My earlier blog post gave a head’s up to married couples about US tax issues that can arise when assets are owned jointly with a spouse who is not a US citizen.
A follow-up blog post detailed the US Gift tax rules that apply when assets are held jointly with right of survivorship (WROS) by a US/non-US citizen married couple. The post explained that unintended and devastating tax consequences can occur as a result of such joint ownership WROS. Now, let’s look at the US Estate tax rules and the impact of such joint ownership when the joint tenant is a spouse who is not a US citizen.
US Estate Tax is a “Transfer” Tax
First, let’s understand the US Estate tax. The Estate tax, like the US Gift tax, is a “transfer tax” and not an “income” tax. A 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 must pay the estate taxes owed, not the individual 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 earlier blog post here.
As we saw from my earlier post on joint ownership WROS, the US Gift tax rules that apply with regard to jointly-owned property when only one spouse is a US citizen differ greatly from the general rules that apply when both spouses are US citizens. The way the rules work often can lead to unfavorable tax results. Unfortunately, it is the same with regard to the US Estate tax rules.
US Estate Tax Rules
First, let’s look at the simple rules that apply to bequests made between spouses when both are US citizens and one spouse passes away. Very simple – no Estate Tax is imposed on the estate with regard to the value of all assets passing to the US citizen surviving spouse, due to an unlimited marital exclusion. The spouses have been viewed as a single economic unit, so the death of one spouse is not an event that merits taxation.
Surviving Spouse Not a US Citizen?
Similar to the Gift tax regime, there is no such unlimited marital exclusion when the surviving spouse is not a US citizen. 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 his or her death.
Property passing to a non-US citizen spouse from the US spouse can escape US estate taxation if the value of the US decedent’s estate does not exceed the lifetime exemption amount permitted to estates of US citizen decedents. Thanks to the Trump Administration and passage of the so-called Tax Cuts and Jobs Act (TCJA), the exemption amount is now quite large for a temporary time period.
For 2019 this amount is USD 11.4 million. The exemption amount is indexed annually for inflation. 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.
In other words, a US citizen can pass away this year owning $11.4 million in worldwide assets and no US estate tax will be assessed on the estate. This remains the case regardless of who are the beneficiaries of the estate (thus, no estate tax even if he leaves the full estate to his non-citizen spouse). For amounts exceeding the threshold that pass to the non-US citizen spouse, the estate tax can be deferred if a so-called Qualified Domestic Trust (or “QDOT”) is used. More about QDOTs in a later post.
Property Held Jointly
Under the general estate tax rule, when any kind of property (real or personal) is held by a decedent and other persons as joint tenants with the right of survivorship the value of the jointly held property included in the estate of the first joint tenant who passes away is calculated through a “tracing” of funds. In other words, the law wants to know “who contributed how much”. The percentage of value of the property included in the estate is based on the amount of consideration paid by the deceased joint tenant to acquire the property (and, if applicable, amounts paid later, for example, capital improvements).
Husband and Wife – Both are US Citizens
This general rule changes if the property is owned only by a husband and wife as joint tenants WROS. If both spouses are US citizens, the rules become simpler and the “tracing” mandates are simply done away with.
Under this rule when the US citizen decedent and the US citizen surviving spouse are the only joint tenants of the property, only one-half of the value of the property is included in the deceased spouse’s gross estate, regardless of who contributed what.
Thus, for example, if the husband provided all of the funds upon creation of a joint bank or brokerage account with his spouse, and he was the sole contributor of additional funds thereafter, upon death, only one-half the value of the account is included in his estate even though the wife did not contribute any funds whatsoever.
Non-US Citizen Spouse
However, the rules change and become complicated again when the surviving spouse is not a US citizen. The simple rule does not apply if the surviving spouse is not a citizen of the United States at the time of the decedent’s death. Instead, the decedent’s estate must employ the “tracing rule” mentioned earlier to determine the amount includible in the deceased spouse’s estate.
Without adequate records and proof, the jointly-owned (non-community) property passing to a non-US citizen spouse is generally fully includible in the deceased spouse’s estate … and remember, there is no unlimited marital deduction to minimize the Estate tax bite! Ouch!
We Can Help
You may already have made the choice and titled property jointly with your non-US spouse and are now faced with confusing tax issues. If the US spouse is considering relinquishing US citizenship, is half the property counted for purposes of determining that spouse’s net worth test under the expatriation rules? Is all of it counted? If you wish to divide the assets now, what are the tax results?
We can help you resolve these critical issues so that your tax planning is optimized.
Posted January 14, 2019
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