An unlimited marital deduction is generally available for transfers of property to a spouse if that spouse is a U.S. citizen (26 U.S.C. §§ 2056 and 2523(a)). As a result, spouses who are U.S. citizens may transfer property to each other either during life or at death without any estate or gift tax liability. However, the unlimited marital deduction is not available for transfers of property to a non–U.S. citizen spouse (26 U.S.C. §§ 2056(d), 2503, and 2523(i)).
Where one spouse is a U.S. citizen and the other spouse is not, it is important to consider the special rules that apply to transfers to and from a non-citizen spouse to avoid the accidental imposition of estate and gift tax or the inadvertent use of the U.S. citizen spouse’s estate and gift tax exclusion amount. This article addresses the special rules for transfers to and from non-citizen spouses and estate planning techniques that can be used to maximize estate and gift tax savings.
Application of the estate and gift tax rules varies depending on the transferor and transferee’s citizenship and residency status. Estate and gift taxes are referred to collectively throughout this Note as transfer taxes. Generation-skipping transfer (GST) tax is an additional transfer tax, but a discussion of GST tax is beyond the scope of this article.
The U.S. transfer tax rules applicable to gifts made during life and at death depend on whether the transferor and transferee are:
Resident aliens and U.S. citizens are referred to in this Note as U.S. persons, while non-residents and non-citizens are referred to as non–U.S. persons.
The determination of a non-citizen’s residence for transfer tax purposes is different from the determination of residence for income tax purposes.
Residence is determined for income tax purposes based on a bright-line, objective test. Generally, a non-citizen is considered a resident of the United States for income tax purposes if the non-citizen either:
(26 U.S.C. § 7701(b)(1)(A), (b)(3)(A); 26 C.F.R. § 301.7701(b)-1.)
For transfer tax purposes, residence means domicile. A person acquires domicile in a place by living there, for even a brief period of time, with no definite present intention of leaving. A determination of domicile is based on a facts-and-circumstances test. Residence without the requisite intention to remain indefinitely is not sufficient to constitute domicile. Similarly, the intention to change domicile is not effective to actually change domicile unless the person leaves their current domicile and establishes a new one. (26 C.F.R. §§ 20.0-1(b) and 25.2501-1(b).)
Transfer tax rules are complicated and become even more complex when one spouse is not a U.S. citizen. There is significant variation in the application of the transfer tax rules depending on each spouse’s citizenship and residency status, and whether the transferor spouse makes a transfer during life or at death.
Gifts made by U.S. persons during life or at death are generally subject to transfer tax regardless of the situs of the asset gifted (26 U.S.C. §§ 2001(a) and 2501(a)(1)).
In 2023, for purposes of calculating the transfer tax imposed on U.S. persons, the following key exclusions and deduction are allowed:
Transfer tax on gifts in excess of the transfer tax exclusion or annual exclusion from gift tax, as applicable, are taxed at a federal rate of 40% (26 U.S.C. §§ 2001(c) and 2502(a)). Additional state transfer taxes may also apply.
Gifts made by non–U.S. persons who are not expatriates are subject to transfer tax only if the property gifted is U.S. situs property (26 U.S.C. §§ 2511(a), 2101, and 2103). U.S. situs property includes:
(26 U.S.C. §§ 2103, 2104(a), and 2501.)
In 2023, non–U.S. persons are entitled to the following key exclusions and deduction:
Where a non–U.S. person makes a gift of U.S. situs property either during life or at death, it is important to consider whether the United States is a party to a tax treaty with the non–U.S. person’s country of citizenship or residence that may alter the transfer tax rules applicable to the non–U.S. person.
The unlimited marital deduction allows for transfer-tax-free gifts to a U.S. citizen spouse. Where the donee spouse is a non-citizen, the unavailability of the unlimited marital deduction can have substantial tax implications that must be considered in estate planning.
A U.S. person is generally entitled to an unlimited marital deduction for transfers of property during life or at death to their spouse if that spouse is a U.S. citizen (26 U.S.C. §§ 2056(a) and 2523(a)). Spouses who are U.S. citizens may transfer property outright to each other either during life or at death without any transfer tax liability.
Transfers of property to a spouse that may terminate or fail on the occurrence or non-occurrence of an event or contingency, however, including transfers of property in trust, do not always qualify for the unlimited marital deduction. These transfers qualify for the unlimited marital deduction only if the property transferred is qualified terminable interest property (QTIP) (26 U.S.C. §§ 2056(b)(1) and 2523(f)). QTIP is property transferred by one spouse in which the other spouse has a qualifying income interest for life and for which a QTIP election is made (26 U.S.C. §§ 2056(b)(7) and 2523(f)(2)).
The unlimited gift tax marital deduction is not available for lifetime gifts from a U.S. person to a non-citizen spouse (26 U.S.C. § 2523(i)). Instead, gifts made by a U.S. person to a non-citizen spouse are eligible for a special spousal annual exclusion from gift tax if the gift otherwise qualifies for the annual exclusion from gift tax under Section 2503(b) of the Internal Revenue Code of 1986 (the Code) (see, Non–U.S. Persons, below, and 26 U.S.C. §§ 2503 and 2523(i)(2); 26 C.F.R. § 25.2523(i)-1(c)). Gifts to a non-citizen spouse in excess of this annual exclusion from gift tax either consume a portion of the donor spouse’s remaining transfer tax exclusion amount, if any, or are subject to transfer tax.
In addition, the unlimited gift tax marital deduction does not apply retroactively if a non-citizen spouse becomes a U.S. citizen after receiving a gift from a U.S. person spouse (26 C.F.R. § 25.2523(i)-1(d), ex. 5).
The unlimited estate tax marital deduction is not available for gifts at death from a U.S. person to a non-citizen spouse (26 U.S.C. § 2056(d)). However, a U.S. person can create a qualified domestic trust (QDOT) for the benefit of a non-citizen spouse to avoid or delay application of the U.S. estate tax (see Qualified Domestic Trusts, below).
In the gift tax context, the citizenship or domicile of the donor spouse is not relevant to the availability of the marital deduction (26 C.F.R. § 25.2523(i)-1(a)) and:
Therefore, for example, a non–U.S. person spouse can transfer U.S. situs property to a U.S. citizen spouse using the unlimited gift tax marital deduction, whereas a U.S. person spouse cannot use the unlimited gift tax marital deduction for a transfer of any property to a non-citizen spouse.
In general, if both spouses consent, a gift of non-community property made by one spouse to any third party is considered as made one-half by the donor spouse and one-half by the non-donor spouse (26 U.S.C. § 2513). This effectively allows one spouse to use the other’s annual exclusion from gift tax. To elect to split gifts, each spouse must file a separate individual gift tax return reporting the split gift (see IRS Form 709 Instructions).
However, gift splitting between spouses is only permitted if each spouse is a U.S. person at the time of the gift (26 U.S.C. § 2513(a)(1))). Gift splitting is not relevant to community property because community property is deemed to be owned equally by both spouses and, accordingly, any gift of community property is made equally by both spouses.
A non–U.S. person spouse may make gifts of non-community U.S. situs property that qualify for the annual exclusion from gift tax, but the non–U.S. person must make the gifts directly, rather than indirectly through gift-splitting. Non–U.S. persons may make unlimited gifts of non-U.S. situs property without being subject to U.S. gift tax.
Despite the gift tax implications of a gift to a non-citizen spouse, gifts between spouses are not considered taxable events for income tax purposes (Hughes v. Comm’r, T.C. Memo 2015-89 (2015)).
Joint tenancy is a common form of ownership between spouses. However, if one spouse is not a U.S. citizen, spouses should understand the consequences of owning property as joint tenants, considering that the unlimited marital deduction is unavailable for transfers to non-citizen spouses.
If spouses own real property as joint tenants, no transfer for transfer tax purposes is deemed to occur between the spouses until the spousal joint tenancy is severed, either during the spouses’ lifetimes or when one of the spouses dies (26 U.S.C. § 2523(i)(3)). When one joint tenant spouse dies, the surviving spouse becomes the sole owner of the property. At that time, the deceased spouse is deemed to make a gift to the surviving spouse of the portion of the property attributable to the contribution made by the deceased spouse on the original purchase of the property. (26 U.S.C. § 2056(d)(1)(B).) The tax consequences vary depending on the citizenship of the surviving spouse:
Similarly, if a joint tenancy in real property is severed by the sale of the property to a third party, and a spouse receives a greater share of the proceeds than that spouse contributed, then that excess amount is treated as a gift (26 C.F.R. § 25.2523(i)-2(b)(2)(i)). Because the unlimited marital deduction for lifetime gifts is not available if the lesser-contributing spouse is a non-citizen, the gift is taxable to the extent it exceeds the available spousal annual exclusion from gift tax (see Lifetime Gifts to or from a Non-Citizen Spouse, above).
For personal property, a spouse who funds the acquisition of joint tenancy property is treated as making a gift to the non-contributing spouse at the time that the joint tenancy is created (26 C.F.R. § 25.2523(i)-2(c)(1)). However, if the joint tenancy property is an account funded by the U.S. citizen spouse that permits the U.S. citizen spouse to withdraw funds unilaterally, there is no completed gift to the non-citizen spouse unless and until the non-citizen spouse withdraws funds from the account for the non-citizen spouse’s own use (26 C.F.R. § 25.2511-1(h)(4)).
In the estate tax context, there are a number of factors to consider when passing property to or from a non-citizen spouse, including that:
The unlimited estate tax marital deduction is not available for property passing to a non-citizen surviving spouse, except for property that passes to a QDOT for the benefit of a non-citizen surviving spouse (26 U.S.C. § 2056(d); see Transfer Tax Rules Applicable to U.S. Citizens and Non-Citizens, above, and Qualified Domestic Trusts, below). Even when the surviving spouse is a U.S. person who is subject to transfer tax, the unlimited estate tax marital deduction is not available unless the surviving spouse is a U.S. citizen (26 U.S.C. § 2056(d)).
The rationale for denying the unlimited marital deduction in this context is to prevent complete avoidance of the transfer tax regime. Transfer taxes could be avoided altogether if:
This rule is mitigated by:
(26 U.S.C. § 2056(d)(3).)
Under certain conditions, a surviving spouse may use the transfer tax exclusion that was not used by the deceased spouse, known as the deceased spousal unused exclusion (DSUE) amount, through portability (26 U.S.C. § 2010(c)(2)(B), (c)(4), (c)(5)). By using portability, a surviving spouse who dies in 2023 can transfer up to $25.84 million of assets free of estate tax (assuming both spouses die in 2023 and neither spouse used any portion of their transfer tax exclusion during their life) (26 U.S.C. § 2010). The availability of portability depends on whether or not each spouse is a U.S. person.
A surviving spouse who is a U.S. person can generally use the deceased spouse’s unused transfer tax exclusion by making a portability election (26 U.S.C. § 2010(c)(2)(B)). The executor of the deceased spouse’s estate must:
The unused transfer tax exclusion of a U.S. person is not portable to a non–U.S. person surviving spouse.
When portability is elected by a non-citizen surviving spouse who is also the beneficiary of a QDOT, the DSUE amount of the deceased spouse may:
(See Qualified Domestic Trusts, below.)
This is because, where property passes to a QDOT for the benefit of a non-citizen surviving spouse, the DSUE amount of the deceased spouse is subject to adjustment on the occurrence of the final distribution of the QDOT, or other event that causes the imposition of estate tax, which is typically the death of the surviving spouse (26 C.F.R. § 20.2010-2(c)(4)).
The estate tax exclusion of a non–U.S. person is not portable to a U.S. citizen spouse. However, this is usually not significant because non–U.S. persons are allowed only a $60,000 estate tax exclusion (26 U.S.C. § 2102(b)(1)).
A U.S. person can mitigate the harsh estate tax rules that generally apply to gifts at death to a non-citizen spouse by transferring assets at death to a QDOT for the benefit of the non-citizen spouse. A QDOT is a trust that meets the requirements of Section 2056A of the Code and the regulations thereunder. The QDOT requirements allow for the deferral of estate tax on assets that pass to a QDOT for the benefit of a non-citizen spouse while ensuring that the deferred estate tax is ultimately paid (26 U.S.C. § 2056(d)(2)).
Although gifts to non-citizen spouses are not eligible for the unlimited estate tax marital deduction, gifts to a non-citizen surviving spouse are entitled to a marital deduction only to the extent the assets are transferred from the deceased spouse to a QDOT (26 U.S.C. §§ 2056(d) and 2056A). A QDOT is generally used if the value of the deceased spouse’s estate exceeds the amount of the deceased spouse’s remaining transfer tax exclusion ($12.92 million for 2023). In that case, a QDOT allows the deceased spouse’s estate to apply the unlimited marital deduction to the assets passing to the QDOT.
QDOTs must satisfy both:
To satisfy the QDOT requirements, the trust must be an ordinary trust, meaning a trust:
(26 C.F.R. §§ 20.2056A-2(a) and 301.7701-4(a).)
For a QDOT to be valid, the trust instrument creating the QDOT must require that:
The QDOT security requirements are designed to ensure that estate tax can be collected on the termination of the QDOT. The security requirements imposed on a QDOT depend on whether the fair market value of its assets, as finally determined for federal estate tax purposes (without reduction for indebtedness), exceeds $2 million. More onerous security requirements apply to QDOTs holding assets with a fair market value of over $2 million, as finally determined for federal estate tax purposes (large QDOTs), than to QDOTs holding assets with a fair market value of $2 million or less (small QDOTs) (26 C.F.R. § 20.2056A-2(d)(1)).
The governing instrument of a large QDOT must require either:
(26 C.F.R. § 20.2056A-2(d)(1)(i).)
The governing instrument of a small QDOT must provide that either:
(26 C.F.R. § 20.2056A-2(d)(1)(ii).)
The deceased spouse’s executor must make an affirmative QDOT election on the deceased spouse’s federal estate tax return (26 C.F.R. § 20.2056A-3(a)). The election must be made on the last federal estate tax return filed before the due date (including extensions of time to file actually granted) or, if not timely filed, on the first federal estate tax return filed after the due date, provided that the first-filed return is filed within one year of the due date (26 U.S.C. § 2056A(a)(3), (d) and 26 C.F.R. § 20.2056A-3(a)). Once a QDOT election is made, it is irrevocable.
The executor of the deceased spouse’s estate can make a protective election to treat a trust as a QDOT if the executor reasonably believes that, at the time the federal estate tax return is filed, there is a bona fide issue.
A bona fide issue arises where, at the time the federal estate tax return is filed, either:
(26 C.F.R. § 20.2056A-3(c).)
The protective election preserves the QDOT election in the event that the bona fide issue is settled and the QDOT election becomes necessary. In that case, the protective election becomes effective and is irrevocable. For example, if a protective election is made because a bona fide question exists as to whether an asset is includible in the deceased spouse’s gross estate, and it is later determined that the asset is includible, the protective election becomes effective with respect to the asset and cannot later be revoked. (26 C.F.R. § 20.2056A-3(c).)
In addition to the protective election, when necessary, the trust must be reformed to comply with the QDOT requirements (26 C.F.R. § 20.2056A-4 and see Reformation of a Trust to Comply with QDOT Requirements, below). The protective election must be:
(26 C.F.R. § 20.2056A-3(c).)
A QDOT can be created in one of two ways:
(26 C.F.R. § 20.2056A-2(b).)
A QDOT ceases to qualify as a QDOT if the trust uses any device or arrangement that has, as a principal purpose, either:
(26 C.F.R. § 20.2056A-2(d)(1)(v).)
For example, under this anti-abuse rule, a QDOT ceases to be a QDOT if the U.S. trustee of the QDOT is an undercapitalized corporation that was established by the surviving spouse or members of the surviving spouse’s family.
QDOTs permit deferral, rather than avoidance, of estate tax except to the extent of the hardship exemption. The rules governing QDOTs provide that estate tax is imposed:
(26 U.S.C. § 2056A(b)(4) and 26 C.F.R. § 20.2056A-5(b).)
The hardship exemption applies to distributions made in response to an immediate and substantial financial need related to either:
(26 U.S.C. § 2056A(b)(3)(B), (b)(4) and 26 C.F.R. § 20.2056A-5(c)(1).)
When estate tax is imposed on QDOT assets, the tax is equal to the additional estate tax that would have been imposed on the deceased spouse’s estate if the amount passing to the QDOT had not been deductible (26 U.S.C. § 2056A(b)). In determining the additional estate tax, any available credits are taken into account (26 C.F.R. § 20.2056A-6(a)). The applicable tax rate is the effective rate at the time of the original deceased spouse’s death, not the effective rate at the time of the distribution or the surviving spouse’s death. Payment of these taxes from a QDOT is treated as a taxable distribution from the QDOT, which is subject to estate tax (26 C.F.R. § 20.2056A-5(c)(3)(ii)).
Although the QDOT rules require that a U.S. trustee be appointed and that the trust be maintained in, and administered under the laws of, a U.S. state or the District of Columbia, a QDOT may be treated as a foreign trust for federal tax purposes (26 C.F.R. § 20.2056A-2(a)).
A trust qualifies as a U.S. trust if:
(26 U.S.C. § 7701(a)(30)(E).)
Control for these purposes means having the power to make substantial decisions, with no other person having the power to veto those decisions (26 C.F.R. § 301.7701-7(d)(1)(iii)).
Any trust that does not meet the requirements for qualifying as a U.S. trust is deemed to be a foreign trust. Substantial decisions, for these purposes, include decisions concerning:
(26 C.F.R. § 301.7701-7(d)(1)(ii).)
If a trust has a U.S. person and a non–U.S. person as co-trustees that must act unanimously, the U.S. person trustee lacks control and the QDOT will be treated as a foreign trust (26 C.F.R. § 301.7701-7(d)(1)(v), ex. 1).
If a non–U.S. person spouse is named as co-trustee of a trust and has the power to make substantial decisions for the trust, the trust:
Most QDOTs are non-grantor trusts. If the trust is classified as a foreign trust and a non-grantor trust for federal tax purposes, this can have negative tax consequences. Foreign non-grantor trusts are not generally subject to U.S. tax unless the trust earns U.S. source income. However, U.S. person beneficiaries are responsible for paying income tax on distributions of trust income, and may be subject to an additional tax, known as a tax on accumulation distributions, or throwback tax, on distributions of prior year trust income.
To avoid foreign trust classification, if a non–U.S. person spouse is a co-trustee:
The primary advantage of a QDOT is that assets passing to the QDOT are subject to the unlimited marital deduction, which:
The primary disadvantage of a QDOT is that it is subject to onerous formation and administration requirements (see QDOT Requirements and Restrictions, above). In addition, except to the extent of the hardship exemption, a QDOT defers but does not eliminate estate taxes. The surviving spouse must pay estate tax each time a principal distribution is made from a QDOT to the surviving spouse that does not qualify for the hardship exemption (see Taxation of QDOTs, below).
Where a decedent’s estate exceeds the decedent’s remaining transfer tax exclusion amount, QDOTs are the most frequently used estate planning technique for transfers at death to non-citizen spouses. However, clients can also consider alternative means of transferring assets to non-citizen spouses at death, including:
The proceeds of a life insurance policy insuring the life of a non–U.S. person are not considered U.S. situs property and therefore are not includible in the taxable estate of a non–U.S. person (26 U.S.C. § 2105(a)). Therefore, a non–U.S. person can obtain significant life insurance policies on their life and pass the proceeds of those policies free of estate tax at death.
If a non-citizen spouse is:
If a non-citizen spouse acquires U.S. citizenship during the life of the U.S. person spouse, the U.S. person spouse can gift unlimited amounts to the previously non-citizen spouse during the U.S. person spouse’s lifetime (see Lifetime Gifts to or from a Non-Citizen Spouse, above).
The surviving spouse is treated as a U.S. citizen as of the date of the decedent’s death if the surviving spouse both:
(26 U.S.C. § 2056(d)(4).)
If the surviving spouse is treated as a U.S. citizen as of the date of the deceased spouse’s death, the unlimited marital deduction is available for bequests made to the surviving spouse, and a QDOT is unnecessary.
A QDOT election must be made no later than one year after the due date for the federal estate tax return, so if the surviving spouse has not acquired citizenship by this time, it is advisable to make a protective election. The Treasury Regulations contemplate this situation and permit a protective election if there is a bona fide issue concerning the citizenship of the surviving spouse (26 C.F.R. § 20.2056A-3(c) and see QDOT Election, above). If citizenship is later granted, no estate tax will be due on distributions from the QDOT to the surviving spouse (26 U.S.C. § 2056A(b)(12)).
An increasing number of U.S. persons, including U.S. resident non-citizens, are considering expatriation from the United States to avoid the complexity of the tax rules and the requirements associated with income and transfer tax, as well as to benefit from potentially substantial tax savings.
A U.S. resident non-citizen is considered a U.S. person and is generally not treated differently from a U.S. citizen for transfer tax purposes when making transfers during life or at death. This means that during life the U.S. resident non-citizen is subject to gift tax on transfers that exceed the amount of the annual exclusion from gift tax, and on all transfers other than annual exclusion transfers once the transfer tax exclusion is used (26 U.S.C. §§ 2010(c), 2503(b), and 2505). At death, the U.S. resident non-citizen is subject to estate tax on their worldwide assets to the extent that the transfers exceed their remaining transfer tax exclusion amount (26 U.S.C. §§ 2001, 2031, and 2051).
In some cases, it may be practical for a U.S. resident non-citizen to consider giving up their status as a U.S. person. If the non-citizen does not hold a green card, giving up U.S. person status involves establishing a new domicile in a foreign country and complying with the rules for avoiding U.S. person status for income tax purposes (see Residence for Income Tax Purposes, above). For a green card holder, giving up U.S. person status also requires relinquishing the green card.
It is important to take into account the potential exit tax associated with leaving the United States, particularly in cases where the U.S. person is a green card holder (26 U.S.C. §§ 877 and 877A). In addition, U.S. person recipients of assets from an expatriate may be subject to tax liability on the receipt of such assets (26 U.S.C. §§ 877 and 877A(f)).
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