Exemption
- For U.S. citizens and U.S. domiciliaries – the maximum estate tax rate is 40 percent with an exemption amount for 2021 of $11,700,000, indexed for inflation.
- For non-U.S. domiciliaries subject to the U.S. estate tax – the maximum estate tax rate is also at 40 percent but the exemption amount is only $60,000, and this is not indexed for inflation.
Domicile
- For estate tax purposes, a nonresident alien (“NRA”) decedent is a decedent who is neither domiciled in nor a citizen of the U.S. at the time of death.
- An NRA is considered a U.S. domiciliary if he/she resides in the U.S. and intends to stay in the U.S. for the foreseeable future.
- A U.S. citizen is a U.S. domiciliary even if the person is not living in the U.S. Holding a green card is one of the factors considered in determining whether the person is a U.S. domiciliary.
- Even if someone is not living in the U.S., if the person still has strong ties to the U.S., this could subject the worldwide assets of the decedent to the U.S. estate tax. Examples of connections include having a permanent home in the U.S., length of time spent in the U.S., business interests in the U.S., ties to foreign country(s).
- Non-U.S. domiciliaries are taxed on the value of their U.S. “situs” assets. Such assets include real estate and tangible personal property located in the U.S., business assets located in the U.S. and stock owned in corporations organized in or under U.S. law.
- It is possible to be domiciled in more than one country.
U.S. Real Estate
- NRAs acquire real estate in the U.S. for a variety of reasons. Without proper income and estate tax planning, they and their heirs may end up being subject to a lot of U.S. federal and state taxes.
- Upon the sale of a residence exceeding $300,000 the NRA is subject to FIRPTA withholding at 15 percent of the amount realized on the disposition. In addition, the NRA is subject to filing federal and state income tax returns to report the sale of the residence. One could argue that this is no big deal since the gain (assuming the property was held for more than one year) would be at capital gain rates and if the FIRPTA tax withheld is less than the federal capital gains tax then the excess tax withheld should be refunded.
- The problem though is the estate tax since the exemption is only $60,000. To get around this many practitioners advise owning the residence through an entity. Owning it through a domestic corporation doesn’t solve the problem since owning stock in a U.S. corporation is still considered owning a U.S. situs asset and thus would subject the estate of the NRA to the estate tax. Owning the property directly via a foreign corporation or having the foreign corporation own the property through its subsidiary, a U.S. corporation, would solve the estate tax issue but then there are other tax issues (such as income tax issues) that would need to be addressed.
- If the residence is owned by an entity should the entity be charging the owner of the entity rent for the use of the home? If so, and if the rent is not at fair market value, would the entity be required to impute rental income? Would the entity need to file a U.S. tax return?
- One possible solution would be to obtain enough term life insurance to cover the estate tax. Another option would be to try and secure as much of the home’s purchase price through “nonrecourse” financing – thereby reducing the value of the property subject to the estate tax.
- It is not uncommon for NRAs to invest in U.S. real estate through a domestic partnership or LLC (taxed as a partnership). The Tax Code is silent as to the situs of a partnership interest. The IRS’s long-standing position though has been to look through where the partnership’s business is located as being the situs of the partnership interest. If the partnership’s sole asset is U.S. rental real estate, it is probably a given that the IRS will view this as a U.S. situs asset and therefore this asset would be included in the deceased NRA partner’s estate.
Estate Tax Treaties
- The U.S. has estate tax treaties with only 15 countries (Australia, Austria, Canada, Denmark, Finland, France, Germany, Greece, Ireland, Italy, Japan, Netherlands, South Africa, Switzerland and United Kingdom).
- When it comes to estate planning it is very important to closely examine whether the treaty provides for an exemption to the estate tax.
- One of my clients passed away in March 2020 due to complications associated with Covid-19. At the time of his death, the person, a citizen and resident of the United Kingdom, was neither domiciled nor a national of the U.S. The value of his three partnership interests, each of whose principal asset was the holding of U.S. rental real estate properties, was greater than $60,000 at the time of his death. As such this could have caused his estate to be subject to the U.S. estate tax. As it turns out though, paragraph 5 of Article 8 of the Estate and Gift Tax Treaty with the United Kingdom reads: Where property may be taxed in the United States on the death of a United Kingdom national who was neither domiciled in nor a national of the United States and a claim is made under this paragraph, the tax imposed in the United States shall be limited to the amount of tax which would have been imposed had the decedent become domiciled in the United States immediately before his death, on the property which would in that event have been taxable. Since the value of the decedent at the time of death was less than the U.S. exemption amount of $11.58 million [the exemption amount for 2020], his estate will not be subject to the U.S. estate tax as a result of this treaty article. An estate tax return will still need to be filed though to claim the treaty position.
Taking into consideration the potential ramifications of the U.S. estate tax is often an afterthought for NRAs looking to hold U.S. assets, whether it be from owning shares in U.S. multinational corporations, such as Apple or Microsoft, or buying a vacation home or investing in U.S. real estate through a partnership. Careful planning prior to making any such investment can result in thousands of dollars in tax savings down the road.
If you have any questions about how the U.S. estate tax might impact you, please contact Richard Linder, at [email protected]
