The term “QDOT” is an acronym for “Qualified Household Trust.” Some people prefer to use the acronym “QDT”, but we will refer to this type of trust as QDOT. Qualified household trusts were created under the Technical and Miscellaneous Income Act of 1988 (TAMRA), effective for decedents who died after November 10, 1988. Before TAMRA, the unlimited spousal deduction was not allowed when property passed to a surviving spouse who was not a United States Citizen. The creation of QDOT was designed to provide a mechanism by which property could pass to a non-US citizen spouse and still qualify for the unlimited spousal deduction. That’s what QDOTs are all about. Now, let’s take a closer look at the requirements for a QDOT and some of the reasons for these requirements. Historically, the transfer of property from one spouse to another has not been subject to either a gift tax or an inheritance tax. The reason is simply that most married couples depend on their combined assets for their financial security. If a gift or inheritance tax is levied every time one spouse transfers property to the other, your combined assets would be severely reduced in no time and your financial security could well be in jeopardy.
And that is particularly true when one of the spouses dies. Remember, gift and inheritance tax rates can be as high as 45% of the value of the transferred property. Think of a married couple as one economic unit. As long as the property remains within that economic unit, the federal government keeps its hands off the property. Married couples can transfer property from one spouse to the other as often as they like, either during their lifetime or at death. It’s only when the property is transferred out of the economic unit (ie, to someone other than the surviving spouse) that the federal government gets a hand. That is not to say that the federal government exempts transfers between spouses from gift and inheritance tax. Rather, it subjects these transfers to gift and inheritance tax, but then grants a corresponding deduction equal to the full value of the property transferred. This deduction is called the spousal deduction because it only applies to transfers from one spouse to another. Also, it is called an “unlimited spousal deduction” because there is no limit to the amount of property that qualifies for the spousal deduction. Using an unlimited spousal deduction, instead of a full exemption, effectively defers the tax until the death of the surviving spouse.
Keep in mind that the federal government is not as benevolent as you might think. Although you are willing to defer the estate tax until the death of the surviving spouse, you are not willing to forgive the tax entirely. In fact, the federal government won’t even allow the tax to be deferred upon the death of the first spouse unless there is reasonable certainty that the property will be taxable upon the death of the surviving spouse. How does the federal government determine if there is reasonable certainty that the property will be taxable upon the death of the surviving spouse? It does this by imposing a triple test at the time of the death of the first spouse. If all three points are met, then the property that passes to the surviving spouse qualifies for the unlimited marital deduction. The three points of this test are: (1) that the property is transferred to a bona fide spouse of the deceased; (2) the spouse of the decedent is a United States citizen; and (3) the decedent’s spouse is not granted a rescindible interest in the property. If all three points of the test are met, the unlimited spousal deduction applies and the estate tax is deferred until the death of the surviving spouse. It is important to note that there is no requirement that the surviving spouse actually keep the property until he or she dies. In fact, it is entirely possible that some or all of the property will be consumed by the surviving spouse during his or her lifetime.
That’s the whole idea behind the so-called “economic unit” theory that drives the unlimited spousal deduction in the first place. Now, let’s take a closer look at this three-point test for qualifying for the unlimited spousal deduction. The first part requires that the property be transferred to a bona fide spouse. Historically, only valid marital relationships between a man and a woman were considered worthy of protection against a potentially devastating gift or inheritance tax. Today, those historic beliefs have come under attack and at least six states have authorized same-sex marriages. Presumably, same-sex marriages will soon be tested against the “bona fide” spouse requirement for the unlimited spousal deduction. That, however, is the subject of another day. The second part requires that the surviving spouse receive all rights to the transferred property. In other words, the assets delivered to the surviving spouse must not be terminable. In general terms, a terminable interest is similar to having certain conditions attached to the property, which makes it doubtful that the property will be encumbered in the estate of the surviving spouse. For example, if the surviving spouse is granted lifetime use of the property and is unable to designate who will receive the property after his or her death, then that property is considered terminating interest property.
As such, you would not be subject to tax on the surviving spouse’s estate and therefore do not qualify for the unlimited spousal deduction. However, there is an exception for rescindible interest property placed in a “Qualified Rescindible Interest Property Trust” or “QTIP Trust”. Again, however, that is the subject of another day. The third part of the test requires that the surviving spouse be a US citizen. Again, the federal government wants to be reasonably sure that the property will be encumbered in the estate of the surviving spouse. If the surviving spouse is not a US citizen at the time of the first spouse’s death, then there is a good chance that estate tax will not be collected when the survivor later dies, simply because the federal government does not have the can. or authority to encumber the property of a nonresident non-US citizen, unless the property is physically located in the United States. So, if a US citizen dies and leaves all of his property to his non-US citizen wife, then there is nothing to stop the surviving wife from returning to her home country and taking all of her property with her. with her. In that case, none of her assets would be subject to federal tax when she later dies. To prevent this from happening, the unlimited spousal deduction is denied for any property given to a surviving spouse who is not a US citizen. While the citizenship requirement is easy to justify, its application can be very harsh, especially for those who have resided in the United States for years and years without obtaining citizenship, but with no intention of returning to their home country. For this reason, the federal government created an alternative way to qualify for the unlimited spousal deduction when property is given to a non-US citizen spouse. The alternative is to transfer the property to a Qualified Domestic Trust (QDOT) instead of giving it directly to the surviving spouse. To qualify as a Qualified Domestic Trust (QDOT), the federal government imposes the following requirements:
- At least one trustee must be a US citizen or a US bank. If QDOT has more than $2 million in cash or property, the trustee must be a US bank.
- The executor of the decedent’s estate must make an irrevocable QDOT election to qualify for the marital deduction on the federal estate tax return within 9 months from the date of death.
- If QDOT has assets equal to or less than $2,000,000, then no more than 35% of the value may be in real property outside the United States, or: (1) the US trustee must be a bank, (2) ) the individual The US trustee must provide a surety bond for 65% of the value of QDOT assets at the time of the transferor’s death, or (3) the individual US trustee must provide a letter irrevocable credit to the US government for 65% of the value.
- If QDOT has assets in excess of $2,000,000: (1) the US trustee must be a bank, (2) the individual US trustee must provide a surety bond for 65% of the value of QDOT’s assets at the time of the transferor’s death, or (3) the individual US trustee must provide an irrevocable letter of credit to the US government for 65% of the value.
In addition to the above requirements, any distribution of principal to the surviving spouse will be subject to estate tax, and funds equal to the tax must be retained by the trustee. However, exceptions are made for capital distributions for the health, education, or support of the surviving spouse or of a child or other person whom the spouse is legally obligated to support, provided there is substantial financial need. Any property that the deceased spouse transfers to the surviving spouse outside of QDOT (ie, directly as a result of joint ownership, or through a will or some other means) can be transferred to QDOT without being subject to estate tax. if the property is transferred before the due date of the estate tax return. If the deceased spouse’s will does not provide for a QDOT, the executor or surviving spouse may choose to establish a QDOT and transfer the assets to the trust before the tax return due date. It should be noted, however, that the best way to ensure the availability of the spousal deduction is to have the non-US citizen spouse establish citizenship beforehand. If that is not possible, then the US citizen spouse must take steps to ensure that a QDOT is established in her will and/or living trust so that the QDOT is automatically established upon her death.