U.S. Estate Tax for Non-US Decedents

“What on earth is an estate tax?” As there are many foreign countries that do not have estate/inheritance taxes, this is a question you might hear when dealing with the executor of a non-US decedent who left certain assets located in the US. Estate tax is a tax levied on the net value of the estate of a deceased person before distribution to the heirs.

For example, Canada does not assess any tax solely by reason of death – estate tax. For a decedent who was a resident of such a country immediately prior to their death, the US estate tax could be a significant additional tax cost that comes along with certain US assets held by the individual.

What type of assets is subject to US estate tax?

As a non-US decedent, only assets referred to as US situs assets are subject to US estate tax. They typically include:

  • •          Real estate located in the US
  • •          Certain tangible personal assets located in the US
  • •          Stock issued by US corporations
  • •          Debt owed by US persons

The most typical US situs assets that could give rise to US estate tax are probably vacation homes owned by non-US residents, while the ones that can be easily overlooked are stocks issued by US corporations. Stocks issued by US corporations are US situs assets regardless of the actual location where the stock certificates are held. There are a number of exceptions with respect to debts owed by US persons including bank deposits and certain US treasury securities. In dealing with a US financial portfolio of a non-US person near death (when their death is somewhat predictable), it may be a good idea to have their assets liquidated and pool them in one or more bank deposit account(s) to protect them from US estate tax.

Partnership interests, interestingly, are a gray area. Some people think that one should look through the partnership, and site each asset based its individual characteristics – i.e., treat US real property owned by the partnership as subject to US estate tax, but treat bank deposits owned by the partnership as not subject. Others would see the partnership interest as a security same as corporate stock, and would tax a partnership formed in a US state, but exclude a partnership formed elsewhere. The latter school of thought seems to be gaining more momentum, as a partnership (whether it is a foreign or US) is just a checkmark away (so-called check the box election on IRS Form 8832) from being converted to an entity taxable as a corporation for US tax purposes.

Only $60,000 in exclusion? Seriously?

As you may know, US citizen decedents are eligible for the life-time exclusion of $5.34 million (for any decedents who die in 2014). Do you know the exclusion amount for non-US decedents? It is $60,000! Yes, you heard it right. It is $60,000 unless an applicable tax treaty provides an exception. US estate tax for non-US decedents is one area which warrants proper attention because the exposure could be significant as 1) it is assessed on the taxable value of assets (instead of net gain or income) and 2) the exclusion from the taxable value can be disproportionately small, absent any treaty benefit.

If the decedent was a resident in a country, immediately prior to their death, that has a tax treaty with the US to shore up the exclusion amount, they may be in luck. Some treaties provide that US exclusion amount ($5.34 million, as previously mentioned) is available for the non-US resident domiciled in such countries prorated by a fraction, the numerator of which is the total US estate over the total amount of the worldwide estate. The exclusion amount determined in this method can be significantly higher than $60,000.

What should we do?

Let’s think about some ways to mitigate the US estate tax exposure for non-US decedents.

For real estate located in the US, make sure that you reduce the amount of taxable estate to the extent of any amount of non-recourse debts attached to the property. This may help bring the exposure down quite a bit. These debts generally include the ones with which the creditor can only recover up to the value of the property and the debtor is not personally liable for the amount.

A non-US person can gift his US situs assets up to $14,000 a year without causing US gift tax implications. If the assets gifted are intangible personal property such as stock and debt, they are generally not subject to US gift tax even though they are considered US situs assets for US estate tax purposes. Cash is considered tangible personal property for US gift tax purposes and it triggers US gift tax if transferred physically within the US. If you want to give cash, make sure you do it outside of the US! The point here is that certain US asset transfers during the decedent’s lifetime can mitigate the future potential US estate tax exposure.

Lastly, let’s remember the situs of assets can be easily changed. For example, a vacation house located in the US is a US situs asset when owned personally by a non-US individual. If the person sets up a corporation in their residence country to hold the piece of the US property, what they own is not US real estate but stock issued by a non-US corporation which is not subject to US estate tax. Of course, there might be some unintended tax or non-tax consequences associated with such a change in the holding structure. Thus, it is probably worthwhile consulting a qualified professional before any change is made.

This blog post is a summary and is not intended as tax or legal advice. You should consult with your tax advisor to obtain specific advice with respect to your fact pattern.