An often-overlooked estate planning trap involves including individuals who are not U.S. citizens as part of an estate plan.
If someone who is not a U.S. citizen or resident is given control over a trust, either as a trustee or a beneficiary, then the trust will be treated as a foreign trust and will be subject to additional income taxes.
While some people have the option of naming individuals who are U.S. citizens or U.S. residents in their trusts, others do not. For them, planning alternatives may be available so they can avoid the additional income tax of a foreign trust. Options may include naming a corporate trustee, naming individuals who are U.S. citizens or U.S. residents to serve as co-trustees with the individual who is not, or limiting the powers of a trustee or beneficiary who is not a U.S. citizen or U.S. resident.
If a client’s spouse is not a U.S. citizen, this raises a different type of tax issue. Generally, a deceased spouse is able to pass an unlimited amount of assets to the surviving spouse estate tax free, through an unlimited marital deduction from estate taxes. However, if the surviving spouse is not a U.S. citizen, that unlimited marital deduction is not available. To avoid this, the spouse should consider leaving his or her assets for the surviving spouse in a qualified domestic trust, commonly known as a QDOT.