Many non-US individuals come to me with questions concerning their liability for US taxes – income, gift, estate tax. I find there are some general misunderstandings – hardly surprising given the complexity of the US tax system. Let’s review!
Before we talk about foreign (non-US) individuals, let’s be clear: US citizens are always treated as US tax residents for Gift/Estate tax purposes; this means they are subject to Gift and Estate tax on their worldwide assets no matter where they are residing at the time of making the gift or at the time of death. Individuals who are not US citizens, on the other hand, may be subject to US Gift or Estate tax based on their tax “residency”.
The foreign individuals asking me for guidance are usually somewhat familiar with the concept of residency under the US income tax rules The determination of residency for US income tax purposes is objective and quite precise. A non-US citizen will be considered a US “resident” for a particular calendar year if he meets the requirements of either the “green card” test or the “substantial presence” test for that year. Such “residents” are subject to tax on their worldwide income, just like US citizens (regardless of where that income is earned). Nonresidents are taxed only on items of income from US sources (many exceptions apply, such as bank deposit interest).
The “residency” rules are not quite so simple for purposes of the US “Estate” and “Gift” tax. Today’s post will explain it all.
Should I Care If I Am A US “Resident”?
In a word, “yes”, you should! A foreign person who is considered a US “resident” will be subject to US Gift tax on transfers of property exceeding US$15,000 per donee in a single calendar year, regardless of where the transferred assets are located. An exemption is available under the Unified Credit rules – generally, to the extent the Unified Credit is used for lifetime gifts it cannot be used to lessen Estate Tax due upon death. An exemption equivalent of approximately $11.2 million in value of gifts is available under current law. For calendar year 2019, the basic exclusion amount will be $11.4 million. Once a gift or gifts to a single donee in the calendar year exceeds the annual US$15,000 permissible threshold, the donor must file a gift tax return and can then use some of his Unified Credit. Even though gift tax is not due, the filing of the gift tax return is very important. The filing crystallizes the transaction as having been a gift and keeps an “accounting” of the remaining Unified Credit.
At death, a resident’s estate is subject to Estate tax based on the value of the worldwide assets owned by the decedent at death. The Unified Credit can provide an exemption amount of approximately $11.2 million of estate assets under current law ($11.4 million for 2019), provided the amount was not used previously to reduce Gift tax liability.
The maximum rate for each of the US Gift and Estate taxes is currently 40 percent (as at 2018).
To the contrary, a foreign national who is not a US “resident” is subject to US Gift tax only if two requirements are met: The transfer must be one of tangible property (gifts of intangible property are exempt), and, the transfer must occur within the US. There is no exemption amount under the Unified Credit rule, discussed previously; but the US$15,000 per donee per calendar year does apply to a non-resident.
With respect to US Estate tax, nonresidents are taxed only on the value of assets located or “deemed located” within the US (e.g., stocks of US companies are deemed located within the US even if the share certificates are located abroad). A small exemption amount of $60,000 is available for such estates of nonresidents (not the generous Unified Credit amount available to US “residents”).
A Question of “Domicile”
Generally, for Gift and Estate tax rules, resident status depends upon whether the person has his “domicile” in the US. Domicile is acquired in a place by living there, for even a brief period of time, so long as the individual has no definite, present intention of leaving. An individual’s physical presence in a place without the requisite intention to remain there indefinitely will not qualify that person for domicile. Also, the mere intention to change domicile will not be effective unless it is accompanied by physical removal.
Various factors are considered in determining domicile for the Gift and Estate tax rules. The major factors include the duration of stay in the US and other countries, and the frequency of travel between the US and other countries as well as between locations abroad: the size, cost and nature of dwelling places and whether these are rented or owned; the location of valuable possessions, family and close friends, church and club memberships and business interests. The foreign individual should be able to prevent classification as a resident by keeping these factors in mind. My blog post here provides more detail on the analysis of one’s “domicile”.
Foreign individuals who are departing the US do not automatically lose a US “domicile” (assuming it had been acquired previously). US domicile remains until the individual establishes a different domicile in another country. Again, this means the person must physically relocate to such country and must intend to remain there indefinitely. In cases of doubt, it is usually presumed that domicile has not changed.
“Override” of Domicile – Don’t Forget to Look to An Estate Tax Treaty
The analysis of “domicile” can become quite complex. First, factors will vary from case to case, depending on the specific facts and circumstances, and the weight given to each factor might be different in a particular case. Second, treaties must also be examined, if relevant. Not many countries have signed an Estate and/or Gift Tax Treaty with the United States. A list of such countries is available here.
Many treaties contain so-called treaty “tie-breaking” rules that can override the US domicile analysis. Third, even if a relevant treaty does not exist, a foreign country may not agree with the US domicile determination and might treat an individual as “domiciled” in that foreign country.
Planning is the Key
The individual who does not wish to create a US “domicile” should carefully review his situation and ensure that as few connections as possible are maintained in the US. If possible, dwelling places in the US should be rented rather than owned, valuable and cherished possessions, as well as a majority of friends, associations and memberships, should also be maintained abroad.
The individual should therefore be fully acquainted with the US tax laws applied to foreign persons in order to prevent unintended tax consequences and to take advantage of tax planning opportunities. Preventing classification as a resident for Income, Gift and Estate taxes is well within the individual’s personal control and effective tax planning is, therefore, easily implemented.
Posted November 17, 2018
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