INTRODUCTION
U.S. inheritance tax planning is considered one of the most complicated aspects of tax planning because of the many moving parts and the changing needs and goals of the family. The exercise gets complicated when the customer is not a US Person but the heirs live in the US and have families in the US
This article is intended to guide a counselor in dealing with the specific issues that arise when a client is of non-US origin and inheritance in the US. For this purpose, a typical factual pattern is created and then 15 problems that are unique to this type of the client are identified. It is based on the currently applicable US tax law. The reader is cautioned that many provisions may change with retrospective effect.
FACT SAMPLE
Mrs. Smith comes into your office. She points out that she is not a US citizen and lives permanently outside the US. She does not have a green card. Mrs. Smith has two grown children and several grandchildren. One child is considered a US citizen and the other is a US citizen by naturalization.
Ms. Smith seeks advice on structuring her estate to lower or eliminate the US federal estate tax. Your assets include the following:
- All shares issued and outstanding in a company incorporated in your home country
- Term life insurance issued by a US insurance company
- A house in a strange land
- All of the issued and outstanding shares of a US company. The company’s primary asset is a US condominium
- All condominium furnishings that were purchased from Ms. Smith that were never brought into the U.S. concern
- A portfolio of publicly traded stocks in US companies
- A portfolio of publicly traded bonds
- A car that belongs in your name and is registered in your name in the state in which your resident child lives and that is used by that child
She has many concerns about U.S. inheritance tax but doesn’t know where to start. Her daughters will inherit, but she wants to provide for them while they are alive.
She is asking for your advice. Below are the top 15 questions to ask and answer in order to create a plan to minimize the U.S. inheritance tax burden – as it exists under applicable law – and to plan for tax issues that you and will face her two daughters could face in the US
15 QUESTIONS AND ANSWERS FOR ESTATE PLANNING
- What properties listed above are subject to US inheritance tax for a foreign individual like Mrs. Smith?
For an individual who is neither a US citizen nor a US resident for inheritance tax purposes (“an NRNC Person”), such as B. Ms. Smith, the only assets subject to US inheritance tax are US-based assets1 This includes shares in a US company, debt securities issued by a US person, unless specifically excluded, physical personal property owned by themselves physically located in the US, and US real estate.
If an NRNC individual owns U.S. Situus Property, the first $ 1,000,000 of taxable value will be taxed at graduated rates totaling $ 345,800. Thereafter, inheritance tax is levied at a flat rate of 40% at federal level. A benefit can be claimed for part of the global administrative costs and claims against the estate. However, direct tracking of expenses in different countries is not allowed for US tax purposes. Rather, the portion of the global estate that resides in the United States controls the portion of global administrative expenses and receivables that reduce the gross US estate. Note that deductions are only allowed if the executor files a truthful and accurate U.S. inheritance tax return listing all of the gross estate located outside the U.S. There is no unlimited marriage allowance for bequests to a surviving spouse. However, inheritance tax can be deferred through the establishment of a Qualified Domestic Trust (“QDOT”) until a triggering event occurs. Eventually, the unitary credit that US persons can claim to abolish inheritance tax from $ 11.7 million in 2021 will be reduced to $ 60,000.
For Ms. Smith, the US home owner’s stock, stock, car, and home furnishings are US situus assets. Certain other assets owned are specifically treated as foreign situs assets as explained in the answer to the following question. Inheritance tax in the United States can be a burden on assets that qualify as U.S. Situus Assets.
- Are certain assets generally exempt from US inheritance tax at the time of Ms. Smith’s death?
From a tax policy perspective, certain assets that would qualify as US situation assets under the general rule discussed in the answer to the previous question are treated as situs foreign assets and are therefore not subject to US inheritance tax. These assets include:
- Account balances with US domestic banks and foreign branches of US banks that are not connected with the conduct of any US business by the NRNC Person2
- Portfolio Notes for which Code 871 (h) interest income is not subject to US tax for an NRNC person, such as publicly traded debt or privately issued debt that meets certain conditions, the most important of which is that the instrument not be endorsed freely transferable, the obligee cannot be related to the US debtor within the meaning of the law, and the interest rate cannot be conditional as it is based, among other things, on profit, cash flow, value of assets and the like3
- Short-term OID commitments, generally commercial paper or treasury instruments, with a maturity of 183 days or less from the date of initial issue4
- Insurance proceeds for the life of an NRNC person5
- Works of art on loan to a nonprofit public gallery or museum in the United States6
For Ms. Smith, the US Situs Assets treated as Situs Overseas Assets are the portfolio of publicly traded bonds and life insurance policies. While Ms. Smith’s taxable estate does not include the foregoing, so there is no need to reorganize ownership during Ms. Smith’s lifetime, her executor could have a practical problem with bank accounts and investment portfolios held by street-name financial institutions . These institutions may refuse to release assets to Ms. Smith’s executor until a closing letter is issued by the IRS of inheritance tax settlement, if any. Anecdotally, consultants have complained that it took the IRS up to two years to issue a closing letter, even if it was an NRNC person’s estate and the assets were located overseas. Consequently, it may be advisable for Ms. Smith to raise the matter with any bank or financial institution that she uses. In the absence of written representations, it is advisable to postpone investments.
- Are all Situs U.S. properties subject to U.S. estate tax at the time of Ms. Smith’s death, if given away in lifetime, is it subject to gift tax?
No. Unlike estate tax, which includes all U.S. situation assets that are not treated as foreign situs assets, U.S. situation system intangibles are not subject to gift tax on a lifetime gift.7 For federal gift tax purposes, intangible property is not in the Internal Revenue Code Are defined. Various rules have developed over the years. Some of them are as follows:
- Cash and cash in physical form are items of tangible property and gift tax is payable when transferred free of charge in the United States by an NRNC person. 8
- Treasury Regulations, which discuss the condition of property in relation to gifts or bequests by foreign persons, state that intangible personal property is a “right of property” and includes stocks, bonds and debentures, including bank deposits. 9
- In Private Letter Ruling 7737063, the IRS stated that intangible property refers to choices in action10 such as company stocks, bonds, banknotes, bank deposits, patents, holdings, goodwill, but not physical cash.
Note that no single credit is allowed for gifts from an NRNC person. However, the annual $ 15,000 exclusion for gifts to each recipient still applies to an NRNC individual. There is no unlimited marriage allowance for an NRNC individual in connection with gift tax. However, the annual $ 15,000 exclusion for a gift between spouses is increased more than tenfold. In 2021 the amount is $ 157,000.
For Ms. Smith, the shares in the U.S. public company that owns the apartment, the portfolio of listed shares of U.S. companies, the portfolio of listed bonds, and the life insurance contract can be given away without incurring 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. Rule. 55-143.
9. Trees. Registration number. Sections 25.2511-3 (b) (3), (4).
10. A chosen one is a right to sue. It is an intangible property right recognized and protected by law, which does not exist without legal recognition and which does not confer present ownership of a material object.
Originally published May 27, 2021
The content of this article is intended to provide general guidance on the subject. Expert advice should be sought regarding your specific circumstances.