Whatâs a qualified domestic trust (qdot)?

the term “qdot” is an acronym for “qualified domestic trust. ” some humans prefer to employ the acronym “qdt,” but we’ll refer to this type of trust as a qdot. Qualified domestic trusts were devised under the technical & miscellaneous revenue act of 1988 (tamra), effective for decedents dying after november 10, 1988. Prior to tamra, the inexhaustible marital deduction wasn’t allowed when property passed to a surviving spouse who wasn’t a united states citizen. The creation of qdots was designed to provide a mechanism whereby property could pass to a non-u. S. Citizen spouse and still qualify for the inexhaustible marital deduction.

that’s what qdots are all about. Now, let’s take a closer consider the necessities for a qdot and some of the reasons for these necessities.

historically, the transfer of property from one spouse to another has not been subject to either a gift tax or an estate tax. The reason is simply because most married couples depend upon their combined sum totals for their financial security. If a gift or estate tax is levied every time one spouse transfers property to the other, their combined sum totals would be severely depleted in short order and their financial security can well be placed in jeopardy. And, that is specially true when one of the spouses dies. Remember, the gift and estate tax rates can be as high as 45% of the value of the property transposed.

think of a married couple as one economical unit. As long as property remains within that economical unit, the federal government keeps its hands off the property. Married couples can transfer property from one spouse to the other as often times as they’d like, either for the duration of life-time or upon death. It is only when property is transposed outside the economical unit (i. E. , to somebody other than the surviving spouse) that the federal government puts its hand out.

that’s not to say that the federal government exempts inter-spousal transfers from the gift and estate tax. On the opposite, it subjects these transfers to the gift and estate tax, but then gives a sameness deduction equal to the full value of the property transposed. This deduction is called a marital deduction because it only applies to transfers from one spouse to another. Furthermore, it is called an “unlimited marital deduction” because there is no limit on the amount of property that qualifies for the marital deduction. The use of an inexhaustible marital deduction, rather than an straight-out exemption, effectively defers the tax until the death of the surviving spouse.

keep in mind that the federal government is not as benevolent as you might think. Altho it is willing to defer the estate tax until the death of the surviving spouse, it is not willing to forgive the tax entirely. In point of fact, the federal government won’t even allow the tax to be deferred upon the primary spouse’s death unless there is a fair certainty that the property will be subject to tax upon the surviving spouse’s death. How does the federal government find out whether there is a fair certainty that the property will be subject to tax upon the surviving spouse’s death? It does so by imposing a three-prong test at the time of the primary spouse’s death. If all three-prongs are satisfied, then property passing to the surviving spouse qualifies for the inexhaustible marital deduction. The three-prongs of this test are: (1) that the property is being transposed to a authentic spouse of the decedent; (2) that the spouse of the decedent is a u. S. Citizen; and, (3) that the spouse of the decedent is not given a terminable interest in the property.

if all three-prongs of the test are met, then the inexhaustible marital deduction applies and the estate tax is deferred until the death of the surviving spouse. It is primary to note that there is no requisite that the surviving spouse genuinely keep the property until he or she dies. In point of fact, it’s entirely feasible that some or all of the property will be consumed by the surviving spouse for the duration of his or her life-time. That is the entire idea behind the so-called “economic unit” theory that drives the inexhaustible marital deduction originally.

now, let’s take a closer consider this three-prong test to qualify for the inexhaustible marital deduction. The primary prong requires that the property be transposed to a authentic spouse. Throughout history, only valid marital relationships between a man and a woman were considered worthy of shelter versus a potentially excessive damage and destruction gift or estate tax. Today, those historic beliefs have come under attack and at least two states have now authoritative same-sex marriages. Presumably, same-sex marriages will be tested soon versus the “bona fide” spouse requisite for the inexhaustible marital deduction. That, notwithstanding, is the subject of another day.

the second prong requires the surviving spouse to receive the entire rights to the property transposed. In other words, the property given to the surviving spouse should not be terminable. In general speaking, a terminable interest is akin to having certain strings attached to the property, which makes it doubtful that the property will be taxed in the surviving spouse’s estate. As an illustration, if the surviving spouse is given a life use of the property and cannot designate who will receive the property upon his or her death, then that property is deemed to be terminable interest property. As such, it would not be subject to tax in the surviving spouse’s estate and, therefore, it doesn’t qualify for the inexhaustible marital deduction. There is, notwithstanding, an exception for terminable interest property placed in a “qualified terminable interest property trust,” or “qtip trust,” again, notwithstanding, that is the subject of another day.

the third prong of the test requires that the surviving spouse be a u. S. Citizen. Again, the federal government wants to be reasonably certain that the property will be taxed in the surviving spouse’s estate. If the surviving spouse isn’t a u. S. Citizen at the time of the primary spouse’s death, then there is a good possibility that the estate tax wouldn’t be assembled when the surviving subsequently dies, simply because the federal government doesn’t have the power or authority to tax property owned by a non-resident, non-u. S. Citizen, unless the property is physically located in the united states. So, if a u. S. Citizen dies and leaves all of his property to his wife who is a not a u. S. Citizen, then there is nothing to come to a halt the surviving wife from returning to her native country and taking all the property with her. In that case, none of the property would be subject to tax by the federal government when she subsequently dies. To prevent this from happening, the inexhaustible marital deduction is denied for any property given to a surviving spouse who isn’t a u. S. Citizen.

while the citizenship requisite is easy to warrant, it’s application can be very harsh – specially for those who’ve resided in the united states for years and years without obtaining citizenship, but with no intent of ever returning to their native country. For this reason, the federal government devised an alternative way to qualify for the inexhaustible marital deduction when property is given to a non-u. S. Citizen spouse. The alternative is to transfer the property to a qualified domestic trust (qdot) rather than giving it directly to the surviving spouse.

in order to qualify as a qualified domestic trust (qdot), the federal government imposes the following necessities:

• at least one trustee should be a u. S. Citizen or a u. S. Bank. If the qdot holds more than $2 million dollars in cash or property, the trustee should be a u. S. Bank.
• the executor of the decedent’s estate should make an irrevocable qdot election to qualify for the marital deduction on the federal estate tax return within 9 months from the date of death.
• if the qdot has sum totals equal to or fewer than $2,000,000, then no more than 35% of the value can be in real property outside of the united states or else: (1) the u. S. Trustee should be a bank, (2) the person u. S. Trustee should furnish a bond for 65% of the value of the qdot sum totals at the transferor’s demise, or (3) the person u. S. Trustee should furnish an irrevocable letter of credit to the u. S. Government for 65% of the value.
• if the qdot has sum totals exceeding $2,000,000 either: (1) the u. S. Trustee should be a bank, (2) the person u. S. Trustee should furnish a bond for 65% of the value of the qdot sum totals at the transferor’s demise, or (3) the person u. S. Trustee should furnish an irrevocable letter of credit to the u. S. Government for 65% of the value.

in addition to the above necessities, any distributions of primary to the surviving spouse will be subject to estate taxes, and the trustee is required to withhold funds equal to the tax. Notwithstanding, exclusions are made for primary distributions for the health, education or support of the surviving spouse or a child or other person whom the spouse is legally obligated to support, as long as significant financial need exists. Any property that the deceased spouse transfers to the surviving spouse outside of the qdot (i. E. , directly as a result of jointly-owned property, or through a will or some other means) can be transposed to the qdot without being subject to the estate tax if the property is transposed prior to the estate tax return’s due date. If the deceased spouse’s will doesn’t provide for a qdot, the executor or the surviving spouse can elect to establish a qdot and transfer the sum totals to the trust before the date on which the tax return is due.

it ought to be cited, notwithstanding, that the most skillful way to insure the accessibility of the marital deduction is to have the non-u. S. Citizen spouse establish citizenship in advance. If that is not possible, then the u. S. Citizen spouse should take the necessary steps to insure that a qdot is traditionalistic in his or her will and/or living trust so that the qdot is traditionalistic automatically upon his or her death.