The gross estate of a US person includes “the value at the time of death of all property, real or personal, tangible or intangible, wherever situated.”[2] The estate and gift taxes attach to all assets regardless of the location of the US citizen or resident (or his property) at the time of gift or death. Citizens and resident noncitizens are afforded a unified credit against the estate and gift tax with an exemption amount of (currently) $13,990,000. No gift or estate tax is payable by US citizens and residents until the value of lifetime gifts and bequests exceeds the unified credit.

US citizens and residents generally receive a credit for estate tax paid to a foreign country on property subject to the estate tax.[3] Note that the credit may be altered by an applicable estate tax treaty.

Completed Gifts

If a US citizen or resident completes a direct gift or devise or funds a trust benefiting someone else (parting with dominion and control over transferred property), whether a domestic or foreign donee, the US estate and gift tax applies. The grantor may apply their unified credit to offset the tax.[4] To the extent that the value of assets transferred by gift or devise (in the aggregate) exceeds $13,990,000, a 40% tax (gift tax, estate tax, or generation-skipping transfer tax [GSTT], as the case may be) is imposed.

To complete a gift (for estate and gift tax purposes), the transferor must retain no right to change the disposition of the property transferred.[5] Gifts generally remain incomplete if the transferor retains the power to alter beneficial interests in the property transferred. The gift tax does not apply to incomplete gifts.[6] Incomplete gifts thus remain in the donor’s taxable estate.

Note that a completed gift may be accomplished despite retaining rights over the manner or time of enjoyment of the property. However, retaining the right to name new beneficiaries of a donee trust or change the proportionate benefit of trust beneficiaries may cause the gift to be treated as “incomplete.” By reserving the right to alter beneficial interests, the transferor has not truly parted with dominion and control of the transferred property (avoiding gift tax yet leaving the asset in the transferor’s taxable estate). Technically, the code deems gifts to trusts “incomplete” when the transferor reserves rights to: 1) change beneficial title to trust property (both income and principal); 2) name new trust beneficiaries; or 3) change the interests of beneficiaries as between themselves—except when the change in interest is limited by a fixed or ascertainable standard.

Gifts in Trust

Gifts to a trust that, by its terms, limit trustee discretion to make distributions pursuant to a fixed or ascertainable standard are considered complete.[7] Trusts so limiting trustee discretion prevent alteration of beneficial interests. This is true even if the grantor is the trustee.[8] An example of a fixed and ascertainable standard (for trustee distribution) is the condition that distributions be made only for the health, support, education, or maintenance of the permissible beneficiaries. Gifts to a trust with such limited trustee control over distributions are considered “completed” gifts because the transferor has relinquished sufficient dominion and control over trust assets.[9]

The relinquishment or termination of a retained power (which prevented completion of the gift) will complete the gift and trigger the gift tax.[10] In the event a trust holding incomplete gifts makes distributions of income or principal during the transferor’s lifetime, such distributions—provided they are unconditional—are considered completed taxable gifts by the grantor to the receiving beneficiaries.[11]

Marital Deduction for Spousal Bequests

The imposition of the gift and estate tax is deferred on transfers between citizen spouses. If both spouses are citizens of the United States, either spouse may transfer assets to the other spouse and receive a tax deduction for the entire value of the property transferred.[12] This concept is known as the unlimited marital deduction. Transfers may be accomplished during life or at death by an outright gift or through gifts in trust that benefit the other spouse.

The first spouse to die may thus leave their entire estate to the surviving US citizen spouse without triggering the estate tax (payable on the death of the second spouse).[13] Any estate tax owed by the estate of the first spouse to die is delayed until the death of the second spouse.

US citizens or residents may port their remaining unified credit to the surviving spouse. Any exclusion amount not used by the first spouse to die (by lifetime and testamentary non-spousal gifts) may be transferred (or ported) to the qualifying surviving spouse.[14] The total value of property excluded from the estate tax for two spouses is just under $28,000,000. The estate exclusion may therefore be “pooled” by US spouses and applied against the taxable estate of the second spouse to die.

Bequests to Non-Citizen Spouse

The unlimited marital deduction is not available for transfers to non-citizen spouses (even if the recipient spouse is a US resident). The estate of the deceased spouse may not receive a marital deduction on spousal bequests to a noncitizen spouse[15] unless the assets pass to a qualified domestic trust (QDOT). The estate of a US grantor spouse must utilize the deceased’s estate tax exclusion (through taxable bequests) or leave their estate to a QDOT[16] as a condition to receiving the estate tax marital deduction.

Thus, US citizens and residents may defer the estate tax on testamentary transfers to a non-citizen spouse only through a QDOT. Through gifts to a QDOT, even an NRNC grantor may devise US situs assets to an NRNC spouse to defer the estate tax on those assets.

The QDOT defers the estate tax (on bequests to an NRNC spouse) until distribution of principal from the QDOT or death of the second spouse (on QDOT assets remaining).[17] Distributions of income are not subject to the estate tax.[18]

Certain mandatory trustee powers must be included to secure US tax compliance.[19] To qualify for the marital deduction, the deceased’s property must pass either 1) directly to a QDOT before filing the deceased’s estate tax return;[20] or 2) from the NRNC recipient spouse (to the QDOT) within nine months of the decedent’s death. The QDOT must also 1) be executed under US law;[21]2) have at least one trustee that is a US citizen or US corporation; and 3) not allow for distributions unless the trustee has the right to withhold tax on transfers from the trust to the surviving (non-citizen) spouse.[22]

Restrictions limit who may act as a QDOT trustee. Trustee distributions are also restricted to ensure payment of US income tax,[23] with certain exclusions for QDOTs with minimal assets and for QDOTs holding the personal residence of the non-citizen spouse.

The fiduciary of the estate must make the QDOT election on the deceased spouse’s estate tax return. In the absence of an estate tax treaty, only through the QDOT may the estate tax (on assets held by a US citizen or resident spouse) be deferred until the death of a surviving non-citizen spouse. Administrative rules exempt the QDOT from “foreign trust” status (and the associated onerous reporting requirements).[24]

If the surviving non-citizen spouse becomes a US citizen before the deceased’s estate tax return is filed, direct bequests to the survivor will qualify for the marital deduction. If the surviving spouse later becomes a US citizen, all QDOT assets may then be distributed directly to the survivor (free of tax, through the marital deduction).

The QDOT restrictions are intended to limit the risk of the surviving (non-citizen) spouse (even if a US resident) leaving the US with the decedent’s taxable estate. A shift in domicile by the surviving (non-citizen) spouse could allow for avoidance of the estate tax, as the survivor (with the marital assets) could permanently leave the US and elude collection of the estate tax on “worldwide” assets.

IRC section 2010(c) allows the estate of a US citizen or resident to make a portability election, to permit a surviving spouse to use the deceased’s unused estate and gift tax exclusion amount. The Treasury Regulations also establish special portability rules for QDOTs. A modified “portability” election allows a surviving non-citizen spouse to utilize the deceased’s unused estate tax exemption (through a QDOT).[25] Upon the death of the non-citizen spouse (or earlier termination of the QDOT), the first spouse’s unused estate tax exemption is applied. The determination of the amount of exemption left by the first spouse to die involves a series of valuation procedures. The formula is influenced by the appreciation or depreciation of assets in the QDOT. Estates of NRNC spouses may not, however, elect portability.[26]

Lifetime Transfers to an NRNC Spouse

Only citizens enjoy an unlimited deduction for lifetime spousal gifts.[27] Similar to the restriction on tax-free testamentary bequests to non-citizen spouses, lifetime gifts are also limited. If the spouse receiving a lifetime gift is not a US citizen, the gifting spouse may only transfer up to $190,000 in tax-free spousal gifts during any calendar year.[28]

The limitation on lifetime gifts applies even if both spouses are domiciled in the US at the time of the gift. The domicile of the donor and done is irrelevant. Annual lifetime gifts to non-citizen spouses are thus taxed on value exceeding $190,000 (adjusted annually for inflation). The limitation on gifts to non-citizen spouses does not limit tax-free gifts by a non-citizen spouse to a US citizen spouse.[29]

NRNCs considering US residency should generally make any intended large spousal gifts of foreign property and US intangible property (free of gift tax) before moving to the US. Once domiciled in the US, the grantor becomes subject to a gift tax on all assets held worldwide (along with the $190,000 limited deduction on spousal gifts to a non-citizen spouse).

To avoid a gift tax on spousal gifts to a foreign spouse, a US citizen or resident spouse may: 1) make gifts through shared title, as tenants by the entireties (if available) or joint tenancy with rights of survivorship; 2) apply, to the extent available, their remaining Estate and Gift Tax exclusion (against the value of gifts exceeding the limitation on gifts to a non-citizen spouse); or 3) defer the spousal gift until death.

Unfortunately, joint titling will only defer transfer tax until the death of the donor spouse, when the estate tax is due on all jointly titled US situs assets (unless contributed to a QDOT).[30]Deferral of the gift until death will potentially defer the estate tax through either 1) transfers to a QDOT trust or 2) applying the grantor’s remaining estate tax credit (to the extent sufficient to cover the value of the gift).[31]

Title to Assets/NRNC Spouse

If a non-citizen spouse is likely to outlive the US spouse, it may be prudent to title a disproportionate amount of non-US assets in the name of the non-citizen (non-resident) spouse. Such assets will (upon the first death of the US citizen spouse) avoid the QDOT encumbrances. Moreover, foreign assets held by an NRNC spouse will also avoid US estate tax (provided the survivor is a non-US domiciliary at death). These substantial tax advantages carry very little tax risk. In the event of the (unexpected) first death of the NRNC spouse, the estate of the NRNC may utilize the unlimited marital deduction (or foreign corporation) to shelter bequests to the US spouse.

An NRNC surviving spouse (upon death) is subject to an estate tax only on US situs assets. If one spouse is a US citizen or resident and the other an NRNC, prudence therefore dictates titling foreign marital assets with the NRNC spouse. If the NRNC spouse is the second to die, the NRNC will retain foreign assets, with no exposure to the estate or gift tax. Failing to shift ownership of foreign assets to the NRNC spouse leaves the QDOT as the only means of preserving the marital deduction, if the value of assets held by a (citizen or resident) first spouse to die exceeds the available lifetime credit. Note that such planning may require analysis of 1) the limitation on the annual gift tax exclusion for lifetime gifts to non-citizen spouses; and 2) potential Exit Tax imposed on a resident non-citizen spouse who abandons US domicile.

If the bulk of marital assets (owned by one or both non-citizen spouses) are in the US, planning beyond retitling may be required. Exit by a surviving non-citizen (resident) spouse will cause the loss of US domicile and associated loss of the larger estate tax credit (afforded to US residents). Moreover, the exit could potentially trigger the exit tax.

[1] I.R.C. section 2001. Some countries do not impose estate or inheritance taxes while other countries have Estate Taxes which are imposed on relatively small wealth transfers. For example, the maximum rate imposed by the Brazilian version of an Estate Tax (the Brazilian “Imposto sobre Transmissã Causea Mortis e Doação,” or ITCMD) is 8%; however, the threshold for the imposition of the tax is substantially lower than in the United States. In Sao Paulo, the tax is imposed on all transfers exceeding 40,000 Brazilian reals (approximately $14,000 US Dollars) and in Mineas Gerais, on all transfers exceeding 20,000 Brazilian Reals.

[2] I.R.C. section 2031(a).

[3] I.R.C. section 2014.

[4] I.R.C. section 2010(c)(3)(A), (B).

[5] Treas. Reg. section 25.2511-2(b).

[6] Treas. Reg. section 25.2511-2(c).

[7] Estate of Klafter v. Comm’r, 32 T.C.M. (CCH) 1088 (1973).

[8] Treas. Reg. section 25.2511-2(b)-(c), (g).

[9] Treas. Reg. section 25.2511-2(c), (g).

[10] Treas. Reg. section 25.2511-2(f).

[11] Treas. Reg. section 25.2511-2(b).

[12] I.R.C. sections 2523(a), (i), 2056(a).

[13] I.R.C. section 2056(a). Under this code section, a deduction is allowed for “any interest in property which passes or has passed from the decedent to his surviving spouse.” Id. (emphasis added).

[14] I.R.C. section 2010(c)(4).

[15] I.R. C. section 2056(d)(1).

[16] I.R.C. section 2056(d)(2)(A); section 2056A.

[17] I.R.C section 2056A

[18] I.R.C. section 2056A(b)(3)(A).

[19] I.R.C. section 2056A(a)(3).

[20] I.R.C. section 2056(d).

[21] Treas. Reg. section 20-2056A-2(a).

[22] I.R.C. section 2056A(a)(1)(B).

[23] Treas. reg. section 20.2056A-2.

[24] I.R.C. section 7701(a)(30), (31).

[25] Treas. Reg. section 20.2010-2(a)(5).

[26] Id.

[27] I.R.C. section 2523(i).

[28] I.R.C. section 2523(i)(2). The deduction was initially set at $100,000 in 1989, indexed for inflation.

[29] See Treas. Reg. section 25.2523(i)1(a)

[30] I.R.C. section 2040(a); see also Treas. Reg. section 20.2056A-8.

[31] I.R.C. section 2040(a).