Taxation of Estates (Inheritance Taxes) in the U.S.A.
Last time we looked at the some of the issues associated with inheritance issues in the USA. This time we will be looking in a bit more detail into the issue of the taxes payable upon death.
Many Brits that own property in the United States fail to adequately plan their estate matters with regards to their US assets. More particularly, they often fail to understand or inform themselves of the tax laws that apply to their estates with regards to their U.S. property. Nonetheless, if one takes the time to become educated on the matter, you will learn that using key planning techniques, which maximize the benefits of new tax legislation, you may be able to significantly reduce, if not eliminate the estate tax.
At the Federal level the United States has a unified gift and estate tax system that applies to taxable gifts of property made by an individual during his or her life and taxable property transferred at death. In addition, some states impose an estate tax or inheritance tax. This article will focus solely on the Federal gift and estate tax system, which is usually far higher than that of the states.
For purposes of estate taxes, the U.S. tax laws distinguish between U.S. citizens and foreign citizens domiciled in the United States on one hand, and foreign citizens who are not domiciled in the United States on the other. Residence in this context means domicile and in order to be domiciled in the United States, a foreigner must reside there and continue intending to do so indefinitely. The intent to reside is a concept that the U.S. tax authorities evaluate based on factors such as location of business and social affiliations, duration of stays in the United States, location of family and friends, and any declarations of intent in documents such as visa applications or wills. In this article we will concentrate on the laws applicable to foreigners who are not domiciled in the United States. We will now provide a general explanation of the way in which federal gift and estate taxes work.
Non domiciled foreign citizens are subject to U.S. gift tax on gifts of real property and tangible property located in the United States. Intangible property such as U.S. stocks and bonds are therefore not subject to US gift tax. Gifts by foreigners to their U.S. citizen spouse are exempt of gift tax due to an unlimited marital deduction. If the spouse is a foreign citizen then an exclusion of up to $120,000 (for years 2006 and 2007) per year applies. An annual exclusion of $12,000 (for years 2006 and 2007) per donee per year also applies to gifts made by foreigners to any other U.S. or foreign person.
The estate tax generally applies to all of the property of a foreigner located in the United States including intangible assets such as stock and bonds of U.S. corporations. However, there are some assets that are exempt from the estate tax because they are not considered to be property located in the U.S. such as deposits with a U.S. branch of any bank, deposits with a foreign branch of a U.S. bank, certain other debt obligations and proceeds from a life insurance policy. Most exemptions, deductions and credits applicable to U.S. citizens do not apply to foreigners, which may only exempt the first $60,000 of their U.S. taxable estate from the estate tax.
With respect to the estate tax, US-based property passing from a non-domiciled foreigner to a U.S. citizen spouse is exempt from estate tax since it is eligible for an unlimited marital deduction. However, property passing to a non-citizen spouse does not qualify for the marital deduction, unless the property is transferred in what is called a qualified domestic trust (also known as a QDOT). This type of trusts do not exempt the property from the tax but defer it by enforcing it at the time the property is distributed from the trust or at the death of the nonresident surviving spouse, whichever occurs first. These trusts are heavily regulated and must meet specific requirements in order for the tax deferral to apply.
Estate and gift tax rates are the same for U.S. citizens and non domiciled foreigners. They vary in accordance with the value of the estate and they currently range from 18-45%. The maximum rate is currently 45%. Under current tax laws the estate tax will be repealed during year 2010 only but the gift tax will remain in effect. However, the current legislation, the estate tax will return in 2011, so technically it would only be repealed for one year. In practice, however, this was merely the result of a political compromise and it is expected that new legislation, probably reducing the estate tax, but keeping it in some form, will be enacted prior to 2010.
The United States has entered into various treaties with respect to estate and gift taxes of foreign citizens and one of them is with the United Kingdom. The treaty allows U.K. citizens to use a credit equal to the amounts paid for estate taxes in the U.S. to any amounts owed for estate taxes in the U.K.
The net effect of the treaty on UK domiciled taxpayers who own property in the US is that you end up paying the higher of the two estate (inheritance) tax rates, but you do not pay the tax twice. For instance, if you died leaving a house in the US, you would have to declare it as part of your UK estate, but you would receive a credit against any tax owed to the UK, in the amount of any taxes you actually paid in the US. For most, UK nationals, this means that there is no net effect. However, for those UK nationals who will have structured their affairs in the UK so as have no UK tax liability, the result could result could be devastating in the US, unless proper US planning is implemented.
Given the complexities of U.S. estate taxation and also the high estate and gift tax rates that apply to the property that a non U.S. domiciled foreigner owns in the United States if you own property in the U.S. with an aggregate value in excess of $60,000 you should consult with a tax advisor to evaluate your situation and explore available planning vehicles. Some of the available estate tax planning strategies include:
- Redistributing the assets in a manner that reduces your ownership of taxable assets.
- Financing the acquisition of U.S. based property in order to reduce the actual basis or cost of the same, which is the equity that you actually have on the property.
- Increasing life insurance policies in order for them to cover the payment of tax liabilities.
- Creating corporate and trust structures to reduce your actual ownership of the U.S. based property in a manner that allows you to keep the control of the same.
These are but a few of the strategies available. An adequate estate planning may significantly reduce your estate’s U.S. tax liability and therefore maximize the transfers to the beneficiaries of your estate.
Again, the UK is one of only a handful of countries, which have an estate tax treaty with the US. As such, unlike nationals of other countries, most UK nationals would not be affected by US estate taxes. Nonetheless, if you own property in the US, it is important to have a US tax planner involved as part of your UK estate planning team.
Marcel Felipe is a Partner and Natalia Munoz is an associate in Marcell Felipe Attorneys and International Lawyers – a firm with offices in Florida and London who specialize in foreigners’ US legal problems. They are linked closely to – and share offices with – The International Law Partnership LLP, who are a specialist firm of English International Lawyers. Daniel Theron is a lawyer and head of the US Department at The International Law Partnership LLP. Main Contact: Tel:+44 20 7061 6700 Fax: +44 20 7061 7601Email: info@uslawinlondon.com Web: www.uslawinlondon.com
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