There are acronyms in our field that are used to shorten the names of legal terms, and one of them is “QDOT.” These letters stand for the qualified domestic trust, and we will explain why these trusts are used in this post.
Federal Estate Tax
In order to understand the reason why people use qualified domestic trusts, you have to digest some facts about the federal estate tax. It carries a 40 percent top rate, so it can have a significant impact, but most families do not have to pay the tax.
There is an estate tax exclusion that can be used to transfer a certain amount tax-free. It is subject to change via legislative mandate, but at the present time, it stands at $11.7 million.
Speaking of legislation, this figure is in place because of a provision contained within the Tax Cuts and Jobs Act that went into effect in 2018. It is going to sunset or expire on January 1, 2026, and at that time, the exclusion is scheduled to go down to $5.49 million.
You would logically consider lifetime gift giving as a response to this tax, but the IRS is one step ahead of you. There is a gift tax in place, and the two taxes are unified under the tax code, so the exclusion applies to your estate and large gifts that you give while you are living.
Married couples can transfer unlimited assets between one another free of taxation because there is a marital deduction. However, you cannot use this deduction if you are married to someone that is a citizen of another country.
Estate Tax Efficiency for Non-Citizen Spouses
If you are a high net worth individual that is married to someone that is not an American citizen, you can delay the imposition of the estate tax if you convey the resources into a qualified domestic trust.
You would name a trustee to act as the administrator, and your spouse would be the initial beneficiary. Your children or anyone else that you want to name would be the successor beneficiaries.
The trustee would choose the qualified domestic trust election when the estate tax return is being filed if you pass away before your spouse. Your surviving spouse would receive distributions of the trust’s earnings for the rest of their life, and these distributions would not be subject to the estate tax.
Regular income taxes would be applicable, and you can give the trustee the latitude to distribute portions of the principal if you choose to do so. The estate tax would be levied on distributions of the principal unless a hardship exemption is received from the Internal Revenue Service.
When your surviving spouse passes away and the successor beneficiaries receive the resources, the estate tax would be levied. However, at the end of the process, the assets would benefit two generations but there would be just one round of taxation.
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