A Closer Look at QDOTs and the Blended International Couple

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. For estate tax purposes, the QTIP trust assets apply to the benefiting spouse’s applicable exclusion amount.

Please find Illustration 3 which provides examples of partial QTIP Election Language for a trust. Illustration 3. Pursuant to section………of the Last Will and Testament of Decedent, the residue of the Estate of Decedent passes to the (QTIP) Trust, established under section…… of said will. (Surviving Spouse) has a qualifying income interest, as defined in Internal Revenue Code Section 2056(b)(7) and regulations thereunder, in such trust, and thus the trust is able to be qualified as a Qualified Terminable Interest Property trust. This election is being made with respect to a part of the trust, as defined by a fraction or percentage of the entire trust. This fraction or percentage is defined by the following formula, as allowed by regulation Section 20.2056(b)-7(b)(2): 1 – (x divided by y)

Where x = the greatest amount that can pass free of federal estate tax in Decedent’s estate, taking into account all relevant tax credits (including, but not limited to, (i) the unified credit provided by Internal Revenue Code Section 2010, (ii) the credit for state death taxes provided by Internal Revenue Code Section 2011, and (iiii) any credit or reduction in adjusted taxable gifts provided by Chapter 14 of the Internal Revenue Code) and other factors pertinent to the computation of the federal estate tax in Decedent’s estate (including, but not limited to, any transfers of property, including in the gross estate, to specific beneficiaries other than the surviving spouse, by will or otherwise), but only to the extent that the use of any such credit or the consideration of any such factor does not increase the amount of death taxes otherwise payable to any taxing authority by reason of Decedent’s death ; and Where y = the total gross estate, less the sum of expenses of administration, indebtedness and taxes; losses; transfers for public, charitable and religious uses; and all property interests including in the gross estate transferred to specified beneficiaries, including the surviving spouse, by will or otherwise. For the estate of Decedent, based upon the amounts as reflected in this United States Estate (and Generation-Skipping Transfer) Tax Return, Form 706, the fraction is …….

The Noncitizen Surviving Spouse

Section 2056(d) generally disallows the marital deduction to the estate of any decedent if the decedent’s surviving spouse is not a citizen of the United States. However, a citizen spouse may gift up to $190,000 (in 2025) to a noncitizen spouse annual gift tax-free. Section 2056(d) applies regardless of whether the surviving spouse is a United States resident. See Treas. Reg. Section 20.2056A-1(a). Congress enacted Section 2056(d) out of concern for the subsequent collection of transfer tax from the estate of the noncitizen spouse, where that spouse could avoid such tax by giving up United States residency. See HR Rep. No. 795, 100th Cong., 2d Sess. 592 (1988).

The marital deduction is allowed with respect to any of the decedent’s property passing to the noncitizen surviving spouse in a QDOT, as defined in Section 2056A. The QDOT arrangement permits a decedent’s estate to postpone payment of the decedent’s estate tax, generally until the surviving spouse’s death. The postponed tax is imposed on the QDOT property revalued at the time of taxation at the decedent’s top marginal estate tax rate and the property held in the QDOT taxed as if it had been included in the decedent’s gross estate. See IRC Section 2056A(b)(2)(A). If the property passing to a surviving noncitizen spouse will be subject to tax in the decedent spouse’s gross estate either, because a marital deduction is denied by Section 2056(d)(1)(A) or because taxation of the property in the decedent’s estate is postponed until a subsequent time as a result of its transfer to a QDOT and if the property is also subject to estate tax in the surviving spouse’s gross estate, then the surviving spouse’s estate is allowed a full credit under Section 2013 for the estate tax paid by the decedent’s estate.

Section 2056 and QDOTs

An estate tax marital deduction is generally not permitted for property that passes from a decedent to a surviving spouse who is not a citizen of the United States because of a Congressional concern over the ability of the United States to subsequently collect tax from the noncitizen surviving spouse. In the legislative history, Congress stated that the ‘[p]roperty passing to an alien surviving spouse is less likely to be includable in the spouse’s estate, since to avoid taxation on the worldwide estate, the spouse must only give up U.S. residence”. See HR Rep. No. 795, 100th Cong., 2nd Sess. 592 (1988). However, if the property passes to the noncitizen surviving spouse in a QDOT, a marital deduction may be permitted. With that said, unlike a typical marital deduction transfer which results in the transferred property being includable in the estate of the surviving spouse, the deduction merely results in the postponement of the imposition of estate tax on the QDOT property as a part of the estate of the transferor spouse. See IRC Section 2056A(b). The QDOT property is revalued at the time of the postponed taxation, either during the surviving spouse’s lifetime or at the spouse’s death. See IRC Section 2056A(b).

The QDOT Passing Requirement

Property must “pass” to the surviving spouse in a QDOT to qualify for postponement of taxation under the applicable provisions of the Internal Revenue Code. (The term “property” includes any property interest). Generally, the property will pass directly from the decedent’s estate to the QDOT. However, property may “pass” to the surviving spouse to a QDOT in following ways.

Reformation Into a QDOT

Property will be treated as passing to the surviving spouse in a QDOT even though it passes from the decedent to a trust which is not initially a QDOT if, after the decedent’s death, the trust is reformed to satisfy the QDOT requirement. The trust can be reformed pursuant to the terms of the decedent’s will, the terms of the trust itself, or a judicial proceeding. See Treas. Reg. Section 20.2056A-4(a)(1). If reform occurs pursuant to the decedent’s will or the trust, Section 2056(d)(5)(A)(i) states that the QDOT qualification must be completed by the time prescribed (including extensions) for filing the decedent’s federal estate tax return. If there is a judicial reformation, the reformation must occur on or before the due date for the decedent’s return (including extensions granted). See IRC Section 2056(d)(5)(A)(ii).

The Surviving Spouse’s Transfer to a QDOT

If a decedent’s property passes outright to a noncitizen surviving spouse as a result of a bequest, devise, operation of law, a marital deduction is disallowed because the outright transfer is not held in a QDOT. However, if the surviving spouse assigns the property to a QDOT, the property is treated as “passing” to the noncitizen spouse in a QDOT. The transfer or assignment of property to the QDOT must be in writing and must occur before the decedent spouse’s estate tax return is filed and during the period allowable for making a QDOT election. If there is a timely valid assignment, the actual transfer of the assigned property to the QDOT must occur before the administration of the decedent’s estate is completed. See IRC Section 2056(d)(2)(B)(i). Only assets that are included in the decedent’s gross estate and pass to the spouse at death may be transferred or assigned to the QDOT. Thus, the surviving spouse cannot fund the QDOT with property owned by such spouse before the decedent’s death in lieu of decedent’s property. The transfer or assignment may be of a specific asset, group of assets, a fractional share of assets or a pecuniary amount ; if the transfer or assignment is of less than an entire asset or group of assets, it may be expressed as a formula amount. See Treas. Reg. Section 20.2056A-4(b)(2).

If the transfer or assignment is in the form of a pecuniary amount, the assets actually transferred must meet one of two tests. They may have a value equal to the pecuniary amount on the transfer date. In the alternative, the amount can be satisfied on the basis of an estate tax valuation date if they are fairly representative of appreciation or depreciation in the value of all property available for transfer or assignment occurring between the valuation date and transfer or assignment date. A protective assignment or transfer of property to a QDOT is permitted if there is a bona fide controversy that concerns the residency or citizenship of the decedent, the citizenship of the surviving spouse, the inclusion of all or part of an asset in decedent’s gross estate, or the specific property that the surviving spouse is entitled to receive. See Treas. Reg. Section 20.2056A-4(b)(8).

An Annuity or Other Arrangement Treated as Passing to a QDOT

An annuity or other arrangement that is not assignable or transferable to a QDOT under federal, state or foreign law or under the terms of the plan or arrangement, and but for Section 2056(d)(1)(A) would otherwise qualify for a marital deduction to the decedent’s estate, is treated as passing to a QDOT if the surviving spouse exercises one of two options. (The term annuity or other arrangement include employee plan benefits, tax sheltered annuities, and tax deferred annuities). Both options involve actions with respect to the “corpus portion” of the annuity or other arrangement.

Under the first option, the surviving spouse must agree to pay the deferred QDOT tax annually on the corpus portion of each annuity or arrangement payment that the surviving spouse receives. See Treas. Reg. Sections 20.2056A-4(c)(2)(i); 20.2056A-4(c)(6). In addition, pursuant to Treasury Regulation Sections 20.2056A-4(c)(2)(ii); 20.2056A-4(c)(2)(iv), the executor of the decedent’s estate: 1) Must file an information statement signed by the surviving spouse with decedent’s estate tax return, which must contain the items listed in Treasury Regulation Section 20.2056A-4(c)(5); 2) Must file an “Agreement To Pay Section 2956A Estate Tax” discussed in Treasury Regulation Section 20.2056A-4(c)(6) signed by the surviving spouse ; and 3) Must make a timely QDOT election with respect to the nonassignable annuity or other payment.

Under the second option, the surviving spouse must agree to transfer or roll over the corpus portion of each payment to a QDOT within 60 days of the surviving spouse’s receipt of the payment. See Treas. Regs Sections 20.2056A-4(c)(3); 20.2056A-4(c)(7).

Requirement of a QDOT

To qualify as a QDOT, the trust to which property passes must satisfy several statutory and nonstatutory requirements that principally ensure the Internal Revenue Service’s (“IRS’s”) ability to collect the federal estate tax on the decedent spouse’s property passing to the QDOT.

1. The trust must be established by a document executed under the laws of a state of the United States, the District of Columbia or under a foreign jurisdiction. If executed under the laws of a foreign jurisdiction, the document must designate the laws of a foreign jurisdiction, the document must designate the laws of a particular state of the District of Columbia as governing the trust’s administration and such designation must be effective under the law of the designated jurisdiction. See Treas. Reg. Section 20.2056A-2(a).

2. The trust instrument must require that at least one trustee of the trust be a United States citizen or a domestic corporation that is commonly referred to as a “United States Trustee”. See IRC Section 2056A(a)(1)(A). A domestic corporation is a corporation created or organized under the laws of the United States, any state, or the District of Columbia. All the trustees of the trust, whether United States Trustee or not, are personally liable for payment of the estate tax imposed on certain distributions from or property held in the QDOT.

3. The QDOT instrument must provide that no corpus distribution can be made from the trust unless the United States Trustee has the right to withhold the amount of tax liability that will be imposed upon the distribution. See IRC Section 2056A(a)(1)(B).

4. If the value of the assets passing to the QDOT at the time of the decedent spouse’s death exceeds $2 million, then at all times during the term of the trust, the trust instrument must satisfy at least one of three requirements. The QDOT may vary which of the requirements is satisfied as long as, at any given time, one of them is satisfied.

Under the first alternative requirement, during the trust’s entire term, the trust instrument must require that at least one United States Trustee be a domestic bank or that a United States branch of a foreign bank is a trustee with a United States Trustee as a co-trustee. See Treas. Reg. Section 20.2056A-2T(d)(1)(i)(A).

Under the second alternative requirement, the trust instrument must require the United States Trustee to furnish a bond in favor of the IRS in an amount equal to at least 65% of the fair market value of the trust corpus as determined for estate tax purposes. See Treas. Reg. Section 20.2056A-2T(d)(1)(i)(B). The bond must generally remain in effect until the termination of the QDOT and the payment of any tax liability finally determined under Section 2056A(b), unless the QDOT notifies the IRS that it will satisfy one of the two other requirements within thirty days of having notified the IRS of failure to renew. There are several additional requirements that the bond must satisfy. In addition, the bond must be drafted as provided in the regulations and it is generally required to be filed by the executor with the decedent’s federal estate tax return. See 20.2056A-2T(d)(1)(i)(B)(2).

Under the third alternative requirement, the trust instrument must require the United States Trustee to furnish security in the form of an irrevocable letter of credit in an amount equal to at least 65% of the fair market value of the trust corpus as finally determined for estate tax purposes. See Treas. Reg. Section 20.2056A-2T(d)(1)(i)(C). The letter of credit must generally remain in effect until the termination of the QDOT and the payment of any tax liability determined to be due under Section 2056A(b), unless the QDOT notifies the IRS that it will satisfy one of the two other requirements within 30 days of having notified the IRS of failure to renew or closure of the United States branch. The letter of credit must be drafted as provided by Treasury Regulation Section 20.2056A-2T(d)(1)(C)(2), and is generally required to be filed by the executor with the decedent’s federal estate tax return. See Treas. Reg. Section 20.2056A-2T(d)(1)(i)(C)(5).

5. A QDOT must meet various requirements to ensure the collection of tax. The primary determinant of which set of requirements applies is whether or not the value of the QDOT assets as finally determined for estate tax purposes exceeds $2 million. In measuring the value of the QDOT assets for determining which set of regulatory requirements apply, the value employed is the fair market value as finally determined for federal estate tax purposes at the date of decedent’s spouse’s death or the alternative valuation date (if applicable), determined without any reduction for indebtedness with respect to the assets. See Treas. Reg. Section 20.2056A-2T(d)(1)(i) and (ii). If more than one QDOT is established, the value of the assets of the QDOTs is aggregated. In determining whether the $2 million threshold is exceeded, the executor of the decedent’s estate may elect to exclude from the value of the QDOT up to $600,000 wherever situated along with related furnishing (the elective exclusion is not available in determining whether more than 35 percent of the QDOT (discussed below) assets consists of foreign real property) that is owned directly by the QDOT and is used as the principal residence of the surviving spouse. See Treas. Reg. Section 20.2056A-2T(d)(1)(iii)(A). (The residence may not be held in a corporation or partnership owned by the QDOT). If the residence ceases to be used as the surviving spouse’s principal residence or is sold and the proceeds are not reinvested in another principal residence within 20 months of the sale, the exclusion ceases to apply. See Treas. Reg. Section 20.2056-2T(d)(1)(iii)(G). Should the executor elect to exclude a principal residence from the computation, the United States Trustee must file an annual report with respect to the exclusion.

6. If the determined value of the assets passing to the QDOT at the decedent’s death valued in the manner above is not in excess of $2 million, the trust instrument may provide for the trust to satisfy any of the three alternative requirements above, or it may require that no more than 35% of the fair market value of the trust assets determined annually consist of real property located outside the United States. If the 35% foreign realty alternative is used, some special rules apply. First, the elective principal residence exclusion is not applicable. Second, a special look-through rule applies if the QDOT owns 20 percent or more of the voting stock or value in a corporation with 15 or fewer percent or more of a capital interest in a partnership with 15 or fewer partners. The purpose of this look-through rule is to determine whether the QDOT owns real estate located outside the United States through a corporation or partnership. In applying the 20 percent and fifteen member tests, stock or partnership interests owned by or for the benefit of the surviving spouse or members of the surviving spouse’s family as defined in Section 267(c)(4) are treated as owned by the QDOT. Section 267(c)(4) is one of several sets of constructive ownership rules in the Internal Revenue Code. Its principal role is to treat an individual as owning stock that is owned by various related parties. The attribution rules in Section 267(c)(4) fall into the following four categories:

• 1) Stock owned, directly or indirectly, by or for a corporation, partnership, estate, or trust shall be considered as being owned proportionately by or for its shareholders, partners, or beneficiaries;
• 2) An individual shall be considered as owning the stock owned, directly or indirectly, by or for his family;
• 3) An individual owning any stock in a corporation shall be considered as owning, directly or indirectly, by or for his partner;
• 4) The family of an individual shall include only his brother and sister (whether by the whole or half blood), spouse, ancestors, and lineal descendants; and

Under Section 267(c)(4), all assets owned by the corporation or partnership are deemed to be owned directly by the QDOT to the extent of the QDOT’s pro rata share of actual ownership of the corporation or partnership. In addition, interests owned by the QDOT in other entities (such as a trust) are subject to a similarly applied look-through rule. (Section 267(c)(4) includes brothers and sisters whether by whole or half blood, spouses, ancestors, and lineal descendants as members of one’s family).

If the 35% foreign realty test is not met at the time of the annual reporting, the QDOT is not disqualified if one of the three other requirements applicable to a QDOT with assets in excess of $2 million (a bank trustee, a bond, or a letter of credit) is satisfied. The 35% test may not be met because of either distributions of QDOT principal during the year or fluctuations in the value of the currency in the country where the real estate is located. If one of these circumstances occurs, the QDOT is not disqualified if, by the end of the succeeding year, either the value of the foreign real property held by the QDOT does not exceed the 35% test or the QDOT meets one of the three alternatives requirements applicable to a QDOT with assets in excess of 2 million.

7. Rules Applicable to both Classifications of QDOTs The United States Trustee of a QDOT is required to file an annual written report in several circumstances. If the QDOT uses the less than 35% foreign real estate alternative and the QDOT owns any foreign real estate either directly or under the Section 267(c)(4) rules on the last day of its tax year, the United States Trustee is required to make an annual report with the IRS. The annual report is done on a Form 706-QDT, U.S. Estate Tax Return for Qualified Domestic Trusts. The United States Trustee must also make an annual reporting if the principal residence exclusion applies to the QDOT during the year, or if a principal residence previously subject to the exclusion is sold or ceases to be used as a principal residence. For the above discussed situations, the report must include identification of the United States Trustee, a current valuation of trust assets including those subject to Section 267(c)(4) rules, and, if applicable, information regarding any sale of a principal residence or cessation of use of a residence as a principal residence. The report is generally required to be filed by April 15th of the following year. The failure to timely file reports to the IRS may result in the disqualification of the QDOT.

8. A QDOT Election The decedent spouse’s executor must make an irrevocable QDOT election on the decedent’s federal estate tax return. The election must be made on the last federal estate tax return filed before the due date (including extensions that have been granted). If no timely return is filed, the election may be made on the first return filed after the due date, but only if such election is made within one year of the time (including granted extensions) such return is required to be filed.

9. Marital Deduction Qualification The property passing from a decedent directly to a QDOT must generally satisfy the requirements of Section 2056. Thus, the property must be included in the decedent’s gross estate, must pass to the surviving spouse, and must satisfy the terminable interest rule.

Taxation of QDOT Property

The imposition of estate tax on the property in the decedent spouse’s estate that qualifies as QDOT property is deferred by allowing the decedent’s estate a marital deduction for the value of such property. The decedent’s spouse’s estate tax liability on the property is generally deferred until the property is distributed from the QDOT, the surviving spouse dies, or the QDOT ceases to qualify as a QDOT.

If there is a distribution of principal from the QDOT during the surviving spouse’s lifetime, the distribution is generally subject to tax when made. However, tax is not imposed if the distribution is a distribution of income, a corpus distribution to the surviving spouse on account of hardship, a distribution to reimburse the surviving spouse for federal income tax paid on an item of QDOT income that the surviving spouse is not entitled to receive under the terms of the trust, or an administrative distribution or disposition. See Treas. Reg. Sections 20-2056A-5(c)(3)(i); 20.2056A-5(5)(c)(3)(iiii). A distribution is for hardship if it is in response to “an immediate and substantial financial need relating to the spouse’s health, maintenance, education, or support or the health, maintenance, education, or support of any person that the surviving spouse is legally obligated to support”. See Treas. Reg. Section 20.2056A-5(c)(3)(iv). The value of any property remaining in the QDOT is subject to tax. If the property remaining in the QDOT at the surviving spouse’s death is includable in that spouse’s gross estate (or would be includable if such spouse were a resident of the United States).

Upon the occurrence of a Section 2056A taxable event, a deferred estate tax is imposed on the decedent’s estate. The property is taxed as if it had originally been included in the decedent’s taxable estate, but the property is valued on the date of the subsequent taxable event. On the first imposition of tax on the QDOT property, the value of the property taxed is added to the amount of the decedent’s taxable estate and adjusted taxable gifts. A tax on the total amount is computed using the Section 2001(c) rates in effect on the date of the decedent’s death. That amount of tax is then reduced by Section 2001(c) tax on the amount of the decedent’s original taxable estate and adjusted taxable gifts.

Liability for and Payment of the Tax

The date for the payment of the tax depends upon the taxable event that triggers the tax. If the tax is due as a result of the death of the surviving spouse, the tax is to be paid nine months from the date of the death. If the taxable event is a taxable distribution from the trust, the tax is generally due on April 15 of the year following the calendar year in which the distribution occurs. However, if the distribution occurs in the year of the surviving spouse’s death, the tax is due on the earlier of April 15 of the succeeding year or nine months after the date of the surviving spouse’s death.

Exception if Surviving Spouse Becomes a United States Citizen

Special rules apply if the surviving spouse becomes a United States citizen. If the surviving spouse becomes a United States citizen before the decedent’s estate tax return is filed and if such spouse was a United States resident at all times after the decedent’s death until becoming a United States citizen, there is no need for a QDOT and Section 2056(d) is inapplicable.

If the surviving spouse becomes a United States citizen after the decedent’s estate tax return is filed, a QDOT may be disregarded with respect to any subsequent distribution and at the surviving spouse’s death, if there is no subsequent need for the QDOT. A QDOT is disregarded if one of several alternative requirements is met. The requirements ensure that any prior taxable distributions from the QDOT do not escape the equivalent of taxation to the surviving spouse. A QDOT is disregarded after the surviving spouse becomes a citizen after decedent’s estate tax return is filed if either: 1) the surviving spouse was a resident of the United States at all times after the decedent’s death prior to becoming a citizen or 2) regardless of residency status, no QDOT tax was imposed under Section 2056A(b)(1)(A) on any distribution before the surviving spouse became a citizen and 3) under either of these alternatives, the United States Trustee notifies the IRS and certifies in writing to the IRS that the surviving spouse has become a United States citizen.

A separate alternative applies if the surviving spouse was not a resident at all times after the decedent’s death prior to becoming a citizen and if their prior distributions upon which tax was imposed under Section 2056A(b)(1)(A). In such circumstances, a QDOT is disregarded for periods after the surviving spouse becomes a citizen of the surviving spouse both: 1) elects to treat the prior taxable QDOT distributions as taxable gifts made by the surviving spouse for purpose of determining the rate of tax imposed on gifts made by the surviving spouse in the current and subsequent years and on the computation of the surviving spouse’s estate tax, and 2) elects to treat any of the decedent spouse’s Section 2010 unified credit allowed against such distributions as used by the surviving spouse, reducing the surviving spouse’s own Section 2505 unified credit in determining the subsequent estate and gift tax liability of the surviving spouse.

Conclusion

The foregoing discussion is intended to provide the reader with a basic understanding and tax considerations of a QDOT. It should be evident from this article, however, that this is a relatively complex subject, especially for the QDOT holds foreign real estate. It is important to note that this area is constantly subject to new developments and changes, as Congress enacts new tax laws and the IRS promulgates new regulations, rulings, announcements, and federal courts issue new opinions impacting the qualifications for QDOTs. As a result, it is crucial that anyone considering establishing a QDOT 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.