Estate Planning for Marriages With A Non-Citizen Spouse

While traveling abroad as a student, John met Grace. Grace was a citizen of Spain. Love at first sight, they began a whirlwind courtship and got married. They returned to the United States and eventually settled down as residents of New Jersey. Intending to reside permanently in this country, she nevertheless maintained her Spanish citizenship.

Married for 10 years, they had three wonderful children. Then, John died suddenly. Although tragic, it appeared that he had properly provided with Grace. Between savings, a 401(k) and substantial life insurance, she was the sole beneficiary of his $3,000,000 estate.

Yet when she consulted an attorney to assist her with the administration of his estate, she was informed that she was required to pay an estate tax to the State of New Jersey of approximately $82,400. Aghast at this revelation, Grace told the attorney that she had been married to John for ten years and had paid income taxes since coming to New Jersey. Of course, she further told the attorney that her friends, as well as her “research on the internet”, revealed that she was not liable to pay any taxes because married couples don’t need to pay these taxes. Unfortunately, in her case, she was wrong.

The reality is that the tax laws often treat non-citizen spouses differently than those who are United States citizens. In general, when an individual dies as a resident of the State of New Jersey, his or her estate is subject to three potential death taxes: (1) the Federal Estate Tax, (2) the New Jersey Estate Tax, and (3) the New Jersey Transfer Inheritance Tax.

The Inheritance Tax is imposed upon the heirs of an estate. A spouse is considered to be what is known as a Class A beneficiary who is exempt from this tax. For this tax, there is no requirement that a spouse be a citizen in order to be a Class A beneficiary. Thus, Grace is not required to pay this tax.

The Federal Estate Tax and the New Jersey Estate Tax are taxes upon the overall size of a decedent’s estate. There are two primary exemptions from these taxes: (a) the marital deduction and (b) the applicable exclusion amount. The marital deduction exempts spouses from paying any estate tax regardless of the amount received when their husband or wife dies. The applicable exclusion amount is that sum that may pass from a decedent’s estate prior to it being assessed with the estate tax.

Unlike the inheritance tax, a surviving spouse must be a United States Citizen to qualify for the marital deduction. Thus, if a surviving spouse is not a US citizen when his or her spouse dies, he or she is not eligible for the marital deduction and the deceased spouse’s estate is assessed a tax for the amount exceeding the applicable exclusion amount.

For the Federal Estate Tax, the applicable exclusion amount is adjusted annually for inflation. For 2017, this amount is $5,490,000. As John’s estate is less than this amount, no Federal Estate Tax will be due.

For the New Jersey Estate Tax, the applicable exclusion amount is $2,000,000. (The tax is scheduled to be eliminated in 2018, but there is a distinct possibility it will be restored.) Although New Jersey exempts non-citizen spouses from its inheritance tax, it does not do so for its estate tax as its estate tax regulations are tied into the federal regulations. Thus, in this case, the initial $2,000,000 from John’s estate passes to Grace free of tax under the applicable exclusion amount. The additional $1,000,000 will be assessed a tax of approximately $82,400.

Non-citizen spouses are denied the marital deduction based on the premise that they may leave the United States with the inheritance they receive. In that event, these assets will not be subject to taxation when they die.

There are ways to minimize or avoid the New Jersey Estate Tax as well the Federal Estate for non-citizen spouses. The easiest way is for the non-citizen spouse to become a US citizen. Of course, many non-citizen residents have strong personal reasons for maintaining their citizenship from the country of their origin.

In the alternative, certain tax planning may be done. Specifically, either estate tax can can be minimized, if not avoided altogether, by what is known as a Qualifying Domestic Trust (QDOT). When an individual dies, assets transferred to a QDOT are not taxed upon their receipt into the QDOT. The law provides that a surviving non-citizen spouse may receive the income earned from the QDOT without any penalty. However, principal withdrawn from a QDOT will be assessed for the otherwise unpaid estate tax. An exception from this assessment may be granted if the surviving spouse on the grounds of “hardship”.

“Hardship” can be demonstrated if principal is withdrawn to pay for the health, support and maintenance of the spouse if and to the extent said spouse’s income and own assets are insufficient to provide for same.

Upon surviving spouse’s death, the remaining principal and accrued income, if any, should pass to the remainder beneficiaries of the QDOT without any penalty. Based on the manner in which the QDOT is established, the assets in the trust may be considered as part of the surviving spouse’s taxable estate, yet these assets will have only been subject to the estate tax upon the death of the surviving non-citizen spouse and not upon both spouses.

There are a variety of requirements a QDOT must meet trusts to be valid. Most notably, there must be at least one US citizen of a domestic corporation serving as a trustee (although a non-citizen may serve as a co-trustee). Moreover, the trust may be established not only through a decedent’s estate plan but the surviving spouse may establish same albeit in a finite period of time after the decedent’s passing. In all, although non-citizen spouses, like Grace, are not entitled to the marital deduction, planning may be available to minimize the potential estate tax burden they face when their US citizen spouses die.


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