Estate Planning for our International Clients
In California it is common to represent clients who are not United States citizens, and who may or may not be U.S. residents. Also, many clients who are U.S. citizens and U.S. residents own assets located in other countries, and many clients have a spouse or other family member who is not a U.S. citizen.
All of these situations create complexities in planning the client’s estate. Below are discussed common issues that arise with international estate planning.
1. Application of Federal Estate Tax and Gift Tax to U.S. Residents.
The U.S. federal estate tax applies to U.S. residents[i] (even if that person is not a U.S. citizen) on their worldwide assets.[ii] A tax treaty may apply so that assets are not taxed twice on the client’s death (in the United States and in the foreign country jurisdiction where those assets are located).[iii] Also, there are special estate and gift tax rules that apply to expatriates making transfers of property.
2. Application of Federal Estate Tax and Gift Tax to Nonresident Aliens.
The U.S. estate, gift and generation-skipping taxes are imposed on the transfers of U.S. assets by nonresident aliens. To be a nonresident alien, the donor must both not be a citizen of the U.S. and not be a resident of the U.S.
The U.S. gift tax does not apply to a nonresident alien’s gift to a U.S. citizen of assets not situated within the U.S., nor to a nonresident alien’s gifts of U.S. corporate stock or corporate bonds. A nonresident alien’s gift of intangible property which is situated within the U.S. is generally not subject to U.S. gift taxes. However, if the foreign (nonresident alien) donor makes a gift of real property or tangible property which is situated in the U.S., then a U.S. gift tax generally applies. Even if U.S. gift taxes do not apply, gifts by nonresident aliens to U.S. citizens may still require the filing of Form 3520.[iv] The federal gift tax applies only to the extent the gift’s value exceeds the §2503(b) per donee annual exclusion. However, the nonresident alien donor cannot apply the unified federal estate and gift tax credit.
As an example, tangible property subject to U.S. gift tax includes U.S. real property. In order for the nonresident alien’s gift to avoid U.S. gift taxes, U.S. real estate could first be transferred to a foreign corporation, and such foreign corporation’s stock would not then be considered property situated within the U.S. This type of planning may have U.S. income tax and reporting issues.
For deceased nonresident aliens, the U.S. federal estate tax only applies to the U.S. situated assets of those deceased nonresident aliens’ estates. U.S.-situated assets, for purposes of the federal estate tax, on deceased nonresident aliens’ estates, include: U.S. real property; debt obligations of a U.S. person, the U.S. and any U.S. state, with exceptions for portfolio debt; U.S. corporate stock (regardless of where the share certificates are located); and tangible personal property located in the U.S. (except certain works of art on loan for exhibition at a nonprofit public gallery or museum). U.S. assets would not include: tangible assets located outside the U.S.; life insurance policy proceeds from a U.S. insurance company insuring the nonresident alien’s life; portfolio debt, such as if the U.S. issues bonds qualifying as portfolio debt in a foreign market if the interest on such debt is not contingent and is exempt from income tax withholding (this portfolio debt exception has many limitations); and deposits in a U.S. bank or savings and loan not in connection with a trade or business.[v]
3. Owning Assets Which are Located in Foreign Jurisdictions.
Where U.S. residents own assets located in foreign jurisdictions, those jurisdictions (for example as to real estate) may not recognize a U.S. trust as a permissible property owner. Additionally, a revocable living trust may not be the best way to title assets which are located in a foreign country, because of that country’s income tax laws. In some cases, a separate legal entity may have to be set up in other countries to accommodate the client’s assets situated in that country. Additionally, clients who have foreign bank accounts have to be sure to comply with the FBAR and FACTA reporting requirements.[vi]
4. Laws of Many Countries Impose a Mandatory Inheritance of Assets.
The laws of many countries require that certain family members (such as spouses or an eldest child) inherit a portion of a decedent’s assets, even if that decedent’s Will or trust specifies a different dispositive desire. These mandatory inheritance laws can trump the provisions of a client’s Will or trust as to assets located in that country or as to citizens of that country.
5. Foreign Death Taxes on U.S. Citizens.
Many foreign countries impose their own inheritance taxes and death taxes. These taxes can apply to a U.S. citizen who is a domiciliary or resident of that other country or own assets in this other country. There is a U.S. federal estate tax “foreign death tax credit” under §2014 which covers foreign inheritance taxes imposed on foreign property. Note that this federal estate tax credit does not apply to foreign death taxes imposed on property located in the United States.
6. When a U.S. Citizen Leaves Assets at their Death to a Non-Citizen Spouse, the Federal Estate Tax Unlimited Marital Deduction Does Not Apply.
The federal estate tax unlimited marital deduction does not apply to assets a U.S. citizen (or a nonresident alien) leaves at their death to a spouse who is not a U.S. citizen. Whether the deceased spouse is or is not a U.S. citizen or a U.S. resident is irrelevant for determining the unlimited federal estate tax marital deduction. Instead, the citizenship and residency status of the surviving spouse determines the application of the unlimited federal estate tax marital deduction. The deceased U.S. citizen spouse’s estate can, however, still utilize the estate tax exclusion amount ($5,340,000.00 currently) to shelter the deceased spouse’s assets from estate tax. Amounts of the deceased U.S. citizen spouse’s estate over such federal estate tax exclusion amount can be transferred to a qualified domestic trust (sometimes known as a “QDT”) in order to qualify assets left to the non-U.S. citizen spouse for the federal estate tax marital deduction.
The QDT has many requirements, such as who may be its trustee (for QDT assets in excess of $2M, a U.S. institutional trustee must serve), and limitations on the distributions of trust principal unless certain estate taxes are withheld. One additional disadvantage of a QDT is that property in a QDT does not receive a further income tax basis adjustment when the non-U.S. citizen spouse later dies.
Note that if the surviving spouse is a U.S. citizen, then the deceased spouse’s estate is entitled to the unlimited federal estate tax marital deduction, even if the deceased spouse is a nonresident alien.
Gifts to a non-U.S. citizen spouse are not entitled to the unlimited marital deduction. For gift tax purposes, gifts to a non-U.S. citizen spouse are limited to a specified annual gift tax exclusion amount, adjusted each year for inflation (this spousal gift tax annual exclusion as adjusted for inflation was $145,000 for the calendar year 2014).
7. Estate Tax Exclusion Amount is Different for Nonresident Aliens.
A nonresident alien’s estate for U.S. federal estate tax purposes could include U.S. corporate stock and U.S. situs real estate, all of which would then be subject to U.S. federal estate taxes. Thus, a nonresident alien decedent’s estate is subject to the U.S. estate tax on that decedent’s U.S. assets. For decedents who are nonresident aliens, the federal estate tax exemption equivalent is $60,000.[vii] No spousal portability rule is applicable to a deceased nonresident alien. This low nonresident alien exemption amount needs to be contrasted against the unlimited federal estate tax marital deduction for recipient U.S. citizen spouses and the current estate tax exclusion amount of $5,340,000 for deceased U.S. citizens’ or residents’ estates.
8. Planning Idea for Foreign Persons Contemplating U.S. Residency.
In order to avoid U.S. gift taxes, a foreign person becoming a U.S. resident or obtaining U.S. citizenship should first consider gifting assets located in other countries to family members. Additionally, making gifts to family members prior to becoming a U.S. resident will help avoid future U.S. federal estate taxes on such gifted assets.
i The determination of residency for estate, gift and generation-skipping transfer tax purposes is different than the determination of residency for income tax purposes. The determination of residency for federal income tax purposes focuses on the definition of “resident alien” under criteria set forth in §7701(b), which definition by its terms does not apply to the estate and gift tax area. A non-U.S. citizen is a U.S. resident for estate, gift and generation-skipping transfer tax purposes if such person is domiciled in the U.S. at the time of the applicable asset transfer. See Regulation §25.2501-1(b) and §20.0-1(b)(1).
Under the Treasury Regulations, “domicile” is defined for this purpose as both being physically present and having no present intention of departing. Thus, to be a U.S. resident for estate, gift and generation-skipping tax purposes, the person must be both a resident in the U.S. and have no current intention to leave the U.S. There is a facts and circumstances test to determine “domicile” under the case law authority.\
ii For U.S. citizens for federal estate and federal gift tax purposes, all of their worldwide assets are subject to these taxes, even if the U.S. citizen lives or dies in another country. This result is the same even if such U.S. citizen has dual citizenship in another country.
iiii The following countries have tax treaties with U.S. governing estate, gift and/or generation-skipping taxes: Australia, Austria, Canada, Denmark, Finland, France, Germany, Greece, Ireland, Italy, Japan, Netherlands, Norway, Sweden, Switzerland, Union of South Africa, and the United Kingdom. These tax treaties vary in their terms. The treaties should be referred to, as they will affect the types of property subject to tax, assist in determining where property is located for tax purposes, and may contain exclusions from tax.
iv Where a U.S. person receives a substantial gift or bequest from a nonresident alien, they are required to file Form 3520 with the I.R.S. pursuant to §6039F. This form is required if the value of all of the gifts received by that U.S. person during the taxable year exceeds a threshold amount of $100,000 for gifts from nonresident aliens. If the gift is from a foreign corporation or a foreign partnership, then the threshold amount, as adjusted for inflation in 2014, equals $15,358. A foreign gift for purposes of this form filing includes amounts received from a nonresident alien as a gift or bequest. Such gift is not a foreign gift for this reporting purpose if that gift would qualify for the unlimited annual exclusion for the direct payment of educational or medical expenses, or if that gift is a distribution from a foreign trust that was properly reported under other Internal Revenue Code provisions. The donee on Form 3520 provides the date of the bequest or gift, a description of the property received, the value of the property received, and other information.
v See §§2104 to 2105.
vi A U.S. citizen or resident, a person in and doing business in the U.S., and a trust formed under U.S. laws are required to file with the United States Treasury a report (known as a Foreign Bank and Financial Accounts Report or “FBAR”) of any financial interest (or where they have signature authority over) in one or more foreign bank accounts, security accounts or other financial accounts that exceed $10,000 in value at any time during the calendar year.
There are income tax return filing requirements in addition to the FBAR rules, under the Foreign Account Tax Compliance Act (or “FACTA”). Under §6038D, an individual with an interest in a foreign financial asset is required to attach to their Form 1040 personal income tax return information about foreign financial assets if the aggregate value of all such specified foreign financial assets is $50,000 or more.
vii See §2102. This $60,000 exemption amount is based upon an estate tax credit of $13,000. Note that the amount of the credit to a nonresident alien could increase to the same exclusion maximum amount allowed to a U.S. citizen or resident if an estate tax treaty between the U.S. and the decedent’s country of domicile so provides.
All Code references are to the Internal Revenue Code of 1986, as amended, and its successor provisions.