Foreign Individuals: US Estate Tax Reform Passed You By (Part I)

Prior to the actual passage of the “Tax Cuts and Jobs Act” (TCJA) on December 22 2017, there were some high expectations that the disparity in the US estate tax exemption for US and non-US persons would be eliminated, or that the US estate tax itself would be repealed. Unfortunately, neither of these hoped-for events eventually came to pass. With this harsh reality in mind, what does the foreigner need to know about the US estate tax?

Unfortunately the US estate tax often catches the nonresident alien family by surprise.  Understanding the information in the following two-part tax blog post will prevent many such unpleasant surprises.  Proper planning can insulate the foreign investor from the US Estate Tax. Let me know if you need help l keeping the US taxman at bay.

Overview

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 the fair market value of all of the worldwide assets owned by the individual at the time of death (or an alternate valuation date). 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.

In addition, a very generous exemption from Federal estate tax exists for a non-US citizen who is treated as a US “resident”.  On the other hand, only a paltry exemption exists for the foreigner who is not treated as a US “resident”.  Tackling this complex issue of “residency” for US estate tax purposes (it is not the same test as for income tax purposes) is obviously very critical.  In summary, it will govern whether (i) worldwide assets or only US-located assets will be subject to US estate tax and (ii) a large or meager exemption in dollar value of assets will be permitted. More on this issue of “residency” under the Estate tax rules, here.

Estate Tax Exemption Amount

A very generous exemption from Federal estate tax exists for a non-US citizen who is treated as a US “resident”. The exemption amount allows estates under a certain value to pass property without payment of any estate tax. For US citizens or “residents”, the basic exemption amount increased with TCJA from US $5 million to $10 million (it applies for those dying after December 31, 2017 and before January 1, 2026; the amount is indexed annually for inflation and is worth approximately $11.2 million in 2018 and $11.4 million in 2019).

Meanwhile, TCJA did nothing to increase the exclusion amount for estates of non-residents who are not US citizens. For such nonresident alien individuals, the estate tax exclusion amount remains at only US$ 60,000 worth of assets located (or treated as located) in the US. This is a very important point for non-US persons who are buying properties or having other investments 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).

“Location” or “Situs” of Assets – A Few Quirks

Let’s look at some of the complicated rules that apply regarding the location (or “situs”) of an asset for US estate tax purposes.

Stocks, Coops, Condos

By way of broad overview, any tangible personal property (a diamond ring, a fancy sports car) or any real property located in the US is considered to have a US-situs. But what about intangible property – such as stocks (including stock in a cooperative apartment), American Depositary Receipts, debt instruments, bank deposits, cash, life insurance proceeds?

Stock in any US corporation is deemed to have a US location regardless of where the share certificates may be held; but stock in a non-US company is treated as having a location outside the US regardless of where certificates may be located.

Ownership of a cooperative apartment located in the US is represented by stock in a corporation.  This stock will be treated as having a US location for estate tax purposes even if the share certificates are kept abroad. Cooperative apartments (“coops”) differ from condominiums (“condos”) in several ways.  When one buys a coop, the purchaser buys stock in the corporation that owns the apartment building.  The coop apartment is then “leased” to the buyer under a long-term proprietary lease.  The coop owner will pay a monthly maintenance to the  corporation for operating expenses, property taxes and the underlying mortgage on the building (if it is mortgaged).  On the other hand, when buying a condo, one purchases an individual parcel of real property, such as an apartment or townhouse.  The condo building is divided into individual condos and common areas.  The owner of a condo owns his own apartment plus an undivided interest in the common areas.

While the value of both US coops and condos will be subject to US estate tax, the cooperative form of US real estate ownership bears other important tax consequences for non-residents who are not US citizens.  The transfer by gift of US cooperative shares by the nonresident/noncitizen would not be subject to US gift tax, whereas transfer of the condominium by gift would be subject to US gift tax.  The difference in results is due to the complexities of US gift and estate tax laws. Succession of ownership (inheritance) will also be impacted by the form of ownership. For example, a foreigner who dies intestate (without a will) owning a cooperative apartment, would be subject to the succession laws of that individual’s home country or country of domicile.  On the contrary, with a condominium, the law of the jurisdiction where the property is located would control for inheritance purposes.

ADRs

In Private Letter Ruling 200243031 (July 25, 2002) the US Internal Revenue Service determined that American Depositary Receipts (“ADRs”) should not be included in the gross estate of a nonresident alien decedent.  American Depositary Receipts are negotiable instruments issued and sold by US banks. They are essentially stocks that trade in the United States, but the ADRs represent a specified number of shares in a foreign corporation located in a foreign country. An example might be Alibaba (BABA).

Just like typical US stocks, ADRs are bought and sold on US markets; they can trade in US dollars and clear through US settlement systems. This allows investors in ADRs the ability to circumvent fees and inconveniences of making transactions in foreign currencies (e.g., ADRs were developed precisely to bypass difficulties associated with trading at different prices and currency values).  In the usual case, a US bank will purchase a bulk lot of shares from a foreign company, bundle the shares into groups and reissue them on a US stock market such as the New York Stock Exchange.  Thus, despite being registered and issued generally by US banks, ADRs represent shares of stock in foreign corporations and should be treated in the same manner for US estate tax purposes.

Posted December 21 2018

Part II of this blog post will examine bank deposits, cash, brokerage accounts, debt obligations and life insurance. Stay tuned!

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