Individuals living outside of the US who inherit a US asset from a foreigner may be in for some surprises. If the decedent is an individual who is treated as a nonresident alien individual (NRA) for US estate tax purposes, his heirs often have a difficult time obtaining actual title to the US asset they inherited. My earlier blog post set out in detail the US estate tax rules for foreign persons and a related post explains when the individual is to be treated as “resident” or “nonresident” for estate tax purposes. Generally speaking, if the total fair market value of the US situs assets held by the decedent at death exceeds the applicable exclusion amount (USD 60,000 unless a greater exemption amount applies pursuant to a relevant treaty) the excess amount is taxed at a graduated rate up to a maximum of 40 per cent on the gross value of US assets over USD 1,000,000.
The challenge to obtaining title to inherited US assets arises because the heir must obtain what is called a federal “transfer certificate” (TC) in order to acquire title to the inherited property. Obtaining this TC is a time-consuming and costly process, but US custodians (e.g., a US broker or a US corporation) will not transfer the property unless the TC is presented. Today’s blog post will educate readers about the TC.
US Estate Tax – Who’s Liable for it?
The US estate tax is paid by the estate and generally, is a tax assessed on the fair market value of the decedent’s assets. For NRA decedents only US-situs assets are part of the US taxable estate. Under various US tax law provisions, upon an individual’s death, a federal tax lien is automatically imposed against the decedent’s assets for the estate tax that may be owed. This lien arises by operation of law and thus, it comes into existence even if the property does not come within the decedent’s estate (i.e., the probate estate controlled by the executor or administrator) but instead passes directly to a beneficiary outside of probate. This may happen for example with a “transfer-on-death” beneficiary designation. Even though these assets may not go through probate, assets passing directly to the beneficiary in this manner are still subject to US estate tax.
The payment of estate tax is the responsibility of an executor who is qualified and acting in the US. If a US executor is appointed, he is not personally liable for the estate tax unless he makes distributions to the estate beneficiaries prior to paying the estate tax due and the remaining assets are insufficient to cover the tax. If no US Executor is appointed, then the tax laws provide that any person who has actual or constructive possession of any US property of the decedent is required to pay the estate tax (and potentially personally liable for it) to the extent of the value of the property in his or her possession.
The Real World: When Foreigners Die Owning US Assets
How does all this work in the real world when foreign decedents have invested in the US? If a US executor is appointed for the US estate of the NRA, the TC is not required. This is so because the US government knows it can pursue the US executor for any unpaid estate tax since the executor (unlike a foreign executor) is clearly within the jurisdiction of the US. In addition, if no estate tax is due because the value of the US estate is below the exclusion amount of USD 60,000, then a TC is also not required (although the party in possession, for example, the US financial institution may still mandate that the IRS provide correspondence that the TC is not required).
Typically, a US executor is not appointed for the NRA’s US estate and often the US assets far exceed USD60,000, thus making the TC a critical document for the heirs. It should be noted that the TC is required once the decedent’s US assets exceed the USD60,000 exemption amount. This remains the case even if a relevant estate tax treaty provides a more generous estate tax exemption such that no actual estate tax liability arises.
Often a US financial institution, for example, is holding the US assets, as the party in possession. Such a “possessor” is the party responsible for the payment of the estate tax and the one who may also be personally liable if it is not paid. As more fully discussed below, this potential liability is the reason custodians in possession of the assets require presentation of the TC before transferring assets to the heirs.
The Federal Transfer Certificate
The TC is issued by the Internal Revenue Service (IRS) and is a essentially a certificate of discharge of any or all of the property subject to the tax lien once the estate tax due has been paid. In other words, the TC is a kind of insurance policy for the party in possession eliminating personal liability for unpaid estate tax. The TC will clearly identify each item of property for which the estate tax has been paid and permits the party in possession to transfer those identified items of property without fear of liability for unpaid estate tax. What this means is that the foreign estate executor must file IRS Form 706-NA, the estate tax return for the NRA-decedent when US assets exceed USD60,000, listing all the US assets and paying any estate tax due.
The Form 706-NA is not required if the USD60,000 threshold is not met, but various documents can be submitted to the IRS to receive IRS confirmation that no TC will be issued. This correspondence can be provided to the party in possession of the US assets.
Sadly, it is often the case that the foreign heirs and executor do not even know that a US estate tax return is required and they miss the filing deadline for the Form 706-NA. The Form is due 9 months after the date of death. Late filing means the estate will be subject to interest and possible penalties. Furthermore, without the TC, the financial institution holding the assets will not permit the estate beneficiaries to access them, which also means they cannot manage the assets. This often leaves the investments with no protection against market risks.
Even if all goes well and the Form 706-NA is timely filed, actual issuance of the TC by the IRS can easily take 9 months. Due to COVID and severe IRS backlogs I suspect far longer time frames are the reality.
UPDATE from my tax colleague Ali Khan – Ali reports that currently it is taking over 18 months to obtain the TC or other clearance from the IRS. IRS recently changed its procedure and now it cannot even be requested before 9 months (it used to be 4, then 6, now 9). My tax colleagues report they have many IRS Forms 706NAs filed in 2019 and are still awaiting the TC or clearance. IRS backlog is likely due to several factors including that many agents in the estate and gift tax division have left the IRS.
Mitigating the TC Headache
Various strategies can be used to mitigate the TC headache. These can include the use of a trust or other structures, but careful planning with an experienced US tax advisor is required. If you need help with estate tax planning for US investments I am here to guide you.
Posted July 29, 2021
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