US Estate Tax:  Location of Assets, More “Situs” Rules

Part I of this blog post examined some of the rules regarding the US estate tax and how it applies to non-US persons (noncitizen/nonresident – based on the concept of “domicile”). Unfortunately, the US estate tax often catches the non-US citizen non-domiciliary’s family by surprise and when it does, it bites hard.  Remember, the non-US citizen non-domiciliary will include an individual who has expatriated (e.g., given up US citizenship). Understanding the rules and taking sound tax advice can prevent many unpleasant surprises.

Today’s post continues to examine which assets are treated as having a US “situs” or “location”. These assets will be included in the non-US citizen non-domiciliary’s US estate and can be subject to US estate tax (40% rate) once the value of US assets exceeds the current exemption amount of US$60,000.

Bank Deposits, Safe Deposit Boxes, Cash, Brokerage Accounts

US bank deposits are generally given special treatment and deemed to be located outside the US so that they escape US estate taxation. Caution is the order of the day, however, with bank deposits.  There are several caveats.  First, in order to escape US estate taxation, the US bank deposits must generate interest income that is not treated as “effectively connected with a US trade or business”. In the typical case of a noncitizen non-domiciliary’s personal bank accounts this exception should apply.

Second, the funds should not be held by the bank in any kind of special deposit in a custodial capacity.  A form of special deposit should be avoided because such deposits may not escape the US estate tax.

Third, cash or other items held in a bank’s safety deposit box is not within the bank deposits exception and will clearly be subject to US estate tax.

Finally, make sure the deposits are being held at “banks” within the meaning of the estate tax rules. Deposits held at a US brokerage firm or other financial institution will not be considered to be held at a bank and will not be exempt from the US estate tax. This often comes as a rude surprise to many non-US persons with US brokerage accounts.

Foreign branch and US branch bank deposits deserve special mention. Deposits with a foreign branch of a domestic (i.e., US) corporation or partnership engaged in the commercial banking business are treated as foreign situs property and thus not subject to US estate tax.  Deposits with a US branch of a foreign bank conducting business in the United States would be treated as US situs property and subject to tax.

Debt Obligations

The location for US estate tax purposes of a debt obligation is similar to the rule for stock in a corporation. Debt obligations of a US person or of a US government entity are treated as property situated in the United States regardless of where the debt instrument is located and regardless whether the decedent was engaged in US trade or business at the time of death. Certain exceptions apply to this general rule for debts, but there are many complicated nuances.

For example, if the interest on the debt qualifies as so-called “portfolio interest”, the debt is not included in the US estate.  There are many nit-picky rules relating to portfolio interest, and careful counsel should be taken to make sure none are inadvertently violated.  For example, if the loan provides that interest payable to the foreign lender is determined by reference to the borrower’s cash flow, or to fluctuations in property value or another contingent factor, then interest payable on the loan will not qualify as portfolio interest and, the loan would be includible in the decedent’s US estate.

Certain short-term debt instruments held by the noncitizen/non-domiciliary individuals are also exempt from US estate tax.  Again, care must be taken to make sure all the nuances are thought through.

Life Insurance with a US Insurance Company

Insurance proceeds payable by a US insurance company on the life of a noncitizen non-domiciliary insured owner of the policy are deemed property situated outside the United States. IRC Section 2105(a) and Treasury Regulation 25.2501-1(g).  Section 2105 specifically provides that “the amount receivable as insurance on the life of a non-resident not a citizen of the United States shall not be deemed property within the United States.” The death benefits payable with respect to the life of a non-citizen/non-domiciliary decedent are not subject to US estate tax, regardless of whether the decedent held incidents of ownership over the insurance policy, the death benefits are payable to his estate, or whether the beneficiary is located inside or outside of the US.

This rule is limited to insurance on the life of the non-citizen/nondomiciliary owner of the policy. If a non-citizen/nondomiciliary owns a life insurance policy issued by a US insurance company on the life of another person, the value of that policy is includible in the foreign owner’s US estate. Insurance on the life of someone other than the decedent is considered situated in the US if the insurer issuing the policy is a domestic (rather than a foreign) insurer.

Posted February 8, 2024

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