Inadequate planning, or a failure to plan, may cost non-U.S. citizens who own U.S.-situated property millions of dollars in unnecessary estate and income taxes.
Background
Under current law, nonresident aliens (NRAs) holding U.S.-situated assets valued at more than $60,000 USD may be subject to the full impact of the United States federal estate tax.
The Tax Cuts and Jobs Act of 2017 increased the estate tax exemption[1] (combined lifetime gift tax, gross estate tax, and GST) available for U.S. citizens to $11.2 million USD for an individual or $22.4 million USD for a married couple, adjusted annually[2], and left the gift and estate tax rules unchanged as they apply to NRAs.
This means that at death, many NRAs with certain U.S. property may only receive a $60,000 USD exemption on such property. NRAs can benefit from proper planning to avoid unexpected tax consequences.
Definitions
Residence
The physical, legal residence an individual currently occupies.
Domicile
The legal residence where a person has a fixed dwelling with the intention of making their permanent home. Domicile can be thought of as an equation: Residence + (Intent to permanently remain) = Domicile.
U.S. Citizens
A citizen is a person born in, or naturalized to, the U.S. and still subject to the U.S. jurisdiction.
Resident Alien
A resident alien is a person who is not a U.S. citizen, intends to domicile in the U.S., and has acquired legal resident alien status from the U.S. government (i.e., “green card”).
Nonresident Alien
A non-U.S. citizen who does not intend to domicile in the U.S.
Assets subject to estate tax
The $60,000 USD estate tax exemption applies to any NRA’s estate consisting of U.S.-situated assets. Generally, U.S.-situated assets include U.S. real estate, tangible personal property, and securities of U.S. companies. Whether an asset is U.S.-situated or not is a facts-and-circumstances test and should be evaluated by professional counsel. Because the individual states are left to determine their own tax and residence policies, separate state analysis of property and tax laws may be required. Numerous countries have entered into treaties with the U.S. that may impact the taxation of certain assets, clarify domicile and situs issues, and provide additional deductions. The citizenship of an NRA must be considered on a case-by-case basis to understand both U.S. and home country tax impacts of planning decisions.
A note on income tax: Laws and regulations affecting federal and state income tax are different than those applying to estate and gift tax regimes. Income tax planning should be considered separately.
Annual gift limits
Annual exclusion of gifts to a non-U.S. citizen spouse is $164,000 USD per year in 2022 compared to the unlimited annual gift between citizen spouses.
Under current law, the annual gift exemption to non-spouses is $16,000 USD in 2022.
An NRA is only subject to U.S. gift and estate tax on U.S.-situated assets. The following matrix demonstrates generally accepted federal tax treatment of certain types of assets:
Planning opportunities
There are numerous planning opportunities if an international client is prepared.
Structuring foreign corporations to hold otherwise U.S.-situated assets may alleviate U.S. gift and estate taxes, as foreign corporate ownership interests are generally not considered U.S.-situated. Management and maintenance of a foreign corporation with a valid business purpose may be complex and costly and may have unintended tax or legal consequences in the client’s home country. Certain assets which could be construed as personal in nature (such as a primary residence, vacation home, or luxury items) may not be suitable for ownership by a foreign corporation.
A life insurance death benefit paid to a non-citizen is considered to be an intangible non-U.S.-situated asset and, when properly structured, is not generally included in the gross taxable estate of a non-U.S. person. Trust ownership of a life insurance policy may be useful in certain situations. Offshore life insurance may be useful to hold assets within the policy and to avoid current income taxation on investment returns within the policy, as life insurance cash values offer tax deferral of gains.
Where a NRA is married to a U.S. citizen, use of a qualified domestic trust (QDOT) can provide a qualified unlimited lifetime marital deduction. Legal counsel should be consulted to properly design such a trust.
Pre-immigration planning prior to establishing domicile in the U.S. will likely be useful in reducing an individual’s future tax liability.
As with all tax and legal situations, a team of professional advisors, including tax and legal experts in both the U.S. and the client’s home country, should be engaged to evaluate and implement planning strategies.
[1] The revised exemption, absent legislative renewal, will expire on Dec. 31, 2025, and revert to pre-2018 levels. Under current law, the exemption will increase each year with inflation.
[2] In 2022, these amounts are $12.06 million for individuals and $24.12 million USD for couples.
This material and the opinions voiced are for general information only and are not intended to provide specific advice or recommendations for any individual or entity. To determine what is appropriate for you, please contact us to discuss. Information obtained from third-party sources are believed to be reliable but are not guaranteed.
The tax and legal references attached herein are designed to provide accurate and authoritative information with regard to the subject matter covered and are provided with the understanding that neither M Financial Group or TRC Financial are engaged in rendering tax, legal, or actuarial services. If tax, legal, or actuarial advice is required, you should consult your accountant, attorney, or actuary. TRC Financial should not replace those advisors.