My recent blog posts (e.g. here, and here) emphasized how important it is for Americans who are investing in foreign (non-US) assets to understand the US tax consequences of making that investment. Far too often I have seen individuals invest substantial amounts of money without knowing the tax impact of that infusion of hard-earned cash.
Equally important is this same caveat for non-US persons who are making US investments. Not understanding the tax consequences can have serious repercussions. For non-US individuals one of the most often overlooked US tax issues is the US estate tax. Foreign persons often believe because they have never set foot on US soil and do not have a green card, that they will be shielded from all US tax. Nothing could be further from the truth. I’ve explained this in earlier blog posts – breathing American air can be hazardous to your wealth.
Today’s post looks at some of the critical tax issues when foreigners invest in US assets. The tax issues are there even if the assets (such as stocks and bonds) are held through a foreign custodian (e.g., a foreign bank holds US securities on behalf of the foreign individual client).
US Estate Tax
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 decedents who are nonresident alien individuasl (NRA) for US estate tax purposes only US-situs assets are part of the US taxable estate.
If the decedent is treated as 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.
Heirs Want Title to the Assets
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. Foreign custodians who are in-the-know will also never transfer the assets without the TC.
Today’s blog post will explain to readers what the TC is, why it is important and that proper tax advice can help avoid these headaches if undertaken carefully and in a timely fashion.
The Federal Transfer Certificate
The TC is issued by the Internal Revenue Service (IRS). Once the estate tax due has been paid by the estate, the IRS will issue the TC. This can be viewed essentially as a certificate of discharge of tax liability for any or all of the decedent’s property subject to the US estate tax lien (this lien is automatically imposed as an operation of various US laws). In other words, the TC is a kind of insurance policy for the party in possession of the US assets. This is typically, the financial institution, whether a US or non-US institution. It eliminates personal liability for unpaid estate tax on the assets covered by the TC. 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 Does this Mean in the Real World?
What this means is that within 9 months of the date of death, the foreign estate executor must file IRS Form 706-NA. This is the estate tax return for the NRA-decedent. It is required when US assets exceed USD60,000 and must list all the US assets and pay any estate tax due. The Form 706-NA is not required if the USD60,000 threshold is not met, but many financial institutions will not release the assets without some form of assurance from the IRS on the estate tax matter, even if the TC will not be issued since the value is below USD60,000. 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. It is very important to sort this matter out since 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.
If the executor is a US person, the TC is not required. This is because, unlike a foreign executor, the US executor who will be personally liable for any unpaid estate tax is easy to reach.
Avoid Estate Tax and Related TC Headaches
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 IRS backlogs I suspect far longer time frames may be the reality.
Various strategies can be used to prevent US estate tax entirely and thus mitigate the TC headache (other related headaches as well, not enumerated in this post). These can include the use of structures, but careful planning with an experienced US tax advisor is required. If you need help with estate tax planning for US investments make sure you have the right advisor to guide you. It’s not as simple as some advisors make it sound!
Posted January 25, 2024
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