Globalization and advances in technology have brought created a very mobile population. This mobility has brought with it a number of international tax planning opportunities and pitfalls. For wealthy United States citizens who are married to non-United States citizens, failing to plan for the loss of the estate and gift tax marital deduction is one of the most frequent pitfalls.Generally gifts between spouses qualify for a 100% gift tax marital deduction. Gifts to non-spouses are not subject to gift taxes if the amount is less than $12,000 per year (assuming that the US citizen has consumed her $1,000,000 lifetime gift tax exclusion). On the other hand, gifts by a US citizen to a non-US citizen spouse do not qualify for the gift tax marital deduction. Instead, gifts from US citizens to non-citizens (be it a spouse or someone else) are not subject to gift tax if the amount is less than $120,000 per year.

Transfers between citizen spouses at death qualify for an estate tax marital deduction. Transfers to non-spouses at death do not qualify for this deduction. However, the decedent spouse can transfer up to $2,000,000 (in 2006) at death to a spouse or non-spouse citizen or non-citizen estate tax free.

As the above rules provide, it is often advantageous for wealthy US citizens to implement a lifetime gifting program for the benefit of non-US citizen spouses. If taken full advantage of, this could result allow $120,000 to be transferred to a non-citizen spouse free of gift tax. This annual gift is in excess of the citizen spouse’’s $1,000,000 lifetime gift tax exemption. These amounts can be even greater if the citizen spouse transfers property to the non-spouse that qualifies for a gift tax valuation discount (such as shares or an interest in a business that is not marketable or where the non-spouse does not gain control of the business).

For most taxpayers, these lifetime gifts should be sufficient to reduce the US citizen’s taxable estate below the $2,000,000 estate tax exclusion amount. In the event that the couple will still incur a federal estate tax upon the demise of the US spouse, the couple might consider establishing a qualified domestic trust or QDOT. The QDOT is simply a trust that, if the requirements are met, allows transfers at death to the trust for the benefit of the non-citizen to qualify for the 100% estate tax marital deduction. Generally to qualify as a QDOT a trust must have at least one US trustee, no distribution (other than income) can be made unless the US trustee can withhold the applicable US taxes from the distribution, and the executor must make an irrevocable QDOT election.

Unfortunately many taxpayers fail to properly account for inter-spousal transfers that they make during their lifetime and the fail to plan for transfers to non-citizen spouses upon their demise. This often results in the spouses, under state law, owning property acquired or earned during marriage jointly. In this situation, if the surviving non-citizen spouse cannot prove that they contributed to acquiring or improving the property, the full amount of the jointly owned property may be included in the US citizen’s estate - resulting in a significant US estate tax liability.

Ideally the citizen spouse’s estate documents would provide a QDOT that would receive any assets that the non-citizen spouse disclaimed. This would permit the non-citizen spouse to determine whether he or she would like to accept some or all of a transfer from his or her US spouse or to allow some or all of it to pass to the QDOT. The non-citizen spouse might also be able to become a US citizen prior to the US citizen spouse’s estate tax return is filed (which is generally due nine months after the spouse’s death) - even if the non-citizen spouse becomes a US citizen after the US spouse died. If these options fail but the assets pass to a trust for the benefit of the non-citizen spouse, the trust may be reformed so that it qualifies as a QDOT. In the US states that permit common-law marriage, US citizens who meet the state common law marriage requirements may be able to successfully demonstrate that they are married, in order to reform a non-QDOT trust to be a QDOT trust.

If these rules are not complex enough, life insurance, retirement and employee benefits can present a whole host of other complexities. Taking the time to properly plan for these transactions can significantly reduce the tax liabilities and help transition the transfer of assets from the US spouse to the non-citizen spouse.

By: Kreig Mitchell
1942 Broadway, Suite 314
Boulder, CO 80302
Ph. 303.521.0053
http://www.irstaxtrouble.com