U.s. Transfer Tax System and the Non-u.s.-citizen Spouse

• Publication year: 2015
• Author: By Cynthia D. Brittain, Esq.*

U.S. TRANSFER TAX SYSTEM AND THE NON-U.S.-CITIZEN SPOUSE

By Cynthia D. Brittain, Esq.*

I. MARITAL ASSETS AND THE U.S. TRANSFER TAX

The Internal Revenue Code¹ limits the amount of property that may pass free of transfer tax by gift or inheritance from a U.S. spouse to a non-U.S.-citizen spouse.² For example, if the donee spouse is not a U.S. citizen, the unlimited gift tax marital deduction is not available for lifetime transfers made to that spouse. In addition, the unlimited estate tax marital deduction otherwise allowed by section 2056(a) for property passing to or for the benefit of the decedent's surviving non-U.S.-citizen spouse is disallowed under section 2056(d), unless the surviving spouse becomes a U.S. citizen or an appropriate election is made with respect to such property passing into a trust that meets the requirements of a qualified domestic trust ("QDOT"). Fortunately, there are planning strategies available to transfer significant value to the non-U.S.-citizen spouse.

A. Gifts to a Non-U.S.-Citizen Spouse

A donor is not allowed an unlimited marital deduction for gifts made to his or her non-U.S.-citizen spouse.³ Instead, the donor is entitled to an inflation-adjusted modified annual exclusion amount for such gifts, which is currently set at $147,000.⁴ Annual transfers within the exclusion amount are not subject to U.S. gift tax, and no U.S. gift tax return is required to be filed. Even if the gift exceeds $147,000, there may be no gift tax due if the transfer does not exceed the current U.S. gift tax exemption amount, provided the donor spouse is a U.S. citizen.⁵ Treasury regulations generally provide that the citizenship or domicile of the donor spouse at the time of the gift is irrelevant; the inquiry is focused on the donee spouse. Therefore, as long as the donee spouse is a U.S. citizen at the time of the gift, and the other requirements of section 2523⁶ are met, the marital deduction will be allowed regardless of whether the donor spouse is a U.S. citizen or U.S. resident. Of course, this is only part of the analysis. If the donor is a non-U.S. citizen gifting non-U.S. situs assets to his or her non-U.S.-citizen spouse, there are no U.S. gift tax implications. Also, as noted above, there is no transfer tax as long as the value of the gift is within the gift tax exemption amount. In such cases, the situs of the assets, the status of the donor spouse, and the status of the donee spouse are all relevant.

When advising clients with respect to inter-spousal transfers, it is important to determine the citizenship of the spouses in order to avoid inadvertent taxable gifts for which a current U.S. gift tax may be due. A common scenario is when upon marriage a spouse adds a non-U.S.-citizen spouse to their marital home's title or to a bank account to be shared. Depending on the rights of the non-U.S.-citizen spouse, this action could trigger a current taxable gift. The rules applicable to jointly held property illustrate some of the issues that can arise when inter-spousal transfers are made to a non-U.S.-citizen spouse:

a. There is no deemed current gift on creation of a joint tenancy for real property, unless an election is so made; however, there may be U.S. estate tax consequences at death of the U.S.-citizen spouse (as discussed below), and gift tax may be triggered upon the ultimate sale of the real property while both spouses are living.⁷
b. In the case of other jointly-held personal property, there will be a deemed gift on the creation of a joint interest, when additions are made thereto, or reductions in indebtedness result, and the interest of each spouse shall be treated as one-half of the value of the jointly-held personal property.⁸

II. PLANNING OPPORTUNITIES

A. Inter-Spousal Loans

Because spouses are treated as one person for purposes of U.S. gift loan rules,⁹ there is no imputed interest under section 7872. This is a useful provision that, when used creatively, can shift funds to the non-U.S.-citizen spouse, allowing that spouse to purchase a property interest for adequate consideration in order to avoid a taxable gift. However, it is critical that any loan be properly documented and administered to avoid recharacterization as a gift, which could result in gift tax liability. Several factors are relevant in determining whether a transaction will be treated as a loan rather than a gift, including the existence of an interest-bearing promissory note, collateral or other security supporting the loan, a fixed maturity date, a consistent pattern of actual repayment, and records of the loan transaction maintained by the parties.

B. Acquisition of Rights Under a Joint and Survivor Annuity

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Section 2523(i) generally provides that the unlimited marital deduction does not apply to transfers to a non-U.S.-citizen spouse. However, this limitation does not apply to transfers resulting from the acquisition of rights under a joint and survivor annuity as described in section...