LEGAL GUIDE
Written by attorney Kevin Andrew Pollock | Dec 14, 2010

The NJ QDOT Trap

When a person dies, the surviving spouse can receive all of the decedent's money free of tax, but only if the surviving spouse is a citizen of America. If the surviving spouse is not a U.S. citizen, anything over the estate tax exemption amount is subject to an estate tax. One way to avoid paying a tax on money going to the benefit of a surviving non-citizen spouse is to set up a Qualified Domestic Trust (QDOT). With the ever increasing federal estate tax exemption, and the fact that we do not have a federal estate tax in 2010, most practitioners are not giving much thought to the use of QDOTs. This is because many practitioners are trying to avoid the large federal estate tax and not the smaller NJ Estate tax. If the estate is not going to be subject to the federal estate tax, the thinking is that there is no need to set up a QDOT for the surviving spouse. Unfortunately, New Jersey has a little known rule that subjects the estate of a decedent to the New Jersey Estate tax if assets in are being left to a non-citizen spouse. This could create a significant tax on the death of the first spouse and another tax when the surviving spouse dies as well. To avoid the NJ Estate tax, a QDOT can be set up for the surviving non-citizen spouse to deal with assets passing to him or her. This is where the trap kicks in. If a QDOT is set up, almost all distributions other than income distribution will be subject to the federal estate tax! As you know, the NJ Estate tax rates are typically 4.8% to 12%, but the federal estate tax rates can be as high as 55%. So what should a surviving non-citizen spouse do? It really depends upon whether the surviving spouse intends to become a citizen or not. If not, it is probably best to just pay the NJ Estate tax. If the surviving spouse does wish to become a citizen, he or she should immediately see an attorney to set things in motion. The decedent's estate must be administered, a QDOT will need to be set up, the surviving spouse must apply to become a citizen and then an application must be made to the IRS to remove the trust's status as a QDOT. This should all be completed before any taxable distributions are made from the QDOT. The New Jersey QDOT trap only applies to decedents who own more than $675,000 at the time of their death as New Jersey allows an estate tax exemption before taxing the surviving non-citizen spouse. However, New Jersey will look at all of the decedent's assets, including retirement accounts, life insurance homes, stocks, bonds, etc. in arriving at the value of the decedent's estate. (Note: it does not matter if the decedent is a citizen or a permanent resident alien. What is important is the citizenship of the surviving spouse.)

Additional resources provided by the author

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