A Qualified Domestic Trust (QDOT) bond is in favor of the Internal Revenue Service (IRS) to guarantee the payment of taxes due on such a qualified domestic trust.
A QDOT is a very specific type of trust. A wealthy American citizen sets up this type of trust, prior to his or her death, to defer estate taxes for the benefit of their non-citizen spouse. According to WealthCounsel LLC, the IRS taxes every dollar of an estate greater than $5 million at a 40% rate in the absence of a QDOT. Thus, this trust allows the surviving spouse to receive income, and sometimes principal, from the trust until their death. The IRS taxes the surviving spouse’s income from the trust as regular income. When the surviving spouse dies, the IRS taxes the estate at the 40% rate.
Why does the IRS require a QDOT to defer taxes? It’s simply because the IRS fears the foreign surviving spouse will return to their home country with millions of estate assets. If the spouse leaves the United States with the liquid assets, the IRS cannot collect any estate taxes. A QDOT is not necessary for a married couple both with US citizenship because the IRS knows it can eventually collect taxes on those assets due to the surviving spouse’s citizenship and residency. In fact, a deceased spouse can leave an entire estate to the surviving spouse without any taxes due thanks to an unlimited marital deduction.
So where does the surety bond fit into this picture? The bond is required by the trustees of the QDOT to guarantee their faithful payment of taxes, including penalties and interest, due to the IRS in relation to the trust. The bond penalty equals 65% of the amount of the trust. Premiums on these bonds tend to run high due to the significant amount of risk and high bond penalty, and the premiums renew yearly until the IRS deems the QDOT no longer qualifies as said trust or the surviving spouse (principal and trustee) dies.
The surety can only cancel the obligation by giving written notice 60 days in advance of the renewal date. If the IRS accepts the cancellation of the obligation, they may tax the trust and draw down on the bond amount. However, the trustee has a 30 day window after receiving the notice of failure to renew to find an alternative surety bond or security arrangement.
The QDOT bond is governed under section 2065A(b) of the Internal Revenue Code. You can read the section on Cornell’s Law website.