All the Fun Rules — US Estate Tax for Nonresident Alien Individuals

Very few US Estate tax returns are actually filed by the estates of nonresident alien individuals. Statistics indicate that the amount of Estate Tax earned by the US Government on such returns is quite small.  The cost of structuring to avoid the tax is probably of far greater magnitude than what is collected by the US government. One has to wonder if the undue complexity of the US estate tax rules serves as a turn-off to foreign investors in the US.  An overview of how the rules work when nonresident alien individuals are involved follows below.

Estate Tax Treatment for US versus Non-US Individuals

The US Estate tax rules apply to a US person (US citizen or “resident”) differently than to a non-US person (non-US citizen and non-US resident). The estate of a non-citizen who is treated as US “resident” will be taxed on all of the worldwide assets owned by the individual at the time of death. On the other hand, if the non-citizen is treated as “non-resident” of the US at the time of death, the estate  will be subject to the US Estate tax only on assets located, or deemed to be located, within the US at the time of death.

“Location” or “Situs” of Assets

Many complicated rules apply to the analysis regarding the location (or “situs”) of an asset.  By way of broad overview, any tangible personal property or any real property located in the US is considered to have a US-situs; stock in any US corporation is deemed to have a US location regardless of where the share certificates may be held (while stock in a non-US company is treated as having a location outside the US regardless of where certificates may be located). US bank deposits are generally given special treatment and deemed to be located outside the US so that they escape US Estate taxation. However, cash held in a US brokerage account is not such a “deposit” and is deemed to be located in the US. This often comes as a rude surprise to many non-US persons with US brokerage accounts.  Debts of US persons generally have a US situs, but can be treated as having a non-US situs if the debt can be treated as a so-called “portfolio debt”. 

Estate Tax Exemption Amount

When a non-US citizen dies with assets located in the US, the question of whether he or she will be treated as a US “resident” for purposes of the US Estate rules is very important. A very generous exemption from Federal estate tax exists for a non-US citizen who is treated as a US “resident”. 

The exemption amount is indexed annually for inflation.  Under new rules enacted in December 2017 with the Tax Cuts and Jobs Act (TCJA), the extremely generous exemption amount equates to an estate with a fair market value of close to US$11.2 million of assets passing at death (2018 calendar year).  

For non-US citizens who are not “resident”, however, this amount is limited to a paltry US$60,000. This is a very important point for non-US persons who are buying properties in the US. If they die owning such properties, the US Estate tax can be assessed on the fair market value of the property (maximum 40% current rate).

Proper tax planning can shield the non-US person from the US Estate tax with respect to US assets.  Professional advice should always be sought beforehand in order to determine the best structure for the particular fact pattern presented.  

Are You a US “Resident” for Estate Tax Purposes?

The rules regarding residency are not the same as for US Income tax purposes.

Whether a foreign national becomes a US “resident” for Estate tax purposes is not based on the mechanical tests applied for Income tax purposes (e.g., how much time they are physically present in the US or whether they hold a Green Card). Tax residency for purposes of the US Estate tax is instead based on the concept of “domicile” which looks in part to the intention to make the US the person’s permanent home as evidenced by the individual’s particular circumstances. Thus, a Green Card holder (while automatically treated as a “resident” for US income tax purposes) will not necessarily be a US “resident” under the Estate Tax rules.

The relevant IRS regulations define domicile quite generally: “A person acquires a domicile in a place by living there, for even a brief period of time, with no definite present intention of later removing there from. Residence without the requisite intention to remain indefinitely will not suffice to constitute domicile, nor will intention to change domicile effect such a change unless accompanied by actual removal.”

There is no bright line rule to establish a non-US domicile, but the following factors are significant and considered to be persuasive indicators by the IRS:

•The place where the decedent was born; his parents’ place of birth and residence and generally speaking, the location of the individual’s family and close friends as well as his or her pets.

• The current place of residence and whether there are factors indicating there is a bona fide residence in the country of domicile, including the amount of time spent there, whether the residence is rented or owned; the cost and nature of the dwelling place is also a factor (e.g., villa versus mobile home).  Simply put, it is expected that significant time be spent in the country one claims as his or her “domicile”.

• The duration of stay in the US and other countries; frequency of travel between the US and other countries as well as between locations abroad.

• Location and dollar value of important tangible possessions (such as jewelry, artworks, family heirlooms).

 • Location of church, political and club memberships; location of business interests; location of newspaper and magazine subscriptions; location of any charitable groups in which the individual is active.

 • Location of financial accounts such as bank and brokerage accounts; location of safe deposit boxes and storage units.

 • Statements concerning “domicile” that are made in any legal documents such as a Will, or a Trust Deed or for visa applications.  

 • Location of vehicle, voting and other required governmental registrations (e.g., hunting or fishing license).

• The tax filings of the individual will be another significant indication of domicile (e.g., did the individual file returns as a “resident or nonresident). In addition, the address listed by the individual on any tax returns can be an important indication of domicile.

 Filing Estate Tax Returns

 It is of critical importance to file an Estate tax return whenever it is required.  Forms can be accessed here: Estate Tax Return for US Citizens or US “Residents” (Form 706).  Instructions are here.  Estate Tax Return for Non-US Citizen Non-US Resident (Form 706 NA).  Instructions are here. 

 Large penalties apply for non-compliance and in certain cases, other parties (e.g., the estate executor or the transferee) can become liable for the taxes if they are not properly paid.  This topic is addressed in my tax blog post here.

 File Form 706 or Form 706-NA within 9 months after the date of death unless an extension of time to file was granted. If it is not possible to file the relevant Estate Tax Form by the due date, use Form 4768, Application for Extension of Time To File a Return and/or Pay U.S. Estate (and Generation-Skipping Transfer) Taxes, to apply for an automatic 6-month extension of time to file.

Posted October 6, 2018

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