Family-owned business owners in Washington State should be aware that leaving family-owned business interests outright to a surviving non-U.S.-citizen spouse can result in Washington estate taxes due at the first spouse's death, which might otherwise be deferred by using a "qualified domestic trust" (QDOT) and making a QDOT election on the Washington estate tax return.
There is also a federal QDOT election in the event the decedent's estate exceeds the decedent's then federal estate tax exemption – the same concepts discussed below apply equally to the federal election and the same trust is used in both cases, however this article focuses on the Washington election.
Estate Tax Marital Deduction
Like federal tax law, Washington grants an unlimited estate tax marital deduction to property passing to a decedent’s surviving spouse, which serves to delay estate taxes until both spouses have died. However, if the surviving spouse is not a U.S. citizen, this marital deduction is not available to property passing directly, free of any trust to the surviving spouse.
Rather, in order to ensure the government ultimately has the ability to collect estate tax where the surviving spouse is not a U.S. citizen, the marital deduction is only available if the decedent's property passes to a QDOT for the benefit of the non-U.S.-citizen spouse.
Generally, Washington QDOT requirements mirror those for a federal QDOT. A Washington QDOT must:
- Have one trustee that is either a U.S. citizen or a domestic corporation;
- Require income distributions to the non-U.S.-citizen spouse; and
- Require that distributions of principal are subject to estate tax at the time of distribution, as if the tax was computed in the deceased spouse’s estate, and the executor must file a QDOT election on the deceased spouse's estate tax return.
In Washington, the decedent's executor may file an election for both Washington and federal QDOT treatment, or can elect QDOT treatment for one and not the other.
If the executor makes an election to treat a trust as a QDOT on both Washington and federal estate tax returns, the Washington election will be valid if the trust satisfies the federal requirements. Many QDOTs meet this requirement by designating a U.S. bank as trustee.
If an executor makes a Washington QDOT election but not a federal election, the QDOT must:
- Have at least one trustee that is an individual citizen of the U.S and a Washington resident, a corporation formed under the laws of the state of Washington, or a bank authorized to transact business in, and is transacting business in, Washington;
- Have a Washington trustee with the right to withhold Washington tax from principal distributions;
- Be maintained and administered under the laws of the state of Washington; and
- Meet certain tax collection requirements.
These requirements are typically met by designating a bank authorized to transact business in, and is transacting business in, Washington. However, if after the first spouse’s death the non-U.S.-citizen surviving spouse becomes a U.S. citizen and complies with certain requirements, then the Washington estate tax will not apply to any QDOT principal distribution before the date of the death of the surviving spouse.
The Trusts and Estates attorneys at DWT are available to assist owners of family-owned businesses having non-U.S.-citizen spouses with tax efficient strategies to help navigate QDOTs and utilize the Washington unlimited estate tax marital deduction.