Having a non-citizen spouse can result in gift tax headaches

April 2, 2008

© 2008 by Michael C. Gray, CPA

The United States has been a destination for immigrants from the beginning. Resident aliens are an important part of our workforce, and make an important contribution to our economy. Also, American men have sought brides from other countries.

There is a tax trap that U.S. residents who have a non-citizen spouse are almost always blissfully unaware of. Our United States tax system includes a gift tax. After applying a $1 million exemption for lifetime gifts, the rate of tax starts at 41% and the maximum rate is currently 45%.

For spouses who are both United States citizens, the gift tax isn’t an issue because there is an unlimited marital deduction for gifts to a spouse who is a U.S. citizen. One benefit of the unlimited marital deduction is U.S. citizen spouses have a lot of flexibility about how to hold title for their assets.

Gifts to a spouse who is not a U.S. citizen (also called an alien spouse), do not qualify for an unlimited marital deduction. Instead, up to $125,000 for 2007 or $128,000 for 2008 may be given in a year to the non-citizen spouse free of gift tax.

This means married couples that include a non-citizen spouse do not have the same flexibility in holding title as couples where both are citizens. For example, during 2008 Chuck and Meg, both resident aliens, get married and buy a home and take title to the home as community property. The down payment comes from funds owned by Chuck before marriage. The down payment is more than $300,000. Since one-half of $300,000 equals $150,000, and that exceeds $128,000, it appears there is a taxable gift to report.

(When the married couple are residents of a community property state, income earned after marriage is generally automatically community property owned by both spouses, so there is no gift tax impact from the use of those funds to purchase community property assets or holding the funds in a community property bank or investment account. The community property rules vary by state, so consult your local attorney about how this works.)

Common estate planning strategies for spouses who are both U.S. citizens may not be appropriate when one of the spouses is not a U.S. citizen. For example, estate planners often recommend that spouses own their residence as community property to qualify for a step-up in basis when either spouse is first deceased.

I recommend that all married couples that include a non-citizen spouse and have significant assets consult with their tax advisor and estate planner about this issue.

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