By Barry Zimmer on November 30th, 2021 in Estate Planning
There are targeted estate planning solutions that can be used as a response to just about any situation that may arise. One of them is the qualified domestic trust (QDOT), and we will provide the details in this post.
Federal Estate Tax
This legal device is used by people that have concerns about the federal estate tax. It is certainly worth your attention if you will be exposed, because it carries a 40 percent maximum rate.
Most people do not have to pay this tax because there is a credit or exclusion that can be used to transfer a certain amount tax-free. During the current calendar year, the exclusion is $11.7 million, and this is the highest figure we have ever seen.
There is a gift tax to stop people from giving large gifts to completely avoid the estate tax, and the two taxes are unified. The $11.7 million exclusion would apply to gifts that you give while you are living along with your estate.
Even if your estate falls a bit short of this mark, you may not be out of the crosshairs of the tax. This record high exclusion is a product of the Tax Cuts and Jobs Act that was passed at the end of 2017.
The provision that doubled the estate tax exclusion is going to expire on January 1, 2026. At that time, the exclusion will go back down to the $5.49 million figure that was in place in 2017 indexed for inflation.
However, the timetable may be accelerated. It could go down at the beginning of next year because there is a reduction included in the reconciliation bill that is making its way through the legislative process.
There is a federal gift tax that is unified with the estate tax, so the exclusion is a unified exclusion. It applies to lifetime gifts and the estate that will be transferred after you are gone.
Since the exclusion may be reduced next year, if your estate is in taxable territory, you may want to consider lifetime gift giving before the change takes place.
Marital Deduction
The estate tax is applicable on transfers to anyone except your spouse, because there is an unlimited marital deduction. However, in order to use this deduction, you and your spouse must be citizens of the United States.
Qualified Domestic Trust
If you are married to someone that is a citizen of another country, you cannot use the deduction, so you have to look for another solution, and it exists in the form of the QDOT.
The way that it works is you fund the trust, and your spouse would be the initial beneficiary. You name successor beneficiaries that will inherit the assets after the death of your spouse. Obviously, most people would name their children.
When you are establishing the trust, you engage a trustee to act as the administrator. The trustee must be a U.S. bank, and if there are multiple trustees, at least one of them must be a bank that is located in the United States.
Assuming you predecease your spouse, the trustee would distribute all the trust’s earnings to your spouse annually or incrementally over the course of the year. These distributions would be subject to regular income taxes, but the estate tax would not be applicable.
The trustee could be given the latitude to distribute portions of the principal, but the estate tax would be levied on the distributions. However, there is an exception to the rule.
If the surviving spouse needs a distribution of the principal for some compelling reason related to their support or well-being, the IRS could be petitioned to grant a hardship exemption.
After the death of the surviving spouse, the children or the other successor beneficiaries that are named in the trust declaration will inherit the resources. The estate tax would be applicable at that time, but the assets would be transferred twice with just one instance of taxation.
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