QDOT & International Offshore Reporting
How Do I Report a QDOT Trust? In accordance with the IRS estate tax rules, Estate and tax planning between U.S. citizen spouses is much simpler than when one of the spouses is a non-U.S. Citizen. When a spouse wants to transfer wealth to the other spouse, and the recipient spouse is a U.S. citizen, the process is relatively clean. There is an unlimited marital deduction that permits one spouse to transfer all their wealth to a U.S. citizen spouse, to avoid immediate taxation.
But, what happens when the recipient spouse is not a U.S. Citizen?
If the recipient spouse is not a U.S. Citizen, the unlimited marital deduction does not apply, and there can be a (substantial) gift tax liability once the total gift exclusion amount is used up.
QDOT, What is it?
A QDOT is workaround to the unlimited marital deduction rules.
A common question we receive from clients who are seeking to transfer (and protect) wealth to a non-citizen spouse, is how the QDOT works?
The Qualified Domestic Trust is a trust that is used to transfer wealth from one U.S. Citizen Spouse to another non-citizen spouse, to avoid tax immediate tax consequences.
While there are benefits and detriments to using a QDOT, the focus of this article are the potential international offshore reporting consequences of reporting assets within the trust.
QDOT Basic Requirements
Some of the basic requirements of a QDOT, include:
- Must qualify as a “Trust”
- One of the Trustees must be either a U.S. Citizen or a Domestic Corporation.
- Irrevocable Transfer to the Trust
- After the death of the Surviving Spouse, the assets will become subject to U.S. estate tax
- Timely Election
Unlimited Marital Deduction
The unlimited marital deduction defers tax between U.S. citizen spouses.
When spouses are both U.S. citizens, they can transfer an unlimited amount of money, without their being any tax liability.
It is referred to as the unlimited marital deduction.
As a result, there is no immediate gift or estate tax. In addition, once portability is also applied in accordance of DSUE (Deceased Spouse Unused Exclusion) the surviving spouse can have a significant buffer against estate tax.
26 U.S.C. 2523 Gift to Spouse
(a) Allowance of deduction
Where a donor transfers during the calendar year by gift an interest in property to a donee who at the time of the gift is the donor’s spouse, there shall be allowed as a deduction in computing taxable gifts for the calendar year an amount with respect to such interest equal to its value.
(i) Disallowance of marital deduction where spouse not citizen
If the spouse of the donor is not a citizen of the United States— (1)no deduction shall be allowed under this section, (2)section 2503(b) shall be applied with respect to gifts which are made by the donor to such spouse and with respect to which a deduction would be allowable under this section but for paragraph (1) by substituting “$100,000” for “$10,000”, and (3)the principles of sections 2515 and 2515A (as such sections were in effect before their repeal by the Economic Recovery Tax Act of 1981) shall apply, except that the provisions of such section 2515 providing for an election shall not apply. This subsection shall not apply to any transfer resulting from the acquisition of rights under a joint and survivor annuity described in subsection (f)(6).
**The $100,000 and $10,000 amounts listed above modify for inflation
Resident vs. Non-Resident Estate Tax Exclusion
The estate tax exclusion differs tremendously between residents and non-residents.
When the spouse is not a U.S. Citizen, there is a limitation on the amount the citizen can transfer to the non-U.S. citizen spouse. The current amount is $157,000 to avoid taxation.
For a spouse with significant wealth, this amount is not sufficient, and may lead to a tax consequence, especially in light of specific hurdles a foreign spouse must overcome to utilize portability.
While a resident spouse will have upwards of $11+ million in exclusion amount, the nonresident is limited to $60,000. This will have a significant impact on the strategies used for effective estate planning.
*The rules for being considered a U.S. person for estate tax differ than Income Tax.
QDOT & Offshore Compliance
While the Foreign assets in a QDOT may escape an immediate estate tax liability, there is the issue of reporting.
If the Trust contains foreign assets, accounts or investments, and/or the trust is considered a Foreign Trust because (oftentimes unintentionally occurs when a foreign administrator/trustee is added to the mix) there may be various reporting requirements on various forms, including
QDOT & FBAR
FBAR is the foreign bank and financial account reporting on FinCEN Form 114.
Even though the QDOT is presumed a U.S. trust (although having a co-foreign trustee may impact the foreign status), what about the assets in the trust.
If the transferor funds the trust with an irrevocable transfer of foreign accounts, investments, then technically the foreign trust own the accounts.
Therefore, the Trust may have an FBAR reporting requirement.
QDOT & FATCA Form 8938
FATCA is the Foreign Account Tax Compliance Act which is reported on Form 8938. The Form 8938 is used to report specified foreign financial assets.
If the transferor funds the trust with an irrevocable transfer of foreign assets, then technically the foreign trust own the accounts.
Therefore, the Trust may have a FATCA Form 8938 reporting requirement.
QDOT & FATCA PFIC Form 8621
PFIC is a Passive Foreign Investment Company, and the investments are reported on Form 8621.
Form 8621 can be very complicated.
If the transfer involved foreign holding companies, mutual funds or other investment funds, then the Form 8621 may be required.
QDOT & Foreign Trust Form 3520/3520-A
While a QDOT Is presumed to be a domestic trust, this may not always be case.
In a situation in which a foreign co-trustee is granted certain authority (even the surviving/transferee spouse) it may lead to transmute the trust into a foreign trust – at least for reporting on Form 3520/3520-A unless certain exceptions, exclusions or limitations apply.
Golding & Golding: About Our International Tax Law Firm
Golding & Golding specializes exclusively in international tax, and specifically IRS offshore disclosure.
Contact our firm today for assistance with getting compliant.