INTRODUCTION
U.S. estate tax planning is said to be among the most
complicated aspect of tax planning because of the numerous moving
parts and the changing needs and objectives of the family. The
exercise becomes complicated when the client is not a U.S. person,
but the heirs live in the U.S. and have started families in the
U.S.
This article is intended to guide an adviser in dealing with the
specific issues that arise when a client has roots outside the U.S.
and heirs in the U.S. It does so by setting up a typical fact
pattern and then identifying 15 issues that are unique to this type
of client. It is based on U.S. tax law currently in effect. The
reader is cautioned that many provisions may change, possibly with
retroactive effect.
FACT PATTERN
Mrs. Smith walks into your office. She advises that she is not a
U.S. citizen and lives permanently outside the U.S. She does not
hold a green card. Mrs. Smith has two adult children and several
grandchildren. One child qualifies as a U.S. resident and the other
is a citizen of the U.S. by naturalization.
Mrs. Smith seeks advice on how to structure her estate in order
to reduce or eliminate U.S. Federal estate tax. Her assets include
the following:
- All the issued and outstanding shares of a corporation formed
in her home country - A term life insurance policy issued by a U.S. insurance
company - A house in a foreign country
- All issued and outstanding shares of a U.S. corporation. The
principal asset of the corporation is a condominium apartment
located within the U.S. - All the furnishings for the condominium apartment that were
purchased by Mrs. Smith and which have never been contributed to
the U.S. corporation - A portfolio of publicly traded shares of U.S. corporations
- A portfolio of publicly traded bonds
- An automobile owned and registered in her name in the state
where her resident child resides, which is used by that child
She has many concerns about U.S. estate tax, but does not know
where to begin. Her daughters will inherit, but she wishes to
provide for them during her lifetime.
She asks for your advice. Below are the 15 most important
questions that should be asked and answered in fashioning a plan
for her to minimize U.S. estate tax exposure – as it exists under
current law – and to plan for tax issues she and her two daughters
may face in the U.S.
15 ESTATE PLANNING QUESTIONS AND ANSWERS
- What properties listed above will be subject to U.S.
estate tax for a foreign individual such as Mrs.
Smith?
For an individual that is neither a U.S. citizen nor a U.S.
resident for estate tax purposes (“an N.R.N.C.
individual”), such as Mrs. Smith, the only assets that are
subject to U.S. estate tax are assets having a situs in the
U.S.1 This includes shares of a U.S. corporation, debt
instruments issued by a U.S. person, unless specifically exempt,
tangible personal property physically located in the U.S., and U.S.
real property.
If an N.R.N.C. individual were to own U.S. situs property, the
first $1,000,000 of taxable value will be taxed at graduated rates
totaling in $345,800. Thereafter, the estate tax is imposed at a
flat 40% rate at Federal level. A benefit can be claimed for a
portion of global administration expenses and claims against the
estate. However, direct tracing of expenses to various countries is
not allowed for U.S. tax purpose. Rather, the percentage of the
global estate that is situated in the U.S. controls the portion of
global administration expenses and claims that reduce the gross
U.S. estate. Note that deductions are allowed only if the executor
files a true and accurate U.S. estate tax return that lists all of
the gross estate situated outside of the U.S. There is no unlimited
marital deduction for bequests to a surviving spouse. However, the
estate tax can be deferred through the establishment of a Qualified
Domestic Trust (“Q.D.O.T.”) until a triggering event
occurs. Finally, the unified credit that may be claimed by U.S.
persons to eliminate estate tax on $11.7 million in 2021 is reduced
to $60,000.
For Mrs. Smith, the shares of the U.S. corporation owning an
apartment, the portfolio of publicly traded shares, the automobile,
and the furnishings in the apartment are U.S. situs assets. Certain
other assets owned are specifically treated as foreign situs
assets, as discussed in the answer to the following question. For
those assets that are considered to be U.S. situs assets, the
estate tax in the U.S. can be burdensome.
- Are certain assets generally thought to be U.S. situs
assets exempt from U.S. estate tax at the time of Mrs. Smith’s
death?
As a matter of tax policy, certain assets that would be
considered to be U.S. situs assets under the general rule discussed
in the answer to the preceding question are treated as foreign
situs assets and for that reason are not subject to U.S. estate
tax. These assets include the following:
- Account balances in domestic U.S. banks and foreign branches of
U.S. banks that are not connected to the conduct of a U.S. business
by the N.R.N.C. individual2 - Portfolio debt obligations for which interest income is not
subject to U.S. tax under Code 871(h) for an N.R.N.C. individual,
such as publicly traded debt instruments or privately issued debt
obligations that meet certain conditions, of which the most
important are that the instrument cannot be freely transferred by
endorsement, the creditor cannot be related to the U.S. debtor as
defined in the statute, and the rate of interest cannot be
contingent because it is based, inter alia, on profits,
cash flow, value of assets, and like items3 - Short-term O.I.D. obligations, generally commercial paper or
Treasury instruments having a term of 183 days or less from the
date of original issue4 - Insurance proceeds on the life of an N.R.N.C.
individual5 - Works of art on loan to a not-for-profit public gallery or
museum in the U.S.6
For Mrs. Smith, the U.S. situs assets that are treated as
foreign situs assets are the portfolio of publicly traded bonds and
life insurance policy. While Mrs. Smith’s taxable estate will
not include the foregoing items, so that nothing need be done
during Mrs. Smith’s lifetime to restructure ownership, her
executor may face a practical problem for account balances with
banks and investment portfolios held in street name by financial
institutions. These institutions may refuse to release assets to
Mrs. Smith’s executor until such time as a closing letter is
issued by the I.R.S. regarding satisfaction of estate tax
liability, if any. Anecdotally, advisers have complained that the
I.R.S. has taken up to two years to issue a closing letter even
when the estate of an N.R.N.C. individual is involved, and the
assets have a foreign situs. Consequently, it may be prudent for
Mrs. Smith to raise the matter with all banks and financial
institutions she uses. If written assurances are not received, it
would be prudent to move the investments.
- Are all items of U.S. situs property that are subject
to U.S. estate tax at the time of Mrs. Smith’s death subject to
gift tax if given away during her lifetime?
No. In comparison to estate tax which covers all U.S. situs
assets other than those treated as foreign situs assets, U.S. situs
intangible property is not subject to gift tax when given away
during life.7 For purposes of the U.S. Federal gift tax,
intangible property is not defined in the Internal Revenue Code.
Over the years, various rules have developed. Some of these are as
follows:
- Cash money and currency in physical form are items of tangible
property, and gift tax will be due if gratuitously transferred in
the U.S. by an N.R.N.C. individual.8 - Treasury Regulations discussing the situs of property in the
context of gifts or bequests by foreign individuals state that
intangible personal property consists of a “property
right,” and includes stocks, bonds, and debt obligations,
including bank deposits.9 - In Private Letter Ruling 7737063, the I.R.S. stated that
intangible property refers to choses in action10 such as
corporate stock, bonds, notes, bank deposits, patents, partnership
interests, goodwill, but not to physical cash.
Note that no unified credit is allowed for gifts made by an
N.R.N.C. individual. However, the $15,000 annual exclusion for
gifts to each recipient remains applicable to an N.R.N.C.
individual. There is no unlimited marital deduction for an N.R.N.C.
individual in connection with gift tax. However, the $15,000 annual
exclusion for an interspousal gift is increased more than tenfold.
In 2021, the amount is $157,000.
For Mrs. Smith, the shares of the U.S. corporation owning the
apartment, the portfolio of publicly traded shares of U.S.
corporations, the portfolio of publicly traded bonds, and the life
insurance contract can be given away without triggering the
obligation to pay U.S. gift tax.
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Footnotes
1. Code §2103.
2. Code §2105(b)(1).
3. Code §2105(b)(3).
4. Code §2105(b)(4).
5. Code §2105(a).
6. Code §2105(c).
7. Code §2501(a)(2).
8. Blodgett v. Silberman, 277 U.S. 1 (1928).
Rev. Rul. 55-143.
9. Treas. Reg. §§25.2511-3(b)(3),
(4).
10. A chose in action is a right to sue. It is an
intangible property right recognized and protected by the law, that
has no existence apart from the recognition given by the law, and
that confers no present possession of a tangible
object.
Originally Published 27 May 2021
The content of this article is intended to provide a general
guide to the subject matter. Specialist advice should be sought
about your specific circumstances.