Foreigners Still Don’t Get an Estate and Gift Tax Break

IRS recently announced an additional increase in the lifetime estate and gift tax exemption, up from the $11,400,000 2019 amount to $11,580,000 for the 2020 tax year.

Despite these increases however, the exemption for non-U.S. persons who die owning U.S. assets remains at the paltry $60,000 level. In general, it remains a surprise to many U.S. assets investors that the U.S. can apply the estate and gift tax at all to foreign persons. This (largely understandable) lack of knowledge of the rules combined with the low level of exemption means planning is a necessity.

Non-U.S. Person for Purposes of the Gift and Estate Tax

A non-U.S. person for purposes of the gift and estate tax is a non-U.S. citizen who is not domiciled in the U.S. at the time of gift or bequest. Domicile is a subjective term based on a long-term intent to remain in the U.S. While this standard can be relatively clear when applied to a foreign person with little or no ties to the U.S., it can create confusion in such cases as a green card holder residing outside of the U.S. or a visa holder living in the U.S. for a period.

What is Subject to Tax?

Broadly speaking, U.S.-situated assets are subject to tax. However, different rules apply to gifts versus estate bequests. The general rule is that estate tax applies to all U.S.-situated assets, except for securities that generate portfolio interest, non-business bank accounts and life insurance proceeds. For gift tax purposes, intangible assets including most securities are not subject to gift tax.

How Does the Tax Apply?

As stated above, the lifetime exemption for a non-citizen, non-domiciled person is $60,000. Gifts of U.S. assets that take place in the U.S. that are in excess of the annual exclusion of $15,000 will reduce the lifetime exemption and if exceeded will be taxed at rates up to 40%. Upon death, the fair market value of U.S.-situated assets exceeding the remaining exemption are taxable at the same rates. Transfers to a U.S. citizen spouse from a non-U.S. citizen spouse will be eligible for the unlimited marital deduction. Although treaties may exempt certain intangible assets from tax or provide a higher exemption, they are limited in numbers and their application. Currently, only 17 estate and gift tax treaties exist and almost all are with European countries.

Estate Tax Return

Many executors or heirs are further surprised that the decedent’s U.S. assets will be effectively tied up until IRS determines that all tax obligations have been met and issues a transfer certificate permitting the custodian to release the assets. To get the certificate, the estate executor must file an Estate Tax Return (Form 706-NA) within nine months (not including extensions) of the date of death with information on their worldwide assets. Once filed, it can take several months if not years to resolve these matters, depending on the complexity of the estate assets. During this period, the estate may also find itself having to file a U.S. income tax return to report U.S. source income generated on the assets.

Planning Ahead

For a non-U.S. citizen, the first issue is to determine domicile status as best as possible. Once determined, several options can provide adequate protection. For example, holding assets through a non-U.S. entity; using an irrevocable trust; or hedging the risk with life insurance. Any strategy should factor in the circumstances of the respective family members, long-term goals and potential income tax considerations. As with any plan, early implementation is key.