One great reason to work with an estate planning attorney is our ability to tailor an estate plan to your needs. Estate planning lawyers will work with you and your family in order to create the best system to meet your goals.
With this in mind, let’s take a look at one device an estate planning attorney may use on your behalf: the Qualified Domestic Trust (QDOT).
Federal Estate Tax
To understand why we might use a qualified domestic trust, you have to know a bit about federal estate taxes. These taxes can be a heavy burden on an estate– up to a 40% (maximum) rate! Of course, these are subject to change through legislative means, and this percentage is as of 2022. That means that the percentage could go down in the future… or it could go up.
On the other hand, this tax is avoidable for many people due to legal provisions that allow you to transfer a relatively high amount of wealth free of taxes. The dollar amount you can transfer is called the “credit” or “exclusion,” and was $11.7 million in 2021 dollars. This federal estate tax exclusion actually increased to $12.06 million in 2022.
Now here’s the bad news. A provision contained within the Tax Cuts and Jobs Act that mandated this large exclusion amount will expire after 2025. Assuming that there are no changes implemented in the meantime, the excluded amount will drop to approximately $6 million.
While we’re here, let’s discuss another tax that dovetails with the federal estate tax: the gift tax. The gift tax is in place to stop people from giving monetary gifts to avoid taxes. The exclusion we discussed earlier is a unified exclusion that applies to large lifetime gifts, and the estate will be transferred after you are gone.
You may want to do some lifetime gift giving before the reduction occurs. It’s also worth considering the possibility that a new tax act (before this planned reduction) could reduce the estate tax exclusion.
What about provisions related to marriage? Perhaps there are some benefits there?
Let’s assume, for the purposes of our example, that you are an American citizen who is married to another citizen. Because you are both citizens of the United States, you are entitled to use the federal estate tax marital deduction. Functionally this means that there is no taxation on transfers between spouses, regardless of the value of the resources that are being transferred. Pretty nifty, right?
Qualified Domestic Trust
Now that we’ve covered the fundamentals, let’s move to the QDOT itself. A qualified domestic trust can be used as part of an efficient estate plan if you are married to someone who is a citizen of another country.
With the QDOT, you will fund the trust and name a trustee to act as its administrator. If your trust is funded with more that $2 million (which is probable if you’re using it for tax efficiency reasons), then a U.S. bank must be one of your trustees.
Assuming you predecease your spouse, your executor will file an estate tax return and make the QDOT election. Your trustee will distribute the trust’s earnings to your surviving spouse and the estate tax would not be applicable. However, distributions would be subject to regular income taxes.
If you allow for it in the trust declaration, the trustee can distribute portions of the principal as well. Keep in mind that these distributions would be subject to the federal estate tax, with one important exception.
You can petition the IRS to grant a hardship exemption if money from your trust is urgently needed. If this exemption is granted, then the estate tax will not be applied to approved principal distributions.
Once both you and your spouse are deceased, the successor beneficiary/beneficiaries that you named in your trust declaration will inherit the enumerated resources. This is when the estate tax applies to the value of your estate which exceeds the exclusion.
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