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Qualifying Domestic Trust (QDOT) Explained
A Qualifying Domestic Trust (or QDOT as it is commonly called) is a special trust used by individuals for end-of-life planning. Basically, a QDOT trust allows assets held by the trust to be free from estate and gift taxes (up to the amount of the marital deduction — which is currently unlimited per IRC Section 1056A) at the time of the trust creator’s death. The trust assets are then held for the benefit of the beneficiary.
Estate planners employ QDOT trusts to protect the interests of a surviving spouse who is not a US citizen. While US citizen spouses receive the assets of their spouse free from estate or gift tax (up to the amount of the martial deduction – currently unlimited), a non-US-citizen spouse does not receive that benefit. As such, the couples often use a QDOT trust to preserve the benefit.
A Little More on Qualified Domestic Trusts
As previously mentioned, a surviving spouse can only receive the assets of her deceased spouse free of estate and gift taxes if she is a US citizen. There is a limited exclusion from estate taxes of up to $152,000 (in 2018) for assets left to a non-citizen spouse.
The QDOT trust can preserve the full marital deduction benefit when the decedent transfers all of his assets into the trust prior to passing away. This means that the decedent no longer has control over the assets at the time of death; rather, the assets are held in the trust, which is controlled by an appointed trustee.
The spouse creating the trust cannot maintain control of the trust (such as the ability to pull money out) after creation. This means that the trust is “irrevocable” by the creator.
The individual appointed to manage the trust (a Trustee) must be a US citizen or a domestic corporation authorized to retain assets for estate tax purposes.
After the decedent passes, the trustee will continue to manage the trust assets for the benefit of the surviving spouse. This means that the trust can disperse funds to the spouse as directed in the trust or pursuant to her default discretion. The assets in the trust will ultimately be considered to be part of the estate of the beneficiary spouse when she passes away.
References for QDOT Trust
Academic Research on Qualified Domestic Interest Trust
A Potpourri of Potential Pitfalls to Avoid with Qualified Domestic Trusts, Pearson, W. M., & Bradley, T. L. (1999). FLORIDA BAR JOURNAL, 73, 47-50. This paper explains that if a property is either held in or transferred to a qualified domestic trust as defined under I.R.C, a marital deduction is allowed. It states that the estate tax is computed under the QDOT rules and deferred up to when distributions from the trust are made or when the surviving spouse dies. However, it also presents various exceptions to the general rule of taxation upon distribution.
Estate Planning Concerns for the Professional Athlete, O’Meara, J. K. (1992). Marq. Sports LJ, 3, 85. This article explains why the creation stage of estate planning for a successful professional athlete is short compared to that for most people which takes many years with an early emphasis on the creation of sufficient wealth to allow the estate owner enjoy the fruits of his efforts. It explains that it is because there is an early emphasis on the preservation and protection of accumulated wealth while the athlete is still young.
Completed Transactions, Qualified Reformation and Bosch: When Does the IRS Care about State Law of Trust Reformation, Spivey, B. F. (2000) ACTEC Notes, 26, 345. This study investigates the extent to which the state law requirements for valid trust reformation proceedings can be examined by the Internal Revenue Service and the extent to which the compliance with state law is necessary on the legal reformation requirements of a trust under state law as it continues to develop.
International Estate Planning 101: A Basic Guide to Estate Planning for Non-Citizen Clients, Stiller, R. R. (2000). Akron Tax J., 15, 121. Since the estate planning considerations for aliens may differ from those of US citizens, this article attempts to highlight the areas of these differences and similarities, if any, and also to explain the basic estate planning needs of the noncitizens. One of the biggest reasons of determining the status of an alien client and then drafting a beneficial estate plan to him and his heirs is because only the portion of a nonresident alien’s estate that is established in the US is taxable under ES estate tax.
Special Issues in Estate Planning for Retirement Benefits: Part 2., Caudill, A. (2011). Journal of Financial Service Professionals, 65(2). This paper explains that people usually put their personal affairs in order when they approach retirement. Estate planning involves wills, powers of attorney, health care proxies as well as other documents that detail end-of-life decisions. This paper investigates the unique issues that arise in estate planning for retirement benefits.
Tax Aspects of Using a Unitrust Amount to Define Appropriate Benefit Currently Distributable from Non-Charitable Trusts, Sherwood, A. M. (1998). NY St. BJ, 70, 70. This paper focuses on the use of total return trusts to equalize the expectations of beneficiaries and wishes of trustees. It also details the proposed Treasury regulations when it comes to facilitating the use of total return trusts to qualify for various federal estate tax benefits that include the marital deduction, the charitable contributions deduction among others.
Final Regulations on the Definition of Fiduciary Income, Mezzullo, L. A. (2005). Prob. & Prop., 19, 26. This article defines a fiduciary as a person in charge of administering and executing the estate of a deceased person. The fiduciaries are required to settle tax obligations and other liabilities before the estate of the deceased can be transferred to the legal heirs. However, this estate continues to earn income and taxes must be paid on this income. This article also presents the final regulations that define fiduciary income.
Five Tax Traps for Resident Noncitizens (and Their Attorneys), Bowman, S. A. (2010). Fla. BJ, 84, 33. This study explains that although the US provides numerous opportunities in a wide range of areas, resident noncitizens (RNCs), the noncitizens who have established residency in the US, face diverse and complicated legal issues, especially in the tax and property regimes. This means that the RNCs together with their lawyers have to be careful not to fall into the common tax traps that affect most people. This study provides an overview of five of these traps.
International Estate Planning, Hauser, B. R., & Erwin, J. M. (2000). The International Lawyer, 591-598. This is research that includes the legal issues that affect estates like taxation, community property, asset protection trusts among others. It also analyzes several countries that are possible sites for the establishment of trusts and other investment mediums that are potential residencies for US nationals in terms of businesses.
Trusts & Estates, Cunningham, S. (2016). Syracuse L. Rev., 66, 1099. This paper explains that estate planning is sensitive since individuals consider it when faced with factors such as a terminal illness or disability, retirement or even after death. It describes the process of estate planning and the importance of transferring responsibilities such as the management of one’s estate to a trustee in case one becomes incapacitated.