My earlier blog post gave a head’s up to married couples about jointly owned assets when one spouse is a non-US citizen. Virtually every aspect of the US tax rules are impacted by such joint ownership – income tax, gift tax, estate tax, tax information reporting and FBAR reporting under the Bank Secrecy Act.
Today’s post provides a brief overview of the Gift tax rules that apply in the case of mixed national couples when only one spouse is a US citizen. Next week’s blog post will cover the US Estate tax rules in such an instance. The US Estate and Gift tax rules that apply with regard to jointly-owned property when one spouse is a non-US citizen differ greatly from the general rules that apply when both spouses are US citizens. So, for all the lovebirds out there, you are well advised to keep this in mind!
First, let’s understand that the US Estate and Gift taxes are “transfer taxes” and not “income” taxes. The transfer tax is asserted against the person making the transfer, not against the recipient of the gift or bequest. So, the giver of the gift might be subject to Gift tax and, in the case of Estate tax, the estate of the individual who passed away itself must pay the taxes owed, not the heir receiving the bequest. You can learn more basics about these transfer taxes and how they apply differently to US and non-US individuals at my here blog posts here and here.
US Gift Tax Rules
Special gift tax rules apply to the creation and severance of joint tenancies when one of the spouses is a non-US citizen. The rules are complicated and lead to confusion even among tax professionals. These rules, of course, are different than the general rules applicable to US citizen spouses and they often lead to unexpected and unintended tax consequences.
First, let’s look at the simple rules that apply to gifts made between spouses when both are US citizens. Very simple – no Gift Tax is imposed on the giver of the gift due to an unlimited marital exclusion. This is so because spouses are viewed as a single economic unit and shifting of assets and wealth between them is not an event that merits taxation.
There is no unlimited marital exclusion when one of the spouses is, God-forbid, an “alien”. The game changes along with the tax rules. Why? The reason is simple – the US government is concerned that the non-US spouse will be able to take the property, live outside of the US and thus, never pay US estate tax on it upon death. If Gift tax is not asserted at the time of the gift by the US spouse, then the property might escape the clutches of the US Taxman entirely. In order not to completely punish the US spouse, a “super-annual” exclusion from Gift tax is permitted each year when gifts are made to the non-US citizen spouse. For 2019, the total amount of annual gifts that can be made tax-free by a US citizen to the non-US citizen spouse (without eating into the US citizen’s so-called “lifetime exemption” amount, more below) is USD 155,000. This “freebie” amount is indexed annually for inflation.
Amounts gifted to the non-US spouse that exceed this threshold will be subject to gift tax, but thanks to the Trump Administration’s Tax Cuts and Jobs Act (TCJA), the so-called “lifetime exemption” amount given to US citizens for Gift and Estate tax purposes may absorb the gift tax otherwise payable. This is possible if proper tax forms are filed.
For 2019 the “lifetime exemption” amount is USD 11.4 million. The exemption amount is indexed annually for inflation. The lifetime exemption amount applies to gifts and estate taxes combined—whatever exemption you use for gifting during your lifetime will reduce the amount that can later be used by your estate when you die, to reduce the estate tax.
But watch out! The law put in place by TCJA has a sunset provision and remains in place only through 2025. Absent further Congressional action, the lifetime exemption amount would revert to the prior law $5 million base, indexed for inflation.
Generally speaking, the creation of a joint tenancy (including tenancy by the entirety) with right of survivorship in real property by a couple when one of the spouses is NOT a US citizen will not constitute a taxable gift at the time the tenancy is formed. Later however, a gift can occur. This will happen if the property is later severed into tenants-in-common, or if that property is sold and the non-US citizen spouse receives more than his or her pro rata share of the sales proceeds attributable to the consideration he or she provided upon purchase/improvement of the property.
The US tax rules governing this particular area of law are complicated since they are based on rules that were at one time repealed and later resurrected by Congress. See IRC Section 2523(i)(3) which resurrected “the principles of sections 2515 and 2515A (as such sections were in effect before their repeal by [ERTA])….except that the provisions of such section 2515 providing for an election shall not apply.” The Internal Revenue Service issued regulations to clarify application of these principles in 1995, but unfortunately they are confusing to many practitioners especially those who do not work with them on a frequent basis.
Example — Prince Harry and Duchess of Sussex, Meghan Markle
By way of simple example, let’s use our favorite royals the Duchess of Sussex, Meghan Markle and her favorite Prince Charming, Harry. This mixed nationality couple were married in May last year to great pomp and circumstance. Let’s pretend that Meghan uses significant money she earned from “Suits” and she alone provides all of the funds to purchase an apartment in some exotic location, naming Prince Harry as joint tenant with right of survivorship.
Under those very specific US tax rules mentioned earlier, no gift is created at that time. Later, the property is sold and let’s assume that Harry takes half the sales proceeds. It is at that time, that the gift is treated as made by Meghan to Harry. A taxable gift will result if the share of the proceeds taken by Harry exceeds the permissible “super annual” exclusion for gifts to non-US citizen spouses. As such, Meghan may have US Gift tax liability at that time (unless she was smart and had already expatriated by that time). On account of this complicated rule (of which many tax professionals seem unaware and even more do not understand), record-keeping will be critical to the dual-national couple. Accurate records must be maintained “tracing” the consideration provided by each spouse toward the property.
Other Assets (Bank and Brokerage Accounts)
Although some practitioners disagree, in my view, the creation of a joint bank or investment account by the US/non-US citizen married couple similarly may not always result in a taxable gift at the time the account is created. This is a far more complicated analysis and will involve examination of various factors, including local law. The gift may occur (along with all the tax consequences) when the account is terminated and one spouse takes an amount greater than the pro rata portion he or she contributed; or prior to termination of the account, when one spouse withdraws or takes from the account an amount that exceeds the pro rata portion of the account that he or she contributed (without any obligation to the other spouse to account for the excess).
Fixing and Planning Exercises May Be In Order
Mixed nationality spouses often need professional tax help when they have jointly held accounts – what if the US spouse is expatriating? Does s/he own half the value of the accounts when determining the USD 2 million net worth test? Should the US spouse have been reporting half the investment income from these accounts all along on the US income tax returns? We can help you sort out such messy questions.
Joint property ownership with a US and non-US spouse can easily become a very tangled web, with frightening tax implications. While you may love your spouse, the best advice may be to make sure you KISS – Keep It Separate Sweetheart!
My next blog post will cover the nuances of the US Estate tax rules for jointly held property by the US/non-US citizen married couple.
Posted January 9, 2019
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