International Estate Planning
Viewpoints on Financial Planning
Clients in today’s wealth management environment need access to reliable financial planning advice and assistance whether they live in the US or another part of the world.
The following article is not an exhaustive study of international estate planning; rather, it is designed to provide a foundational understanding of the complex nature of international transfer tax planning. Certainly, one should consult with legal and tax counsel in dealing with multi-national planning.
FREQUENTLY ASKED QUESTIONS
1. How does estate and gift tax planning differ for non-US citizen clients?
The answer depends upon the non-US citizen client’s status as a domiciliary or non-domiciliary.
Generally speaking, an individual who is a US citizen or non-citizen domiciliary is subject to US transfer taxes on their worldwide assets. However, the application of the US transfer tax regime may be more complex (and even more onerous) for a non-US citizen non-domiciliary.
Under the estate and gift tax domicile rules, a person acquires a domicile in a place by living there, for even a brief period of time, with no definite present intention of later leaving.
Unlike the more objective income tax residency test, simply living in the US for a certain number of days is not sufficient to establish “domicile” under transfer tax law. Furthermore, a client who is a US resident for immigration purposes is not automatically treated as a domiciliary for transfer tax purposes.
Although Visa status or the length of time a person lives in one place is certainly significant in determining domicile, those facts are only part of the IRS’s subjective analysis. Other factors considered include the location of business interests, the location of valuable art or tangible personal property, the location of other residences, the domicile of their family and friends, and interestingly, burial plot location.
2. Do non-US citizens qualify for the estate and gift tax exclusions?
Again, the answer depends upon the client’s status as a domiciliary or non-domiciliary.
If a non-US citizen is deemed a non-domiciliary for transfer tax purposes, the estate tax exemption amount is only $60,000. Moreover, the location and type of property transferred at the time of the gift or death is critical in determining whether the transfer is subject to US transfer taxation. Unfortunately, the lifetime gift tax exclusion and unlimited marital gift tax deduction are unavailable.
On the other hand, if a non-citizen is deemed a domiciliary for transfer tax purposes, the estate and lifetime gift tax exclusion amounts available to a US citizen are also on hand to a domiciliary. For 2013 and beyond, portability of a deceased spouse’s estate tax exclusion is available. Regrettably, the unlimited marital gift tax deduction is not available for tax planning purposes.
Both a non-citizen domiciliary and a non-domiciliary may use annual exclusion gifts as well as a limited marital gift tax deduction for gifts between non-citizen spouses. First, annual exclusion gifts ($14,000 per person per year in 2014) may be used to transfer wealth directly to children or into a trust for their benefit. Secondly, a gift to or between non-US citizen spouses in 2014 is limited to $145,000 per year. This can make proper estate tax planning rather difficult for a non-citizen married couple or a couple where only one spouse is a non–citizen. Note: The IRS indexes these two gift tax provisions for inflation but only in $1,000 increments.
Lastly, whether a client is deemed a domiciliary or non-domiciliary, the unlimited marital estate tax deduction is not available; however, this deduction may be “restored,” in effect, by a Qualified Domestic Trust (QDOT) (See FAQ #6).
3. Which assets of a non-US citizen are subject to US transfer taxation?
All of the worldwide assets of a non-citizen who is a domiciliary of the United States are subject to the estate and gift tax.
On the other hand, only certain assets of a non-US citizen who is a non-domiciliary constitute US situs assets for transfer tax purposes and are therefore subject to US transfer taxes.
Please note that the rules vary between estate and gift tax. The US gift tax applies to a non-citizen, non-domiciliary only if the tangible personal property is physically located within the US. For example, real estate and personal property are subject to both gift and estate tax if they are located in the US.
Transfers of intangible, personal property located in the US by a non-domiciliary are exempt from gift taxes. Intangible personal property includes stock, debt obligations, LLC units and partnership interests. For a non-citizen, non-domiciliary, US estate taxes only apply to US situs assets. These assets include real and tangible personal property located in the US. and stock of US corporations. Although stock in a US corporation is definitely subject to estate tax, transfers of stock in a US corporation would not be subject to gift tax. In contrast, partnership and LLC interests are not subject to federal gift tax or estate tax. Clearly, the potential use of business entities by a non-citizen, non-domiciliary to avoid transfer tax cannot be ignored.
4. How do international tax treaties influence a non-US citizen client’s tax status?
The US has entered into income and transfer tax treaties with a multitude of foreign nations. For non-US citizens, a treaty may change the rules regarding domicile, residency and the location of assets.
Older transfer tax treaties allow the individual’s “domicile” to be determined under the law of each country signing the treaty. The older treaties do not modify the criteria used by a nation to determine an individual’s domicile. Unfortunately, an estate may be subject to double taxation on worldwide assets by two nations. Generally, the tax authorities allow tax credits on property situated in the other country.
The newer treaties avoid conflicts between tax authorities via “tie breaker rules”. If an individual is viewed by both countries as a domiciliary, he will be treated by both countries as a domiciliary of the country of citizenship if he resided there for a certain period of time (sometimes five of seven years) before his death or the gift in question. If, for whatever reason, this rule is inapplicable, domicile is determined in this order: permanent residence, center of vital interests, habitual abode and citizenship and, as a last resort, the tax authorities settle the matter by mutual agreement.
In some cases, a foreign country, such as Australia, Italy or Sweden, has abolished the gift or estate tax (or both) subsequent to signing a treaty with the US. Despite that fact, the treaties will not terminate or change.
Finally, the US estate tax applies to the entire estate of a US citizen regardless of where he is domiciled or where his or her property is situated.
5. Does a non-US citizen spouse qualify for the marital deduction?
The estate of a non-US citizen is entitled to a marital deduction for property situated in the US passing to a US citizen spouse. If the surviving spouse is not a US citizen, however, transfers will qualify for the marital deduction only if the surviving spouse becomes a US citizen before the filing of the US estate tax return and was a domiciliary of the US at all times between the decedent’s death and the date of the survivor’s naturalization; or the property passes to a Qualified Domestic Trust (QDOT).
6. What are the general rules for a QDOT?
First, the election to treat a trust as a QDOT is made on the decedent’s federal estate tax return by the personal representative of the estate. The election may be made between the date of death of the decedent and the estate tax return’s due date.
As stated previously, in order for bequests from a decedent to a non-US citizen spouse to qualify for the unlimited marital deduction, the property must pass to the surviving non-US citizen spouse by way of a QDOT. The QDOT restores the marital deduction, in effect, but is subject to a number of requirements. The QDOT allows the non-US citizen surviving spouse to postpone estate taxes, while ensuring the IRS that the assets stay in the US to pay estate taxes.
A QDOT must pay all of the income to the spouse for life, has at least one US trustee, and may make principal distributions only to the surviving spouse. Estate taxes are due on either withdrawals of principal by the surviving spouse from the QDOT, or upon the death of the surviving non-citizen spouse.
If the QDOT has assets in excess of $2 million, the IRS imposes additional requirements to ensure the trust pays all the estate taxes due. The additional requirements are the trust must have a US bank as an institutional trustee, or a US branch of a foreign bank and a US citizen as co-trustees.
7. Are there QDOT distributions that are exempt from estate taxation?
Exempt from estate taxation are withdrawals that qualify under the hardship exemption. Treasury regulations state that the principal distribution must be made to the spouse in response to an immediate and substantial financial need relating to the spouse’s (or any person that the surviving spouse is legally obligated to support) health, maintenance, education or support.
Before making such a withdrawal, the trustee must consider other assets or sources of income reasonably available to the spouse. So, if the spouse has available cash, stock or other liquid assets available to meet the financial need, the amount of funds raised by these assets would reduce the amount of the exempt hardship distribution.
8. Is there any way to plan around the QDOT requirement?
By planning in advance, the use of life insurance can enable significant benefits that could be an alternative (or counterpart) to the QDOT arrangement: (1) the proceeds are not included in the estate of the US decedent spouse, assuming no incidents of ownership in the policy are held by the decedent at death; and (2) the insurance proceeds paid by a US insurance company upon the death of the insured are not includible in the gross income of the recipient.
Additionally, this insurance arrangement may even provide a foreign beneficiary with an inheritance denominated in US dollars, which could be an advantage depending upon where they live in the world. Lastly, the policy proceeds received by the spouse could be loaned to the estate of the US decedent if the estate of the US spouse is illiquid.
Also, a joint and survivor annuity is an alternative to a QDOT. The portion of the annuity that constitutes principal is not subject to estate tax when paid to the non-citizen spouse. Lastly, an annuity enables a spouse to transfer more than the annual exclusion to their non-citizen spouse gift tax free.
Affluent families are no longer relegated to one city or even one country. Due to the ease of overseas travel or intra-family cultural diversity, families are increasingly mobile on a worldwide scale. Thus, it is important to avoid both unexpected pitfalls and unforeseen tax consequences.
|Decedent||Surviving Spouse||Annual Marital Gift Tax Exclusion - 2013||Avail. of Gift-Splitting to a Third Party||Avail. of Gift Tax Annual ($14,000) Exclusion||Decedent’s Estate Tax Applicable Exemption - 2013||Estate Tax Unlimited Marital Deduction|
|US Citizen||US Citizen||Unlimited||Available||Available||$5,340,000||Unlimited|
|US Citizen||Non-Citizen Domiciliary||$145,000||Available||Available||$5,340,000||Only with a QDOT|
|US Citizen||Non-Citizen Non-Domiciliary||$145,000||Not Available||Available||$5,340,000||Only with a QDOT|
|Non-Citizen Domiciliary||US Citizen||Unlimited||Available||Available||$5,340,000||Unlimited|
|Non-Citizen Domiciliary||Non-Citizen Domiciliary||$145,000||Available||Available||$5,340,000||Only with a QDOT|
|Non-Citizen Domiciliary||Non-Citizen Non-Domiciliary||$145,000||Not Available||Available||$5,340,000||Only with a QDOT|
|Non-Citizen Non-Domiciliary||US Citizen||Unlimited||Not Available||Available||$60,000||Unlimited|
|Non-Citizen Non-Domiciliary||Non-Citizen Domiciliary||$145,000||Not Available||Available||$60,000||Only with a QDOT|
|Non-Citizen Non-Domiciliary||Non-Citizen Non-Domiciliary||$145,000||Not Available||Available||$60,000||Only with a QDOT|