportunity to avoid the post-mortem headache of achieving the marital deduction for a non-citizen spouse.