A Potpourri of Potential Pitfalls To Avoid with Qualified Domestic Trusts

In Florida, when one or both spouses are not U.S. citizens, special planning is needed for their estate. If the surviving spouse is not a U.S. citizen, they cannot receive a marital deduction for estate tax unless the property is held in a Qualified Domestic Trust (QDOT). This rule was created to prevent noncitizen spouses from leaving the U.S. and avoiding estate taxes. A QDOT must meet certain requirements, such as providing income to the surviving spouse and having at least one U.S. trustee. If these requirements are met, the estate tax can be deferred until distributions are made from the trust. If a trust meets all the requirements, the personal representative must file an election on the decedent’s estate tax return to be considered a QDOT. This election must be made on the last federal estate tax return filed before the due date or, if a timely return is not filed, on the first estate tax return filed after the due date. Once made, the election cannot be revoked.

Distributions from the QDOT are generally taxable, but income distributions and “hardship” distributions are exempt. Income is determined by the governing instrument or local law, and does not include capital gains. If there is no specific law on the topic, the allocation is made by “general principals of law.” “Hardship” distributions from a QDOT are for a noncitizen surviving spouse who has an urgent financial need. These distributions can be used for the spouse’s health, living expenses, education, or support of someone else the spouse is responsible for. However, the distribution can’t be made if the money can be obtained from other sources that are reasonably available. Certain assets, like personal investments and revocable trusts, are considered reasonably available, while others, like business interests and real estate, are not. Miscellaneous distributions and payments, like regular QDOT expenses and taxes, may also be exempt from QDOT estate tax. It’s important to follow the rules closely to avoid any additional taxes. When a spouse passes away and leaves assets in a QDOT, those assets are not taxed until they are distributed to someone else or the surviving spouse dies. If the assets are distributed, they are taxed as if they were originally taxed when the first spouse died. The person in charge of the QDOT is responsible for paying the tax, and they can ask the IRS to determine how much tax they owe. They may need to pay the tax or provide a bond to get out of paying it. If a QDOT has more than $2 million in assets, it needs to meet certain extra requirements. These include having a U.S. bank as a trustee, having a bond or letter of credit worth 65 percent of the trust assets, or having a letter of credit. If the assets change in value, the trustee needs to adjust the bond or letter of credit within 60 days. These requirements also apply if the QDOT has $2 million or less but more than 35 percent of its assets are foreign real property. The personal representative can exclude up to $600,000 in value from real property used by the surviving spouse. This special election must be made when filing the estate tax return. Multiple QDOTs are considered together when applying these rules. If property is being passed to a noncitizen spouse, it can be put into a special trust to avoid extra taxes. The spouse needs to transfer the property to the trust before the estate tax return is filed. If there is no estate administration, the transfer must be done within a year after the tax return is due. It’s a good idea to have a formal administration opened when dealing with this trust. Sometimes, it might be useful to have more than one of these trusts, but you need to choose someone to file the necessary tax forms for all of them. If you don’t do this properly, some of the trust’s money might be taxed. If a person who is not a U.S. citizen is married to someone who is a citizen of another country, they may be able to use their country’s tax treaty with the U.S. to get certain tax benefits. They can also combine a special type of trust called a QDOT with a charitable trust to make things simpler and save on taxes. If the noncitizen inherits a family-owned business, they may have to pay back some of the tax benefits if they lose their U.S. citizenship, unless they put the business assets in a trust or other security arrangement. In conclusion, QDOTs are becoming more common in estate planning in Florida. It’s important to pay attention to the rules and details, as mistakes can lead to loss of tax benefits. There are specific requirements and regulations that must be followed when setting up and managing a QDOT to avoid potential issues. It’s crucial for attorneys to be aware of these potential problems and stay updated on any changes in the regulations. William M. Pearson and Todd L. Bradley are lawyers in Naples, Florida. They specialize in helping people with their wills and estates. They work for a law firm that focuses on tax law. This article is written on behalf of a section of lawyers that wants to improve how the law is practiced and help the public.

Source: https://www.floridabar.org/the-florida-bar-journal/a-potpourri-of-potential-pitfalls-to-avoid-with-qualified-domestic-trusts/