My recent blog post covering the Federal Transfer Certificate generated various questions about the US estate tax for foreign individuals who die owning US properties.
US Estate Tax – Overview
Briefly, the US estate tax is a “transfer tax” and not an “income” tax. This transfer tax is asserted against the estate of the individual who passed away, not against the recipient of the inheritance or bequest. It is assessed on the value of property in the decedent’s estate.
With regard to non-US citizens who are not “domiciled” in the US, only assets that are considered to be located within the US are part of the estate, subject to US estate tax. Many complicated rules apply to the analysis regarding the location (or “situs”) of an asset. An executor will need help in understanding which assets are subject to US estate tax. Given the ever-present threat of personal liability for getting it wrong, the executor should make sure to get proper US tax assistance.
Some of the tasks of the estate executor are to locate all of the estate’s assets and to ensure all relevant taxes are paid before making any distributions to estate beneficiaries. Under US laws, if the estate tax is not properly paid by the executor, the executor can have personal liability for the tax. More below on this scary thought! Although not detailed to any extent in this post, readers should be aware that an executor can also be held personally liable for a decedent’s unpaid income and gift taxes if the executor had knowledge of the debt and distributed the estate without first paying these taxes. Indeed, being an executor is a dangerous business.
Executor’s Personal Liability
The Federal Claims Priority Act (FCPA) establishes the personal liability of the executor of an estate, to pay any claim owed to the government, such as unpaid taxes of a decedent. Broadly speaking, the FCPA provides the United States with a direct cause of action against the estate executor if he makes payments to other creditors or beneficiaries of an insolvent estate over the tax owed to the US government. Personal liability attaches in the absence of any bad intent on the part of the executor. Personal liability can result even if the executor is merely making a distribution from the estate of a bequest or a portion of the residuary estate to beneficiaries who have been named in the decedent’s will, or to those who are inheriting under intestacy laws.
Various tax law provisions (see e.g., IRC sections 2203, 6324 and 6325), some discussed below, back up the FCPA’s bite.
Who is an “Executor”?
You’d be surprised!
The tax laws define it most broadly, so as to ensure (at least, as much as possible) the collection of estate tax that is owed. Under Section 2203 of the Internal Revenue Code, the term “executor” means the executor or administrator of the decedent, or, if there is no executor or administrator appointed, qualified, and acting within the United States, then any person in actual or constructive possession of any property of the decedent.”
In many cases, the estate of a nonresident alien decedent will not have an appointed US executor. This means that certain other parties will be treated as the estate “executor” charged with the duties and potential personal liability for unpaid estate tax.
When the “executor” is any person in actual or constructive possession of any property of the decedent this is often referred to as a “statutory executor”. In many cases, you can think of such person as the “Accidental Executor”. Relevant Treasury Regulations under Section 2203 provide that “the term ‘person in actual or constructive possession of any property of the decedent’ includes, among others, the decedent’s agents and representatives; safe-deposit companies, warehouse companies, and other custodians of property in this country; brokers holding, as collateral, securities belonging to the decedent; and debtors of the decedent in this country.”
A statutory or accidental executor can arise, for example, when there is no US executor because all of the US assets are owned jointly with survivor rights, so they pass outside of probate. In such an instance the statutory “executor” would include a joint owner of the US property (for example, a spouse). An accidental executor can also include the trustee of a revocable trust, or a foreign attorney or similar professional who is handling the US affairs of the decedent’s estate. Brokers “holding as collateral [US] securities belonging to the decedent” may also possibly include foreign brokers under this broad definition when there is no US probate. Upon discharge of the appointed executor by a probate court accompanied by notice to the IRS on IRS Form 56 (discussed below) the heirs of the decedent’s estate can then become accidental executors!
Preventive Measures
If you are an executor, it is not a good idea to make mistakes! Certain preventive measures can be taken by those who know they are “executors”. Unfortunately, accidental executors are often completely unaware of the mistakes they are making and remain oblivious to their unintended status.
The estate executor absolutely should file IRS Form 56 with the IRS to inform the IRS that a fiduciary relationship has been created. While there is no penalty for failing to file the form, it protects the executor from unanticipated events such as failure of the IRS to send correspondence (including a Notice of Deficiency) to a different or incorrect address. This same form should be used by the executor to notify the IRS that the fiduciary relationship is terminated and that all duties as administrator of the estate have been completed.
The executor should also ensure there are no unpaid back taxes involving the decedent. This can be done by filing IRS Form 4810 (Request for Prompt Assessment for Income and Gift Taxes). It is wise to wait for the IRS to respond prior to making any distributions to the estate beneficiaries. An unexpected tax assessment would be very difficult to manage if the executor has paid out the estate assets to the beneficiaries!
An executor appointed and acting within the US can apply to the IRS for discharge from personal liability of the decedent’s Income, Gift, and Estate Taxes by completing Form 5495. By filing this form, the US executor is automatically discharged from personal liability if within 9 months of filing the IRS does not notify the executor of an unpaid income, gift, or estate tax liability.
Forms, Forms and More Forms
Estates of non-US persons must file a US estate tax return on IRS Form 706-NA if the taxable estate which is comprised of US-situs assets exceeds USD 60,000. This is a very small sum and any foreigner owning US real estate will likely exceed that value very easily! Estate tax returns are to be filed within 9 months of death but one can request a 6 month extension within the first 9 months. The extension request is made by filing Form 4768. Penalties and interest can be applied to late filed returns unless one can demonstrate “reasonable cause”.
Estates of non-US persons owning US assets are also affected by certain “basis reporting” provisions using Form 8971. The basis reporting rules apply if the estate tax return is filed after July 2015. Filing of Form 8971 with the IRS and providing a Schedule A to any beneficiary (whether or not a US person) receiving a US-situs asset is another task for estate executors. Executors file Form 8971 to report the final estate tax value of such US-situs property distributed or to be distributed from the non-US decedent’s estate. This form, along with a copy of every Schedule A, is used to report values of the assets to the IRS. One Schedule A is provided to each beneficiary receiving property from an estate. The beneficiary must keep careful track of the basis records so he will know what to do later when he disposes of the asset and must report the capital gain on a US tax return. IRS has an information page devoted to the Form 8971.
If you need help with any issues related to the US estate tax – let us know. We are here to help.
Posted August 5, 2021
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