If you are a US person living abroad or have a US spouse, have a green card or even invest within the US, there are considerable tax and cross border planning issues to consider. All cross-border families need to have a strategic investment plan, properly arranged and synced with a custom-tailored cross-border estate plan to protect their assets.
In order to execute a flaw proof estate plan, it is important to have good counsel and CPA’S onboard. Counsel that are familiar with the intrinsic details of the US tax and legal system will hep you with understand potential techniques that mitigate the effect of transfer taxes and help guide you to a tailored estate plan.
This guide is a short introduction into cross border estate planning, protection planning and tax efficient investment concepts.
Find out how local laws impact issues around guardianship, trusts, asset transfer, and estate taxes;
• Learn how to best draft and execute wills, trusts and other documents while living abroad;
• Discover methods to reduce U.S. estate liabilities and utilize foreign tax credits;
• See how to address cross border issues, including having a non-U.S. spouse, ownership of non-U.S. businesses and real estate;
• Know when to update and adjust your estate plan.
U.S. Estate Tax 101
The United States is unique in a great number of ways, it’s tax system but very few facets of American exceptionalism are as noticeable as to how the U.S. Treasury exacts its tariffs on nationals who choose to leave the country to live and work abroad.
While the international income taxation of U.S. nationals gets far more attention, U.S. transfer taxes apply regardless of where a U.S. citizen resides, gifts property, or dies. Historically speaking, the U.S. government has been taxing the estates of its decedents since 1916. Gifts have been taxed since 1924, and in 1976 Congress enacted the Generation-Skipping Transfer tax, linking all three taxes into a single unified estate and gift tax.
As an expat, you should anticipate the U.S. Treasury to set estate tax upon all of your global assets, including proceeds of life insurance policies, retirement assets, personal property, real estate, and all of your otherworldly belongings available at the time of your demise. In addition to that, estate tax may be owed on certain assets transferred to others within a fixed time period before passing, or where you, the decedent in cause, retained an interest in the property.
A disconcerting fact is that Americans (at home or abroad) are often unconcerned with U.S. federal estate taxes, and unaware of their impact. Presently, because of the recent changes that happened in estate tax law, federal estate and gift tax lifetime exemptions have been pushed up to considerable thresholds and conditions, namely:
• The individual lifetime exemption has been raised to $11.58 million (2020);
• For interspousal transfers, gifts and bequests (during lifetime or upon death) between citizen spouses are unlimited;
• Portability of unused exemption to surviving spouse; if the first-to-die spouse’s tax exemption amount is not fully used, an election on that estate tax return will preserve the remaining unused exemption amount for the second-to-die spouse.
With a $23.16 million-per-couple exemption, the vast majority of American citizens still consider that the estate tax is something that can be ignored. Even if you will never come close to exceeding this exemption, it is crucial to remember that you may still be required to file gift tax returns.
What estate planning challenges do expats and/or their multinational families have to expect abroad?
Multi-jurisdictional estate planning affairs are common for U.S. citizens and their financial consultants. An average upper-class American family may hold brokerage accounts, savings accounts, a security deposit box in L.A., a primary residence in California, a second home in Colorado, and possibly even a trust or two established in D.C. or Massachusetts.
Transfer tax regimes of multiple states factor into the distribution of wealth in addition to the federal estate, gift and generation-skipping transfer (GST) taxes. As you have already noticed, this is an intricate situation, that requires the aid of legal and financial expertise.
Now picture the same common affluent American family, but in a global, setting. For example, a husband that is a U.S citizen living in Switzerland is married to a French citizen (a “non-U.S. citizen”), with three children from his previous marriage when he was residing in the U.S., and two with his current spouse living in Switzerland. Real capital may be available in various jurisdictions, independently or jointly titled, personal property that spans the globe, limited partnership interests (i.e., hedge funds, private equity, or structured products), joint brokerage accounts, individual brokerage accounts, pension funds, defined contribution plans, IRAs, Roth IRAs, and college savings or UTMA/ UGMA accounts for the children. Several factors will make the transfer tax planning conundrum even more difficult for the exemplified global family than for a multistate family.
The notions of citizenship, residency and domicile
Citizenship, residency and domicile hold key importance in asserting how a person is subject to the transfer tax regime of any particular country around the globe. As an expat, you have to apprehend the specific definitions and requirements under the laws of the country(s) in which you live, work, or own property. The chance that the degree of efficacy of your existing estate plan to go downhill depends not only on where your family relocates, but also on how much your family integrates wealth, assets, and investments into your latest country of residence, and for how long you and your family remain (or plans to remain) in the new country.
The United Kingdom has three statuses for residence, which levy different norms based on the length of residency or election of status: resident, domiciliary, or deemed domiciliary. The status of the taxpayer is significant in terms of income and transfer tax outcomes, the particular distinctions varying by country.
In the United States, to determine whether the person is a U.S. resident for income tax purposes there is an objective screening procedure called the substantial presence test, that measures the days of the tax year in which the taxpayer was physically present in the country.
Although the terms “domicile” and “residence” are oftentimes used interchangeably, from a legal and tax perspective they do not express the same. For example, a domicile is based upon two requirements: one, that a person’s domicile is their fixed and permanent home; and two, that they intend to remain or return in it. You can have multiple residences, but only one domicile.
Domicile is crucial because it affects everything in your financial and legal life, from income taxes, transfer taxes and creditor protections, to family matters such as child guardianships and divorces. If you die abroad, and your domicile at death remains, for example, New York, a probate court there will have jurisdiction over your estate, including your New York real property and any personal property, even if it is physically located in another country.
What is situs?
In Latin, “situs” means position or situation, and as most Latin words, it is also used for legal purposes. Situs plays a major role in your cross-border estate planning. The conventional situs rule maintains that assets physically found in the U.S. are subject to federal estate tax, but the situs rules for intangible property are somewhat involved and complicated. For example, consider the following: an asset may be considered non-U.S. situs for gift tax purposes, but for estate tax purposes it is regarded as U.S. situs.
To be more explicit, let’s see the general situs criterion for non-resident foreigners and their U.S. estate tax subjection:
• Real Property – all real property, including land, structures, fixtures and renovations/improvements located in the U.S. are regarded as U.S. situs;
• Tangible Personal Property – property physically inside the U.S. is considered U.S. situs, which includes art, jewellery, gold, physical dollars or other currencies are subject to U.S. estate tax;
• Intangible Personal Property – U.S. situs will depend on the character of the investment;
• Business Investment Funds – funds used in conjunction with a U.S. trade or business and held in bank or brokerage (including domestic branches of foreign banks) are considered U.S. situs.
Situs also includes Personal Investment Funds, such as:
• Checking or Savings – demand deposits in U.S. banks are regarded as being non-U.S. situs, while money market funds or cash in a brokerage account are considered U.S. situs;
• Qualified Retirement Plans – if funded through U.S. employment, they are U.S. situs;’
• Stocks – if they are issued by a U.S. corporation, they are U.S. situs, even if stock certificates are held abroad. (Stock/ADRs in non-U.S. corporations are non-U.S. situs assets, even if they are purchased and/or held in the U.S.);
• Bonds – The U.S. passed a law in 1989 that created a “portfolio exemption” for publicly traded bonds, including treasuries, to not be considered U.S. situs. Privately offered debt instruments issued by U.S. organizations may still be considered U.S. situs;
• Life Insurance – if issued by a U.S. licensed insurance company, the cash value of a life insurance policy is considered a U.S. situs asset, while the death benefit is regarded as a non-U.S. situs asset;
• Annuities – if they issued by a U.S. licensed insurance company they will be considered U.S. situs assets. Policies issued by foreign-licensed insurance companies abroad will not be considered U.S. situs assets.
The role situs plays in International Transfer Taxation
As an expat (or non-U.S. person), the transfer tax for your estate will rely
upon the interplay of four factors, namely:
• On the character or nature of the belongings;
• Asset physical location;
• Estate applicability (and/or gift tax treaty between the U.S. and the country of residence, domicile and/or citizenship);
• Tax credit availability in relevant jurisdictions where overlying taxes are imposed.
United States nationals and residents are subject to federal estate tax on their global assets, but a non-resident’s estate is prone to federal estate tax only on U.S. situs assets. In turn, situs plays a big role in estate planning for many cross-border families.
How do tax treaties and foreign tax credits interplay on cross-border estates?
The U.S. has estate and/or gift tax treaties with sixteen other independent nations from around the globe. Created to serve several important roles that determine the transfer tax consequences of assets held within your cross-border estate, these treaties may also provide a significant reduction in estate taxes by alleviating double taxation and discriminatory tax treatments, allowing for reciprocal administration.
The treaty will control which treaty state can assess transfer taxes by either:
• Determining which country is the decedent/donor’s domicile for transfer tax purposes;
• Determining in which country the property is deemed to be located.
The path of your estate planning will alter because of these treaties, besides the pertinent jurisdictions. Your estate planning team has to evaluate the interplay of the relevant transfer tax regimes and the pertinent treaty to ascertain the transfer tax outcome, considering not only the property’s nature and location but also the impact of citizenship and domicile on your net tax outcomes.
What happens to foreign tax credits in the absence of an estate tax treaty?
If no treaty is available, which happens to be the case in the majority of jurisdictions, the risk for double taxation increases, but foreign transfer tax credits may still be able to provide you with a degree of relief from double taxation. The availability of a U.S. foreign tax credit will depend upon three factors, namely:
• Whether your property is located in a foreign country;
• Whether your property is subjected to transfer/death taxes;
• Whether your property is included accordingly in the gross estate.
We have to mention that there is also the potential that a foreign transfer tax credit could be unavailable, because of a Presidential proclamation based on the foreign country’s failure to provide a reciprocal tax credit to U.S. citizens. Everything about this is expounded in the relevant portions of the U.S. Tax Code including 26 U.S. Code § 2014 “Credit for foreign death taxes”.
Classic Estate Planning Tools
There are many solutions or tools for estate planning and wealth management that you can put to use at any time, out of which we’d like to point out:
• Wills – either a U.S. Will or a U.S. Will accompanied by a “situs Will” where the expat has accumulated property;
• Trusts – living or testamentary, grantor or non-grantor, revocable or irrevocable, QDOT;
• Life Insurance – whole, universal, second-to-die, using irrevocable life insurance trust (ILIT) for business planning, retirement, estate preservation;
• Gifting Strategies – charitable, inter-spousal and trans-generational gifting;
• College Savings Plans – a 529 gifting strategy can prove to be an extremely effective estate tax planning tool, especially for grandparents and great-grandparents;
• Personal Investment Companies (PICs);
• Cross-portfolio investment optimization – the right investment, in the proper type of account and the proper owner’s account.
The vast majority of these tools are very often used by domestic financial planners and estate planning attorneys to aid single and multistate U.S. families.
Offshore PICs are generally no longer employed for U.S. clients because Passive Foreign Investment Company (PFIC) rules and the Foreign Account Tax Compliance Act (FATCA) create income tax issues that vastly outweigh any estate planning benefits. However, PFICs may be instrumental for you if you’re a non-U.S. person and have a financial plan to invest within, or outside of, the United States.
Wills in the Context of International Estate Planning
One of the most common and widely utilized estate planning tools in the United States is the will. As you may already be aware, a traditional will provides the written instructions on how an individual – the testator – wishes to distribute his or her assets upon death.
Certain legal requirements for executing a will with legal effect differ from state to state, but the general rules are straightforward: you have to be legally competent and not under due influence, you have to describe the property that is to be distributed, and you will have to be witnessed by the requisite number of witnesses.
Living wills (powers of attorney) are also used to appoint who can make the decisions for a person in the event of her physical or mental incapacity.
If you own property in a foreign country, a good option would be to execute an international will. The greatest benefit to an international will is the knowledge that, when drafted to meet the requirements set forth, the will is valid in any jurisdiction that has signed or enacted the Washington Convention, also known as the Uniform International Wills Act. The signatories of the treaty are Belgium, Bosnia-Herzegovina, Canada, Cyprus, Ecuador, France, Italy, Libya, Niger, Portugal, and Slovenia have enacted the Uniform International Wills Act; the Holy See, Iran, Laos, the Russian Federation, Sierra Leone, the United Kingdom, and the United States.
Some international estate planning experts recommend multiple “situs” wills, with each will governing the distribution of property in the country for which the will is executed. Multiples wills, as a strategy, implies a certain risk, because the traditional rule holds that the legal execution of a will extinguishes the validity of any prior will. Others advocate for a “geographic will,” which would incorporate the laws of all relevant jurisdictions involved in the distribution of the testator’s property. The propriety or effectiveness of the geographic will is likely to depend on the particular laws of the relevant jurisdictions, and the particular expertise of the legal advice that went into the design and execution of the will. In a cross-border context, it is wise to seek legal counsel with a specialized focus on estate planning in the relevant jurisdictions.
Be wary of trust structures when moving abroad
If your estate plan includes trusts, we do not recommend moving abroad with your old domestic estate plan in tow. Consider the following case: a United States citizen starts a revocable grantor trust in favour of his grandchildren, but shortly afterwards relocates and works abroad. This situation brings a series of negative outcomes that will vary depending on the new country of residence and how long the national and his family remain in their new country of residence.
When examining distributions to heirs through such a trust, an inherent problem can be found in the civil law/forced heirship regimes, namely that the beneficiary receives the assets from the trust, rather than from the lineal relative. If the expat from our aforementioned case moves to Germany with his family, the children-beneficiaries will be German residents, and the intended outcomes of the grantor trust will conflict with German gift and inheritance tax laws. This subjects the asset distribution from the trust to some potentially costly German transfer taxes, the extent of these inadvertent tax consequences posing the threat to grow in size over time. If both the grantor and beneficiaries remain in Germany for over a decade, the tax relief offered by the U.S.-Germany Estate and Gift Tax Treaty phases out, and distributions from the trust could be exposed to the highest German transfer tax rate of 50%.
As an expat, you face dangers even if you relocate to a civil law jurisdiction. If you, a U.S. citizen, arrived in the U.K. (a common law jurisdiction) as a U.S. national with an already available U.S. trust, the government may not recognize the trust structure. The government might even go at lengths to regard the trust a UK resident and subject its assets to immediate income taxation on the unrealized gains within the trust.
Estate planning for families that include a non-U.S. citizen spouse
Most Americans that live overseas are likely to end up sooner or later with more than their assets and income. It’s quite common for Americans living abroad to marry non-American partners. According to the Census Bureau, 1/5 married households have at least one spouse born outside the U.S., and out of the foreign-born spouses, 39% are non-citizens and 61% hold the status of naturalized citizens.
The tax hurdles and difficulties that American expats experience extend even more when marrying a non-U.S. citizen. Even if an expat’s spouse obtains a green card, gifts and bequests to the non-citizen spouse are not eligible for the unlimited marital deduction. But, on the other hand, the $11.58 million (2020) lifetime exclusion that we mentioned earlier applies to bequests left to anyone, including a non-U.S. citizen spouse. For estates larger than the lifetime exclusion limit, you’ll have to resort to other estate planning strategies.
Gifts to a non-U.S. Spouse
Although you can give unlimited assets to a fellow citizen spouse during her lifetime, there is a certain limit ($157,000 each year) allowed for tax-free gifts to non-U.S. citizen spouses. A gifting strategy can be implemented to shift non-U.S. situs assets from the citizen spouse to the non-citizen spouse over time, thereby shrinking the taxable estate of the citizen spouse. We advise that the nature, timing, and documentation of the gifts should be done wary and with the assistance of an experienced tax and/or legal professional.
Non-U.S. citizens are subject to gift tax only on gifts of U.S. situs real estate and personal property that is physically located in America. No gift tax is imposed on a gift of cash if the gift is handed via a check or wire transfer. It’s also worth mentioning that there is no tax on gifting securities of a U.S. company, even though these assets may be subject to estate tax. There is no limit on the amount that a foreigner may gift to a U.S. taxpayer, whether or not such gift is subject to the estate tax, but there may be a reporting requirement if the recipient of the gift is a U.S. taxpayer.
The Qualified Domestic Trust (QDOT)
What is a QDOT? The QDOT was designed to convey the surviving spouse the power to claim use of and income from the decedent’s estate during his or her lifetime but, upon the death of the surviving spouse, all QDOT assets will pass back to the decedent’s original heirs. This type of trust may prove to be an effective wealth planning tool for delaying the estate tax until distribution to U.S. heirs when the surviving spouse is a non-U.S. citizen.
Although the QDOT trust can certainly be an effective tool, tax and high maintenance consequences may outweigh its benefits. The cross-border family may have alternative solutions for providing for the heirs and for the maintenance of the non-citizen spouse that are more practical or even more tax-efficient (such as a lifetime gifting strategy, discussed earlier). The personal and financial merits of the QDOT and alternative planning tools must be analysed on a case-by-case basis.’
Foreigner gifts and inheritances
Unlike most succession/heirship-based transfer tax systems found overseas, gifts and inheritances in the U.S. are not taxed to the beneficiary of the gift or bequest. America has a transfer tax system that charges these transfers at the source of transfer. In addition to receiving the distribution tax-free for transfers on death, the beneficiary of a bequest receives a “step-up in basis” to the fair market value of the asset on the date of death (or the alternative valuation date, 6 months after the date of death). In the case of gifts, the recipient takes the donor’s original cost basis.
The general rule still applies for American taxpayers that inherit or receive gifts from foreigners: no income or transfer tax will be due at the time of receiving the gift or inheritance, and the beneficiary receives the donor’s basis in a gift or receives a full step-up in basis in a bequest.
If you, as a U.S. taxpayer, receive annual aggregate gifts above $16,388 (2019) from a foreign corporation or partnership, or aggregate gifts or bequests from a non-resident alien or foreign estate exceeding $100,000, the taxpayer must report the amounts and sources of these foreign gifts and bequests on IRS Form 3520, which must be filed at the time that the income tax is due, including extensions.
The idea behind this guide was to provide you with a basic road map of the estate planning journey. To help you get started, to provide for your heirs and lessen their administrative burden, and to understand what you’ll have to do to minimize estate and income taxes as much as you can. Hopefully, we’ve enabled you to approach your legal experts better, and other professional advisors with a clearer idea of what your cross-border estate planning should entail.
As you have seen, citizenship, domicile, residency, location and character of investments, applicable tax treaties and/or the availability of foreign tax credits, and the existing or proposed estate plan are some of the critical variables that must be factored into a financial plan that is optimized for both incomes and transfer tax efficiency.
If you want to tailor a financial or estate plan, an investment strategy that is correctly in tune and advantageous with the multijurisdictional taxation regimes, you require the aid of a party of trusted experts in cross-border legal, tax, and financial planning issues.