The term “QDOT” is an acronym for “Qualified National Trust”. Some people prefer to use the acronym “QDT”, but we will refer to this type of trust as QDOT. Qualified Household Trusts were created under the Technical and Miscellaneous Income Act of 1988 (TAMRA), effective for the deceased who died after November 10, 1988. Prior to TAMRA, unlimited marriage deduction was not allowed when property passed to a surviving spouse who was not a United States Citizen. The creation of the QDOTs was designed to provide a mechanism whereby property could pass to a non-US citizen spouse and still qualify for the unlimited marriage deduction. That’s what QDOTs are all about. Now, let’s take a closer look at the requirements for a QDOT and some of the reasons for these requirements. Historically, the transfer of property from one spouse to another has been subject to neither gift tax nor inheritance tax. The reason is simply because most married couples depend on their combined assets for their financial security. If a gift or inheritance tax is levied every time one spouse transfers property to the other, your combined assets would be seriously depleted in a short time and your financial security could be threatened.

And that is particularly true when one of the spouses dies. Remember, gift and inheritance tax rates can be as high as 45% of the value of the transferred property. Think of a married couple as an economic unit. As long as the property remains within that economic unit, the federal government keeps its hands off the property. Married couples can transfer property from one spouse to another as often as they like, either during life or upon death. It is only when property is transferred outside of the economic unit (that is, to someone other than the surviving spouse) that the federal government reaches out. That is not to say that the federal government exempts transfers between spouses from gift and inheritance tax. Rather, you subject these transfers to gift and inheritance tax, but then grant a corresponding deduction equal to the full value of the transferred property. This deduction is called a marriage deduction because it only applies to transfers from one spouse to another. Also, it is called an “unlimited marriage deduction” because there is no limit to the amount of property that qualifies for the marriage deduction. Using an unlimited marriage deduction, rather than a full exemption, effectively deferring the tax until the death of the surviving spouse.

Keep in mind that the federal government is not as benevolent as you might think. Although you are willing to defer the estate tax until the death of the surviving spouse, you are not willing to forgive the tax entirely. In fact, the federal government will not even allow the tax to be deferred after the death of the first spouse, unless there is reasonable certainty that the property will be taxable after the death of the surviving spouse. How does the federal government determine if there is a reasonable certainty that the property will be taxable after the death of the surviving spouse? It does this by imposing a three-pronged test at the time of the death of the first spouse. If all three extremes are satisfied, then the property that passes to the surviving spouse qualifies for the unlimited marriage deduction. The three aspects of this test are: (1) that the property is transferred to a genuine spouse of the deceased; (2) that the spouse of the deceased is a US citizen; and, (3) that the spouse of the deceased does not receive a terminable interest in the property. If all three points of the test are met, then the unlimited marriage deduction applies and the estate tax is deferred until the death of the surviving spouse. It is important to note that there is no requirement that the surviving spouse actually keep the property until they pass away. In fact, it is entirely possible for some or all of the property to be consumed by the surviving spouse during his or her lifetime.

That’s the whole idea behind the so-called “economic unit” theory that drives unlimited marriage deduction in the first place. Now, let’s take a closer look at this three-prong test to qualify for the unlimited marriage deduction. The first aspect requires that the property be transferred to a spouse in good faith. Historically, only valid marital relationships between a man and a woman were considered worthy of protection against a potentially devastating gift or inheritance tax. Today, those historic beliefs have come under attack and at least six states have authorized same-sex marriages. Presumably, same-sex marriages will soon be tested against the “bona fide” spouse’s requirement for the unlimited marriage deduction. That, however, is the subject of another day. The second aspect requires that the surviving spouse receive all rights to the transferred property. In other words, the property given to the surviving spouse must no be terminable. Generally speaking, a terminable interest is similar to having certain conditions attached to the property, which makes it doubtful that the property will be encumbered in the estate of the surviving spouse. For example, if the surviving spouse is given a life use of the property and cannot designate who will receive the property after death, then that property is considered terminable interest property.

As such, it would not be taxed on the surviving spouse’s estate and therefore does not qualify for the unlimited marriage deduction. However, there is an exception for terminable interest property placed in a “Qualified Terminable Interest Property Trust” or “QTIP Trust”. However, again, that is the subject of another day. The third part of the test requires that the surviving spouse be a US citizen. Again, the federal government wants to be reasonably certain that the property will be encumbered in the estate of the surviving spouse. If the surviving spouse is not a U.S. citizen at the time of the first spouse’s death, then there is a good chance that estate tax will not be collected when the survivor subsequently passes away, simply because the federal government does not has the power. or authority to encumber the property of a nonresident, non-U.S. citizen, unless the property is physically located in the United States. So if a US citizen dies and leaves all of his property to his wife who is not a US citizen, then there is nothing to stop the surviving wife from returning to her home country and taking all the property with her. In that case, none of the properties would be taxed by the federal government when she later dies. To prevent this from happening, the unlimited marriage deduction is denied for any property given to a surviving non-US citizen spouse.While the citizenship requirement is easy to justify, its application can be very severe, especially for those who have resided in the United States for years and years without obtaining citizenship, but with no intention of ever returning to their country of origin. For this reason, the federal government created an alternative way to qualify for the unlimited marriage deduction when property is given to a non-US citizen spouse. The alternative is to transfer the property to a Qualified Domestic Trust (QDOT) rather than giving it directly to the surviving spouse. To qualify as a Qualified National Trust (QDOT), the federal government imposes the following requirements:

• At least one of the trustees must be a US citizen or a US bank. If the QDOT has more than $ 2 million in cash or property, the trustee must be a US bank.
• The executor of the decedent’s estate must make an irrevocable QDOT election to qualify for the marriage deduction on the federal estate tax return within 9 months of the date of death.
• If the QDOT has assets equal to or less than $ 2,000,000, then no more than 35% of the value may be in real estate outside the United States or else: (1) the U.S. trustee must be a bank, (2) the The individual US trustee must provide a bond for 65% of the value of the QDOT assets at the time of the transferor’s death, or (3) the individual US trustee must provide a letter of credit irrevocable to the US government for 65% of the value.
• If the QDOT has assets that exceed $ 2,000,000 either: (1) the U.S. trustee must be a bank, (2) the individual U.S. trustee must provide a bond for 65% of the value of the QDOT’s assets at the time of the death of the transferor, or (3) the individual US trustee must provide an irrevocable letter of credit to the US government for 65% of the value.

In addition to the above requirements, any capital distribution to the surviving spouse will be subject to inheritance tax and the trustee must withhold funds equal to the tax. However, exceptions are made for distributions of capital for the health, education, or support of the surviving spouse or a child or other person whom the spouse is legally obligated to support, provided there is substantial financial need. Any property that the deceased spouse transfers to the surviving spouse outside of the QDOT (that is, directly as a result of joint ownership, or through a will or other means) can be transferred to the QDOT without being subject to estate tax. if the property is transferred before the expiration date of the estate tax return. If the deceased spouse’s will does not provide for a QDOT, the executor or surviving spouse may choose to establish a QDOT and transfer the assets to the trust prior to the tax return due date. However, it should be noted that the best way to ensure the availability of the marriage deduction is to have the non-US citizen spouse establish citizenship in advance. If that is not possible, then the US citizen spouse should take the necessary steps to ensure that a QDOT is established in their will and / or living trust so that the QDOT is automatically established after their death.