To understand the relevance of a qualified domestic trust, you have to digest some background information about taxation as it applies to your estate. First off, we can provide some good news. An inheritance is not considered to be taxable income for regular income tax purposes, so your heirs will not have to worry about taxation from this perspective.
However, that is not the end of the story. There is a federal estate tax in place, and it carries a hefty 40 percent maximum rate. This tax can play havoc with your legacy if you are exposed.
Estate Tax Exclusion
Fortunately, it is only a factor for high-net-worth families, because there is a relatively high estate tax credit or exclusion. For the rest of the 2023 calendar year, the exact amount of this exclusion is $12.92 million.
There are annual adjustments to account for inflation, so next year, an adjustment will be added to raise this figure. The portion of your estate that exceeds this amount is potentially subject to the death tax.
In 2026, a key provision in the Tax Cuts Jobs Act will expire. At that time, the exclusion will be reduced to the $5.49 million that was in place in 2017 indexed for inflation.
Federal Gift Tax
When you hear about the existence of the federal estate tax, you may consider lifetime gift-giving as a way to avoid the tax. Wealthy people used to take this route shortly after the estate tax was enacted in 1916.
However, to close this loophole, a gift tax was enacted. The gift tax is unified with the estate tax. As a result of this unification, the $12.92 million exclusion that we have in 2023 is a unified exclusion. It applies to large gifts that you give during your life, and it also applies to the estate that will be transferred after you are gone.
So, if you were to utilize all of your unified exclusion giving large tax-free gifts while you are living, the entirety of your estate would be subject to the estate tax.
Estate Tax Marital Deduction
The federal estate tax could be a factor if you are transferring assets to anyone other than your spouse. We have an unlimited marital estate tax deduction in the United States. This allows you to transfer any amount of money and other forms of property to your spouse without incurring any estate tax exposure.
Since the gift tax and the estate tax are unified, the unlimited marital deduction also applies to lifetime gift giving. You can give unlimited gifts to your spouse free of taxation.
However, to take advantage of the unlimited federal gift and estate tax marital deduction, your spouse must be a citizen of the United States. This stipulation is instructive, even if you are married to a citizen, when you look at the reason behind it.
Think about the scenario that would unfold if you left a taxable estate to your citizen spouse free of taxation using this deduction. The tax man would still be looming, because your surviving spouse would be in possession of an estate that could be taxed. Eventually, the tax would come into play.
On the other hand, if a citizen of another country was allowed to use the unlimited marital deduction, this individual could return to his or her country of citizenship with a tax-free inheritance. The United States Internal Revenue Service would never be in a position to collect anything.
Qualified Domestic Trust
Now that we have provided the necessary background information, we can look at qualified domestic trusts. If you are married to a citizen of another country, and you are exposed to the estate tax, you could convey assets into this type of trust.
If you predecease your spouse, the trustee could distribute the earnings from the trust to your spouse throughout the rest of his or her life. These distributions would be subject to regular income taxes, but they would not be subject to the estate tax.
Portions of the principal could be distributed at the discretion of the trustee, but the estate tax would be applicable unless the IRS grants a hardship exemption.
After the death of your surviving spouse, a secondary beneficiary of your choosing would assume ownership of the remainder that is left in the qualified domestic trust trust. This exchange would potentially be subject to federal transfer taxes.
Schedule a Consultation!
We are here to help if you like to discuss estate tax efficiency or any other objectives with a Phoenix, AZ estate planning lawyer. You can send us a message to request a consultation appointment, and we can be reached by phone at 888-222-1328.
- Are Handwritten Wills Legal in Arizona? - October 8, 2026
- Do All AZ Estates Go Through the Full Probate Process? - October 1, 2026
- New Arizona Transplant? Schedule an Estate Plan Review - September 24, 2026
Flagstaff
