Estate tax planning for a U.S. citizen with a noncitizen spouse.

• Author: Klahsen, Rick

Under current U.S. tax law, a U.S. citizen may transfer property to his or her U.S. citizen spouse without any tax consequence or limitation. However, a U.S. citizen married to a noncitizen can make only a limited amount of bequests to his or her spouse. Any excess bequests are taxed at the estate tax rate, which can be extremely high. From 2007 to 2009, the maximum estate tax rate was 45% (Sec. 2001(c)(2)). In 2010, the estate tax is repealed for one year, but it is scheduled to return in 2011 at a 55% maximum rate.

This item addresses various estate tax planning rules and techniques used to benefit U.S. citizens with noncitizen spouses. Gift tax will be mentioned as well, since it is an important factor in the estate tax planning process.

Gift Tax Exclusion and the Unified Credit

Estate and gift tax are related to each other. Individuals are entitled to a unified credit against estate tax at the time of their death. Any gifts made in excess of the annual exclusion amount reduce the unified credit. For 2009, the applicable exclusion amount was $3.5 million. After 2010, the unified credit reverts to $1 million.

Each individual is allowed an annual gift tax exclusion. The first $10,000 (adjusted for inflation) of gifts made is not taxed and does not reduce the unified credit (Sec. 2503(b)(1)). In 2009 and 2010, any gifts in excess of $13,000 for single individuals and $26,000 for married individuals who split gifts ($13,000 for each spouse) will reduce the credit. Gifts made to a U.S. citizen spouse are unlimited and therefore do not reduce the credit. However, gifts made to noncitizen spouses have certain limitations. Instead of the annual exclusion amount for all gifts made, the spousal annual exclusion amount is $100,000 for gifts made to noncitizen spouses. The inflationary adjusted spousal amount in 2009 was $133,000. For example, if a U.S. citizen gives his or her spouse a gift of $200,000 and the spouse is a noncitizen, $67,000 of the gift would reduce the donor's unified credit ($200,000 - $133,000).

Qualified Domestic Trusts

Prior law allowed U.S. citizens to make bequests to their spouse and receive an unlimited federal estate tax marital deduction for all transfers to the surviving spouse (Sec. 2056(a)). Citizenship of the spouse was not an issue at that time. Current law denies the unlimited marital deduction to transfers made to noncitizen spouses (Sec. 2056(d)). In order to receive a similar benefit of the estate tax marital...