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A QDOT (Qualifying Domestic Trust) trust exempts assets held by the trust from estate and gift taxes at the time of the trust creator’s death (up to the amount of the marital deduction, which is currently unlimited per IRC Section 1056A).
Find out what this means for your business and your finances as you read through this article.
First, what is Qdot?
What is QDot?
According to Investopedia, A QDOT which fully stands for Qualified Domestic Trust is a special kind of trust that allows taxpayers who survive a deceased spouse to take the marital deduction on estate taxes, even if the surviving spouse is not a U.S. citizen.
When a US citizen marries a non-US citizen, a QDOT is used. The Qualified Domestic Trust is intended to hold all or a portion of a US citizen’s wealth in order to avoid or postpone the Federal Estate Tax.
Now, the purpose of QDOT is clearly because Congress is concerned that a non-US Citizen spouse will try to shift assets outside of the United States to avoid paying the Federal Estate Tax, a non-US Citizen spouse is not granted an unlimited spousal exemption.
This means that upon the death of the US Citizen Spouse, a tax may be owed. Congress did specify out how to avoid or postpone the tax, and the QDOT has adopted those provisions.
The QDOT works in such a way that it allows a non-citizen surviving spouse of a deceased taxpayer to claim the marital deduction on inheritance tax for any assets deposited in the trust prior to the decedent’s death.
This type of trust is beneficial for non-citizen surviving spouses who would otherwise be ineligible for the marital deduction on estate tax under ordinary tax legislation.
A surviving spouse is entitled to a full marital deduction for any estate taxes due on assets. This means that the surviving spouse is exempt from paying taxes on all assets, regardless of their value. The marital deduction is not available if the surviving spouse is not a U.S. citizen.
What is QDOT Trust?
A QDOT trust functions similarly to any other trust. After you’ve established the trust, you’ll need to transfer assets into it.
The interest earned on the assets is subsequently paid to your spouse for the rest of his or her life. When the surviving spouse dies, the trust’s principal is distributed to beneficiaries, usually children, and any gift and estate taxes are paid at that time.
The non-citizen spouse cannot touch the trust principal as a general rule; however, there is a hardship exception that allows access to the trust principal if your spouse has an “immediate and considerable” need for money for “health, maintenance, education, or support”
A QDOT is subject to requirements that do not apply to other trusts. For example, the trust’s trustee must be a U.S. citizen and trusts with assets worth more than a specific amount must be handled by a U.S. bank.
Because the rules for a QDOT are complicated, you will have to talk to your estate planning attorney about setting one up if you’re worried about protecting a spouse who isn’t a U.S. citizen.
A QDOT permits a qualifying non-citizen surviving spouse to claim the marital deduction on assets held in the trust, but it does not exclude the trust from paying estate taxes. It only postpones it till the death of the non-citizen spouse.
A U.S. citizen or a domestic entity permitted to retain estate tax must be at least one trustee of the QDOT. If all of these conditions are met, incorporating a QDOT and transferring marital assets to it can help the surviving non-citizen spouse keep their assets.
What is the QDOT Trust Sample Form?
This is a trust provision for converting a marital deduction trust to a qualified domestic trust (QDOT). Practical advice and drafting comments are included in this manner.
This form is intended to be incorporated into the trust instrument of a qualified terminable interest property (QTIP) trust or a lifetime income plus power of appointment trust when the trust would otherwise be ineligible for the marital deduction due to the surviving spouse’s non-US citizenship.
An otherwise legal marital deduction trust will not qualify for the marital deduction unless this provision is incorporated if the settlor’s surviving spouse (or the surviving settlor of a two-settlor trust) is not a U.S. citizen at the time of the settlor’s (or first settlor’s) death.
The Treasury Regulations specify which clauses must be included in a QDOT’s governing instrument. These provisions differ depending on whether the trust assets’ fair market value at the time of the deceased spouse’s death was greater than zero.
The Qualified Domestic Trust (QDOT) form is to be used when the surviving spouse is not a United States citizen, but the marital deduction at the death of the first spouse to die is desired to be used.
The general rule of taxation prohibits the use of the marital deduction if the surviving spouse is not a U.S. citizen. Code Section 2056A requires a series of special requirements to enable the use of the marital deduction in this situation, which requirements are incorporated in this document.
Divisions of the Qdot Trust Form
Note that this trust is drafted from the viewpoint of the decedent’s husband being the survivor. Obviously, that can be modified.
The QDOT trust form is divided into different sections such as:
- Lifetime of Grantor
- Powers of Trustee
- Miscellaneous Provisions
- Successor Trustee
- Trust for Surviving Spouse
The QDOT trust form also contains the signature of the Grantor, the name of Grantor, and the Name of the Trustee.
QDot Trust Requirement
- Provide that the laws of a U.S. state or the District of Columbia govern its administration;
- Qualify as an ordinary trust under Regs. Sec. 301.7701-4(a);
- Have terms that qualify it as a power of appointment trust, a qualified terminable interest property trust (QTIP trust), a qualified charitable remainder trust (qualified CRT), or an estate trust;
- Require at least one trustee to be a U.S. citizen or a U.S. corporation (i.e., a corporation created or organized under the laws of a U.S. state or the District of Columbia), and
- Provide that no distributions (except distributions of income) may be made from the trust unless the trustee has the right to withhold the Sec. 2056A estate tax (discussed below); and
- Provide that if the property transferred to the QDOT has a value that exceeds $2 million (based on the values finally determined for estate tax purposes and ignoring any indebtedness on the property) at least one trustee must be a U.S. bank, the trustee must post a bond with the IRS equal to 65% of the fair market value of the property transferred to the trust, or the trustee must furnish the IRS with a letter of credit of 65% of the fair market value of the property transferred to the trust; and
- Provide that if the property transferred to the QDOT has a value that is $2 million or less (based on the values finally determined for estate tax purposes and ignoring any indebtedness on the property), then either no more than 35% of the trust property determined annually on the last day of the trust’s tax year will consist of foreign real property, or the trust will meet the bank, bond, or letter of credit rules above.
In addition to these requirements, the deceased spouse’s executor must make a QDOT election on the deceased spouse’s timely filed estate tax return (including extensions).
Or, if not timely filed, on the deceased spouse’s first-filed estate tax return, provided it is filed within one year of the date the estate tax return was due.
Property funded into the QDOT generally must pass from the deceased spouse. However, if the property first passes from the deceased spouse to the surviving spouse and the surviving spouse transfers or irrevocably assigns the property to the QDOT, the surviving spouse’s receipt would qualify for the marital deduction.
But for his or her noncitizen status, and if the assignment occurs before the deceased spouse’s estate tax return is filed, the transfer of those assets to the surviving spouse (and ultimately to the QDOT) does qualify for the marital deduction.
In that case, the trust does not have to meet the requirements of a power of appointment trust, a QTIP trust, a qualified CRT, or an estate trust.
Instead, the trust must meet requirements 4 and 5 above, and the executor must still make the QDOT election. The surviving spouse does not need to be a beneficiary of the trust.
The surviving spouse is treated as the transferor of the property in the trust for all other purposes except the QDOT rules and the special valuation rules of the Chapter.
If the surviving spouse transfers all of his or her interest in the property to the QDOT, then the surviving spouse is also not treated as the transferor if the QDOT would have received the property had the surviving spouse executed a qualified disclaimer.
I hope this article explains what a Qdot trust really is and what it means for your business and finance.
If you have any questions or suggestions, kindly let me know in the comments section.