Chapter 4.7 Atypical Beneficiaries

• Jurisdiction: Washington

§4.7 ATYPICAL BENEFICIARIES

There are certain "atypical" beneficiaries who will be treated differently than "typical" beneficiaries for estate and trust administration purposes, as discussed below.

(1) Noncitizen spouse beneficiaries

If the surviving spouse of a taxable estate is not a U.S. citizen at the time of death (or before filing IRS Form 706), no marital deduction is allowed to the decedent spouse's estate unless such property passes to the surviving spouse via a Qualified Domestic Trust (QDOT). See I.R.C. §2056(d)(2); I.R.C. §2056A. Put another way, a QDOT is required to avoid the imposition of estate tax at the death of the first spouse in any estate wherein the marital deduction would otherwise have deferred the federal estate tax for the surviving (noncitizen) spouse. This is true even if the noncitizen spouse is a resident of the U.S. or a green card holder. The objective of the disallowance is to prevent property from completely escaping U.S. estate tax in the event that the surviving noncitizen leaves the country with the assets of the estate prior to his or her own death.

If a QDOT is not used, an estate tax is imposed on the estate of the first spouse to die. The U.S. estate tax will again be applicable at the death of the surviving spouse. This taxation will occur with respect to assets with a situs in the U.S. if the surviving spouse is not a domiciliary of the U.S. at the time of the surviving spouse's death, see I.R.C. §2103, and with respect to all assets, wherever situated, if the surviving spouse is a U.S. domiciliary at the time of the surviving spouse's death, see I.R.C. §§2001(a), 2031(a).

A QDOT postpones the imposition of the estate tax until the surviving noncitizen spouse dies. I.R.C. §2056A and Treas. Reg. §20.2056A-2 set forth the basic requirements that a trust must satisfy to qualify as a QDOT:

(1)	The noncitizen spouse cannot be the sole trustee; the QDOT must have at least one trustee who is a U.S. citizen or a domestic corporation;
(2)	The U.S. trustee's approval must be necessary for all distributions made from the trust;

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(3)	Certain requirements must be satisfied to assure the collection of the estate tax, and the trust must qualify for the federal marital estate tax deduction;
(4)	Within nine months of the date of death, the executor must make an irrevocable QDOT election on the decedent's IRS Form 706;
(5)	If the QDOT has assets of $2 million dollars or less, then no more than 35 percent of the value can be in real property outside of the United States or else the trust must satisfy one of the following requirements:
(a)	The U.S. trustee must be a bank;
(b)	The individual U.S trustee must furnish a bond for 65 percent of the value of the QDOT assets at date of death; or
(c)	The individual U.S. trustee must furnish an irrevocable letter of credit to the U.S. government for 65 percent of the value.
(6)	If the QDOT has assets exceeding $2 million dollars, then the trust must satisfy one of the following requirements:
(a)	At least one U.S. trustee must be a bank;
(b)	The individual U.S. trustee must furnish a bond to the Internal Revenue Service for 65 percent of the value of the QDOT assets as of the date of death; or
(c)	The individual U.S. trustee must furnish an irrevocable letter of credit to the U.S. government for 65 percent of the value of the QDOT assets.

Practice Tip: This is a highly technical area of taxation and the explanation above is not meant to be a substitute for expert advice. It is very important to consult an experienced practitioner, as there are other Internal Revenue Code sections that impact the taxation of noncitizen spouses.

Practice Tip: Some countries have estate, gift, and/or income tax treaties with the United States that may modify the marital deduction rules. It is important to understand any applicable treaty. For a current list, see Internal Revenue Service, Estate & Gift Tax Treaties (International), https://www.irs.gov/businesses/small-businesses-self-employed/estate-gift-tax-treaties-international (last visited Apr. 9, 2019).

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A QDOT may not be necessary if the value of the decedent's estate does not exceed his or her remaining federal applicable exclusion amount or if the Washington estate is under $2 million dollars. For example, if a U.S. decedent left a $2 million estate to his or her noncitizen spouse, and the decedent had $5 million of remaining applicable exclusion amount, then no marital deduction via a QDOT may be necessary.

If the deceased spouse's will or trust does not contain provisions for a QDOT, the election may be made by the executor and a postdeath QDOT can be established.

If the surviving spouse becomes a U.S. citizen before the due date of the IRS Form 706 and remains a resident of the U.S. at all relevant times, a QDOT is not necessary. In addition, if the noncitizen spouse becomes a U.S. citizen after the due date of the Form 706, the necessity for a QDOT may cease. See I.R.C. §2056(a).

(2) Nonresident alien beneficiaries

The U.S. income tax system applies to U.S. trusts and estates worldwide such that the worldwide income of a U.S. trust or estate is included in its U.S. gross income. I.R.C. §61(a). The citizenship or residency of its beneficiaries does not change this. The U.S. executor or trustee is the withholding agent for the U.S. government. A trustee or executor is required to withhold tax from U.S.-sourced fixed or determinable annual or periodic income (but capital gain generally is not subject to withholding) that is to be distributed to a nonresident beneficiary. See Treas. Reg. § 1.1441-3(f). The withholding rate maybe reduced by an applicable treaty. Treas. Reg. § 1.1441-3(g)(1).

Nonresident alien beneficiaries of distributions of real property located in the U.S. are also subject to the Foreign Investment in Real Property Tax Act of 1980 (FIRPTA), I.R.C. §897, with the withholding provisions found in Treas. Reg. § 1.1445 the trustee disposes of a U.S. real property interest (as that term is defined in I.R.C. §897), the withholding rate is 35 percent of the net gain. I.R.C. §1445(e)(1). If the distribution is in kind and taxable, the withholding rate is 15 percent of the fair market value of the distribution. I.R.C. §1445(e) (4). If, on the other hand, the distribution is in kind and not taxable, Treas. Reg. § 1.1445-2 and Treas. Reg. § 1.1445-3 may allow for relief from withholding.

U.S. income tax may be avoided if the foreign beneficiary receives current distributions of either (1) foreign-sourced income or (2) U.S.-sourced income that is immune from U.S. income tax when received by the nonresident alien beneficiary. I.R.C. §871. Fiduciaries also should

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make sure that they collect and maintain all necessary tax forms (including, but not limited to W-BEN, W-8CE, W-8ECI, W-8BEN-E, and W-9, and Request for Taxpayer Identification Number and Certification) to verify residence and to compute the correct withholding tax. The fiduciary must also file IRS Forms 1042, 1042-T, and 1042-S (and provide copies of 1042-S to the beneficiaries) to name a few. Nonresident aliens may also have to file IRS Form 1040NR in the U.S., along with applicable filings in their home country.

Practice Tip: To comply with U.S. withholding and reporting rules, before making distributions to foreign beneficiaries, fiduciaries and practitioners must determine the beneficiaries' tax status and whether the income distributed is subject to withholding. This is a highly technical area of taxation and it is very important to consult an experienced practitioner. Fiduciaries should also seek professional advice in the beneficiary's home country to comply with applicable laws and best plan for distributions.

(3) Incapacitated beneficiaries

An executor may not distribute estate property directly to an incapacitated beneficiary. A beneficiary may be incapacitated by virtue of his or her status as a minor or due to mental or physical incapacity. See, e.g., RCW 11.88.010(1)(a)-(d). In any case, the executor or trustee must take certain precautions before making any distribution to or for the benefit of an incapacitated beneficiary.

The terms of the decedent's will may account for distributions to an incapacitated...