How Special Treaty Provisions Can be Utilized to Obtain Marital Deductions for Blended International Couples

Married couples in the United States often utilize an unlimited marital deduction to avoid the U.S. estate and gift tax. However, the estate of non-citizens of the United States are generally not permitted to utilize a marital deduction for U.S. estate tax purposes other than for property passing to a qualified domestic trust (“QDOT”) or if the surviving spouse is a U.S. citizen. Sometimes, significant planning possibilities exist for married couples that do not qualify to utilize a marital deduction through a treaty. This article discusses how individuals may utilize an estate and gift tax treaty or an income tax treaty to claim a marital deduction. A qualified domestic trust (“QDOT”) is a specific type of trust used in estate planning to permit U.S. citizens to transfer assets to a non-U.S. citizen spouse in order to delay or avoid the U.S. estate and gift tax. In essence, a QDOT permits non-U.S. citizen spouses to receive benefits of assets placed in trust while deferring the estate and gift tax until their death or the death of their U.S. spouse. This article discusses how a QDOT works and the rules governing a QDOT.

The Estate and Gift Tax

As discussed above, QDOTs are created to defer or avoid the estate and gift tax. Federal law imposes a transfer tax upon the privilege of transferring property by gift, bequest or inheritance. This transfer tax takes the form of a gift or estate tax. Gift and estate taxes are computed on the progressive unified rate schedule set forth in Section 2001 of the Internal Revenue Code with the rates ranging from 18% to 40% on the value of a gift or the value of an estate. A unified credit is available to minimize the impact of the transfer tax. The unified credit gives a set dollar amount that an individual can gift during their lifetime and pass on to beneficiaries before a gift or estate taxes apply. U.S. citizens and resident individuals are permitted a unified credit that exempts $13.99 million (for the 2025 calendar year) from the estate and gift tax. This means that U.S. citizens and residents can pass $13.99 million (in 2025) to their heirs without being assessed a gift or estate tax. The unified credit is significantly smaller for foreign individuals that are not domiciled in the U.S. The current unified credit for non-domiciliaries is equivalent to a $60,000 exemption, unless an applicable treaty allows a greater credit. See IRC Section 2505(a).

There are also significant differences as to how the estate tax is calculated for individuals domiciled in the U.S. compared to individuals not domiciled in the U.S. The worldwide estate of a decedent is subject to U.S. estate tax only if the individual was either a U.S. citizen or resident at the time of death. See IRC Sections 2001(a) and 2031(a). In contrast, the estate of an individual not domiciled in the U.S. is subject to estate tax solely on his or her U.S. situs assets.

Marital Deduction

An unlimited deduction is allowed in computing the value of the taxable estate for the value of all property included in a decedent’s gross estate passing from the decedent to the decedent’s surviving spouse. This is the most important deduction available to married couples wishing to minimize estate taxes on their property. The marital deduction is available only for a deductible interest passing from the decedent to the surviving spouse. A deductible interest is a property interest passing to the spouse that is not made nondeductible by the “nondeductible terminable interest rule.” See IRC Section 2056(b). Under the nondeductible terminable interest rule, a property interest passing from the decedent to the surviving spouse is not deductible if, upon the happening of an event or contingency or upon the lapse of time, the spouse’s interest will terminate and upon such termination the interest or the property from which the interest is carved passes to someone other than the spouse for less than adequate and full consideration in money or month’s worth. See IRC Section 2056(b)(1).

For example, if Tom bequeaths $100,000 in trust to pay the income to Lisa for 20 years, remainder to Tom, Jr., Lisa’s term interest is nondeductible because 1) it will terminate upon the lapse of 20 years, and 2) upon the termination of that interest the trust will pass to Tom, Jr., for less than adequate and full consideration in money or money’s worth. On the other hand, if Tom bequeaths to Lisa his remaining term interest in a patent interest passing to Lisa qualifies for the marital deduction. While Lisa’s interest terminates at the end of the patent’s term, upon the termination of her interest no interest passes to any other person for less than adequate and full consideration in money or money’s worth.

The nondeductible terminable interest rule is subject to a number of important exceptions. First, if the spouse’s interest will terminate because the gift to the spouse is conditioned upon the spouse surviving the decedent by six months or less, or upon the spouse and the decedent not dying as the result of a common accident or disaster, and in fact the spouse’s interest does not terminate, the property passing to the spouse qualifies for the marital deduction. See IRC Section 2056(b)(3).

Second, if the property passing from the decedent passes in form such that 1) the spouse is entitled to all of the income from the property, or a specific portion thereof, for payable at least annually, 2) the spouse has a power to appoint the property either to herself or to her estate which is exercisable alone and in all events and 3) no person, except the spouse, has a power to appoint the property to any person other than the spouse, the property passing from the decedent qualifies for the marital deduction. See IRC Section 2056(b)(5). To illustrate, below, please find Illustration 1.

Illustration 1. Suppose Sue creates a $100,000 trust to pay income to Tom for life, remainder to such persons, including Tom’s estate, as he appoints by will and in default of appointment to Craig. Sue’s estate is entitled to a marital deduction in the amount of $100,000. The marital deduction would be allowable even though Tom had a special inter vivos power of appointment exercisable in favor of his issue, in addition to his testamentary general power. The trust would qualify for a $100,000 marital deduction even if the trustee of the trust could invade the trust corpus for Tom. However, if the trustee could invade the corpus for the benefit of another person, other than Tom’s dependent and in satisfaction of his legal obligation of support the trust would not qualify for the marital deduction. Property qualifying for the marital deduction under the life estate/power of appointment (a power of appointment is a legal mechanism where one person (the donee) is granted the authority to decide who will receive a specific asset or assets) exception will be included in the surviving spouse’s estate tax base either because the spouse exercises the general power (a general power of appointment means the holder has the right to decide who will receive assets subject to the power, including themselves) at the time of his death. See IRC Section 2041.

Third, property transferred to the spouse for life, remainder to the spouse’s estate qualifies for the marital deduction even if the spouse is not entitled to the income for life or the income may be paid to the spouse or accumulated.

Fourth, under Section 2056(b)(7) qualified terminable interest property passing from the decedent to the surviving spouse qualifies for the marital deduction. Qualified terminable interest property (“QTIP”) is property in, or with respect to, which (1) the spouse is entitled to all of the income for life payable at least annually, (2) no person, including the spouse, has the power to appoint any of the property to someone other than the spouse during the spouse’s lifetime and 3) the executor has made an election that the property should qualify for the marital deduction. To illustrate, below, please find Illustration 2.

Illustration 2. A transfer from Tom to Lisa for life, remainder to Craig qualifies as a QTIP so long as no one can appoint the property to someone other than Lisa during her life. To assure that a QTIP enters into the surviving spouse’s transfer tax base either under the gift or the estate tax, Section 2519 and Section 2044 were enacted. If a person with a qualifying income interest for life in QTIP transfers that income interest to another, the person is deemed to also have transferred the remainder interest. Whether or not the transfer of the income interest is a transfer for less than adequate and full consideration in money or money’s worth, a transfer of that interest also results in a transfer of the remainder under Section 2519. When the spouse who possesses a qualifying interest in QTP dies, the QTIP is included in the spouse’s gross estate under Section 2044 unless during the spouse’s life a Section 2519 transfer occurred. If the spouses follow certain guidelines, a QTIP trust allows the surviving spouse to benefit from the trust and be able to use the marital deduction. The QTIP trust must only benefit the surviving spouse during their lifetime, and this must be specifically provided for in the trust document and unchanged by the spouse or trustee. Otherwise, the QTIP trust will not receive the marital deduction. After the benefiting spouse passes, the QTIP trust assets pass to the beneficiaries as set by the granting spouse, not the benefiting spouse.

Treaties and the Marital Deduction

The estates of a nonresident domiciliaries are generally not entitled to a marital deduction (a marital deduction is a trust in which transfers of property between married partners are free of federal transfer tax) for U.S. estate tax purposes other than for property passing to qualified domestic trust or “QDOT” to a surviving spouse that is a U.S. citizen. There are a number of treaties that abrogate these rules. For example, Denmark and United Kingdom Estate, Gift, and Generation-Skipping Tax Treaties provide for an unlimited marital deduction for property which would have been eligible for such a deduction had the decedent been domiciled in the U.S. at his death. We will discuss various provisions contained in tax treaties below that contain provisions for the marital deduction.

The United States Estate, Gift, and Generation-Skipping Tax Treaties with Denmark and the United Kingdom

Denmark and the United Kingdom’s treaties with the United States provide for an unlimited marital deduction which would have been eligible for such a deduction had the decedent been domiciled in the U.S. at his death. Under these treaties, individuals domiciled in Denmark or the United Kingdom can claim a valuable marital deduction for purposes of U.S. estate or gift taxes as if they were U.S. citizens. This offers a significant planning opportunity for mitigating the consequences of the U.S. estate and gift tax. The United States-United Kingdom Estate, Gift, and Generation-Skipping Tax Treaty goes one step further and increases the unified credit from $60,000 to $13.99 million (in 2025) for individuals domiciled in the United Kingdom to the same amount as a U.S. citizen or resident. Article (5) of the United States United Kingdom estate, gift, and generation skipping tax treaty states as follows:

Where property may be taxed in the United States on the death of a United Kingdom National who was neither domiciled in nor a national of the United States and a claim is made under this paragraph, the tax imposed in the United States shall be limited to the amount of tax which would have been imposed had the decedent become domiciled in the United States immediately before his death, on the property which would in that event have been taxable.

The related U.S. Treasury Technical Explanation for this provision states as follows: Article 8 Paragraph(5) provides that U.S. tax imposed on the estate of a national of the United Kingdom, who was neither domiciled in nor a national of the United States, will be greater than the tax which would have been imposed if the decedent had been domiciled in the United States and taxed by the United States on his worldwide property.

Paragraph (5) does not require a formal election; the appropriate information need only be included in an estate tax return, which is filed or amended within the applicable time period. This provision may benefit the estates of U.K. citizens with assets in the United States as long as the worldwide estate of the decedent does not exceed ($13.99 million for 2025).

United States-German Estate, Gift, and Generation Skipping TaxTreaty

Not all estate and gift tax treaties are as simple and generous as the United States’ treaties with Denmark and the United Kingdom. This is demonstrated by the U.S.-German Estate, Gift, and Generation-Skipping tax treaty. Under the U.S.-German Estate, Gift, and Generation-Skipping Tax Treaty, interspousal transfers are excluded from a qualifying decedent’s gross estate for U.S. estate tax purposes to the extent that their value does not exceed 50 percent of the value of all property included in the U.S. taxable base. This marital deduction is limited to the amount that would reduce the U.S. estate tax due to what would apply to U.S. citizens or resident aliens. Under the wording of the United States-German Estate, Gift, and Generation-Skipping Tax Treaty, the estate would then be subject to U.S. tax in the lower amount of a) the figure determined using the marital deduction; or b) that generally imposed upon nonresident aliens under U.S. law.

In general, the treaty provides the following benefits to foreign investors that are residents of Germany:

1. The estate of a German domiciliary may claim a proportion of U.S. estate unified credit based upon the respective values of the decedent’s U.S. gross estate and his worldwide gross estate.
2. An estate of a German domiciliary is entitled to a marital deduction equal to the value of any “qualified property” passing to the decedent’s surviving spouse so long as such amount would qualify for the U.S. estate marital deduction if the surviving spouse were a U.S. citizen and all applicable elections were properly made, providing that:
   1. At the time of the decedent’s death, both the decedent and the surviving spouse were domiciled in either the U.S. or Germany; and
   2. If the decedent and the surviving spouse were at the time both U.S. domiciliaries and one or both of them were German citizens; and
   3. The executor of the decedent’s estate elects to use the marital deduction treaty benefits and irrevocably waives the right to make a QDOT election on behalf of the estate.

To illustrate how the pro rata unified credit and the marital deduction are applied, the Treasury Department has provided a number of examples in the Treasury Department’s Technical Explanation to the protocol governing estate tax in the United States-German estate, gift, and generation skipping tax treaty illustrates the operation of the pro rata unified credit and marital deduction. The examples provided by the Treasury Department provide as follows: for purposes of these examples, presume that: 1) H (the decedent) and W (his surviving spouse) are German citizen residents in Germany at the time of the decedent’s death; 2) H died in 2016, when the Section 2010 unified credit was $2,125,800 and the related applicable exclusion amount was $5,450,000; 3) the conditions set forth in the Protocol are satisfied; 4) no deductions are available under the Internal Revenue Code in comparing the U.S. estate tax liability. Please see illustrations 1 and 2 below for a more detailed discussion regarding the U.S.-Germany Estate and Gift Tax Treaty.

Illustration 1. (i) H has U.S. real property worth $10,000,000, all of which he bequeaths to W. The remainder of H’s estate consists of $10,000,000 of German situs property. (ii) Pursuant to the existing marital deduction provision of the Germany Treaty [Article 10(4), as modified by the Germany Protocol], the U.S. gross estate equals $5,000,000 [the amount by which the $10,000,000 of U.S. real estate bequeathed to W exceeds $5,000,000 (50 percent of the total value of U.S. property taxable by the United States under the Germany Treaty)]. H’s worldwide gross estate equals $15,000,000 ($5,000,000 plus $10,000,000 of German situs property). (iii) The $5,000,000 U.S. gross estate is reduced by the $2,500,000 marital deduction of Germany Treaty Article 10(6), resulting in a $2,500,00 U.S. taxable estate. The tentative tax on the taxable estate equals $945,800. H’s estate would also be entitled to the pro rata unified credit allowed by Germany Treaty Article 10(5) of $708,600 [$2,125,800 (the full 2016 unified credit) x $5,000,000/$15,000,000 (the $5,000,000 U.S. gross estate divided by the $15,000,000 worldwide gross estate)]. Thus, the total U.S. estate liability is approximately $237,200 ($945,800 – $708,600 = $237,200).

Illustration 2. (i) The facts are the same as in Illustration 1 except that H bequests $1,000,000 of his real property to W and $9,000,000 of his real property to C, H’s child. (ii) The $9,000,000 of U.S. real property bequeathed to C is included in H’s U.S. gross estate. Pursuant to the U.S.-Germany Treaty Article 10(4), none of the U.S. real property bequeathed to W is included in the gross estate because such property would be included only to the extent its value (i.e., $1,000,000) exceeded 50 percent of the $10,000,000 total U.S. situs property taxable under the applicable provisions of the Germany Treaty. H’s worldwide gross estate equals $19,000,000 ($9,000,000 plus $10,000,000 of German situs property). (iii) Because none of the U.S. situs property bequeathed to W is included in the U.S. gross estate, the property is not “qualifying property,” and therefore no marital deduction is allowed with respect to that property under Germany Tax Treaty Article 10(6). The tentative tax on the $9,000,000 gross estate equals $3,545,800. H’s estate would also be entitled to the pro rata unified credit allowed by Germany Treaty Article 10(5), which equals approximately [$2,125,800 (the full 2016 unified credit), multiplied by a fraction equal to the $9,000,000 U.S. gross estate over the $19,000,000 worldwide gross estate. Thus, the total U.S. estate tax liability is $2,538,843 ($3,545,800- $1,006,957). See Estate and Gift Taxation of Nonresident Aliens in the United States, Michael Rosenberg (2016).

Although not as generous as the U.S. treaties with Denmark and the United Kingdom, the US-German estate tax treaty significantly increases the unified credit for foreign investors domiciled in Germany. The treaty also establishes a partial marital credit that is unavailable to individual foreign investors domiciled in many other countries.

The United States-Canadian Income Tax Treaty

The U.S.- Canada Income Tax Treaty also provides relief from the U.S. estate tax. (However, the treaty does not provide any relief from the U.S. gift tax). Some Canadian citizens in the U.S. are also able to enjoy an estate tax marital deduction. The U.S.- Canadian Income Tax Treaty provisions relevant to the U.S. estate tax may be summarized through the following points and illustrations:

Canadian residents are not subject to U.S. estate tax unless their gross worldwide estate exceeds $13.99 million (for 2025 calendar year). Below, please see Illustration 1. which discusses how the U.S.- Canada Income Tax Treaty applies to U.S. estate tax.

Illustration 1. Justine Lieber owns a vacation home in Florida with a value of $10,000,000, unencumbered by a mortgage. His other worldwide assets amount to U.S. $1,000,000. There will be no U.S. estate tax whether or not Justine Lieber is survived by his spouse. This is because Canadian citizens who die owning U.S. assets are entitled to a credit against his or her U.S. estate tax liability in an amount equal to that proportion of the U.S. unified credit as his U.S. situated estate would apply to his worldwide estate. Below, please find Below, please see Illustration 2. which provides a more detailed discussion as to how the U.S.-Canadian Income Tax Treaty operates.

Illustration 2. Bryan Bosling, a Canadian resident, owns vacation homes in California and Hawaii with a value of $10,900,000, unencumbered by mortgage, and Canadian property valued at $10,900,000. If Bryan Bosling died, his estate, for U.S. estate tax purposes would be entitled to a credit of U.S. $4,417,800 [the U.S. $4,417,800 (for proration of unified credit for 2018) “unified credit” x [(U.S. assets)/(Worldwide assets) ($10,900,000 + $10,900,000 = $21,800,000]. U.S. Worldwide Assets x $4,417,800 unified credit (2018) = $96,308 Bryan Bosling’s estate tax will be U.S. $96,308 unless Bryan Bosling is married and makes a qualifying transfer to a Qualified Trust. Instead of relying on the rule that allows a deduction for bequests by a Canadian resident to a non-U.S. citizen spouse provided assets are timely transferred to a QDOT, the U.S. will allow an election to be made for an additional nonrefundable marital credit up to the amount of the proportionate credit. The purpose of this limited marital credit was to alleviate, in appropriate cases, the impact of the estate tax marital deduction restrictions enacted by the Congress in the Technical and Miscellaneous Act of 1988 (“TAMRA”). The U.S. negotiators believed that it was appropriate, in the context of the Canada Protocol, to ease the impact of those TAMRA provisions upon certain estates of limited value. Below, please find Illustration 3, which demonstrates the marital deduction under the U.S.-Canada treaty.

Illustration 3. The facts are the same as in Illustration 3. Bryan Bosling leaves the U.S. residence to his Canadian spouse. The additional marital deduction “credit” equal to the $10 million “unified credit” will eliminate the $96,38 liability otherwise due, but any excess marital deduction credit does not result in a refund. The decedent’s estate may also need to make an allocation between the decedent’s worldwide assets and U.S. assets to claim a unified credit and marital credit.

The United States-France Estate, Gift, and Generation Skipping Tax Treaty

The U.S.- France Estate, Gift, and Generation-Skipping Tax provides French residents provide interspousal transfers that are excluded from a qualifying decedent’s gross estate for U.S. estate tax purposes to the extent that their value does not exceed 50 percent of the value of all property included in the U.S. taxable base. As with the U.S.- German Estate, Gift, and Generation Skipping Tax, this marital deduction is limited to the amount that would reduce the U.S. estate tax due to what would apply to U.S. citizens or resident aliens.

Conclusion

The foregoing discussion is intended to provide the reader with a basic understanding regarding utilizing treaties to obtain a marital deduction. It should be evident from this article, however, that this is a relatively complex subject. As a result, it is crucial that foreign individuals that hold U.S. assets consult a qualified tax attorney.

Anthony Diosdi is an international tax attorney at Diosdi & Liu, LLP. Anthony focuses his practice on domestic and international tax planning for multinational companies, closely held businesses, and individuals. Anthony has written numerous articles on international tax planning and frequently provides continuing educational programs to tax professionals. He has assisted companies with a number of international tax issues, including Subpart F, GILTI, and FDII planning, foreign tax credit planning, and tax-efficient cash repatriation strategies. Anthony also regularly advises foreign individuals on tax efficient mechanisms for doing business in the United States, investing in U.S. real estate, and pre-immigration planning. Anthony is a member of the California and Florida bars. He can be reached at 415-318-3990 or adiosdi@sftaxcounsel.com.

This article is not legal or tax advice. If you are in need of legal or tax advice, you should immediately consult a licensed attorney.