Planning for the non-US citizen spouse is necessary because there is no deferral of estate and inheritance tax at the death of the US citizen spouse. At the death of the US citizen spouse, any assets going to the surviving non-US citizen spouse subject to the marital deduction is fully taxable. It is only the marital deduction that is not extended to non-US citizen spouses. If and when the applicable credit returns in 2011 (expected to be $1,000,000), the credit does extend to such surviving spouses. It is the excess that will not be subject to the marital deduction for assets passing to a surviving non-US citizen spouse. However, if the non-US citizen spouse becomes a naturalized citizen before the estate tax return (Form 706) is timely filed, the marital deduction will apply even though at the time of death the surviving spouse was not a US citizen.
Another technique is to create a qualified domestic trust which allows for a deferral of the estate tax. The requirements of such a trust are:
1. It is a valid trust under state law;
2. At least one Trustee is a US citizen or domestic corporation;
3. The Trustee will collect and pay estate tax when distributions of principal are made;
4. All of the income from the trust must be distributed to the surviving spouse;
5. An election as a qualified domestic trust is timely filed;
6. Trustee posts a bond or letter of credit where appropriate; and
7. Foreign real estate investments are limited.
If there was not qualifying trust created before death and the surviving spouse is unable to become a naturalized citizen in time, the surviving spouse may create a qualifying trust to which he/she makes an irrevocable assignment of the assets; or, petition the Court for a reformation of an existing trust to qualify.
Before going to the trouble of naturalize, court reformation, or irrevocable assignment, a non-US citizen spouse should do the numbers. What is the tax liability and are there adequate funds to pay the liability. It may be better to pay the tax and have complete use of the assets. One reason to consider paying the tax is that the qualifying trust only defers the estate tax. All of the tax will be paid on the principal subject to this trust. It will be collected and paid with each distribution of principal. The remainder, if any, will be paid at the death of the non-US citizen spouse. The rate of tax is that in existence at the time of death of the US citizen spouse.
Where a family business is one of the assets, deferral of the tax and paying in installments may be the better than having to sell off assets needed for the operations in order to pay the tax. But all options should be explored.