My recent blog posts here, here and here have been examining the US estate tax and its impact on foreign investors in the US. The posts explored estate tax basics, the concepts of “domicile”, ”situs” of assets, the troublesome Federal Transfer Certificate and the paltry estate tax exemption of USD60,000 given to non-US non-domiciliaries for their US-situs assets. (More detail here and here on the concept of “domicile” and how unexpected tax issues arise if the decedent was domiciled in a country that follows community property laws).
Today’s post will examine how an estate tax treaty might mitigate the US estate tax when a non-US domiciliary’s estate is subject to the tax, but a treaty is available.
US Citizen / Domiciliary? Forget it… the Estate Tax Treaty Will Not Help!
Just in case the decedent is a US citizen or domiciliary, I caution readers to lose hope claiming treaty benefits. That’s right. The United States generally retains the right to tax US citizens and domiciliaries under the treaty through what is known as the “savings clause”. The savings clause preserves the right of the United States to tax its citizens and domiciliaries as if the treaty had not been entered into.
What this means for example, is that a US citizen who becomes domiciled in a treaty country cannot use the advantages of the treaty! A number of treaties expressly contain a savings clause, but in most treaties this is simply implied. The Tax Court construed one such “implied savings clause” in Estate of Vriniotis v. Commissioner 79 T.C. 298 (1982). In that case, the decedent was a dual national being a citizen of both the United States and Greece. At the time of death, he was domiciled in Greece. The decedent owned real property in Greece and bank accounts in New York. The estate argued that the US-Greek estate tax treaty exempted the estate from US estate tax.
The Internal Revenue Service (IRS) argued that the decedent was a US citizen at the time of his death and that his estate was therefore liable for US estate tax. IRS further argued that the US-Greece estate tax treaty did not alter the estate’s liability for US estate tax since the treaty’s only purpose was to prevent double taxation of a decedent’s assets by providing credits for any foreign taxes paid. The Tax Court agreed with the IRS and held that the estate was liable for US estate tax on all of his assets, including the decedent’s real property in Greece. However, the estate was entitled to a credit for Greek inheritance tax paid on that property pursuant to the US estate tax laws and not under the treaty.
The Tax Court stated: “Except for providing credits under article VI for taxes imposed by Greece on a decedent’s movable assets, the treaty does not affect the application of the Federal estate tax to the estate of a decedent who dies a citizen of the United States. In other words, the U.S. estate tax applies to the entire estate of a U.S. citizen regardless of where he is domiciled or regardless of where his property is situated, and the treaty does not change those basic rules. [emphasis, mine]. Report of the Senate Foreign Relations Comm., Aug. 6, 1951, CCH Tax Treaties par. 3177 (1968).”
Let’s move on to how an estate tax treaty might mitigate the US estate tax when a non-US domiciliary’s estate is subject to the tax.
Overview Of Estate Tax Treaties
Estate and gift tax treaties provide rules to minimize and avoid double taxation that can arise when two countries both have the right to tax the decedent under their domestic laws. Broadly, treaties accomplish this by providing primary and secondary taxing rights, situs rules, and special rules dealing with credits, deductions and exemptions. The US has negotiated 14 estate and gift tax treaties and has an income tax treaty with Canada which encompasses estate tax provisions at Article XXIXB of the US-Canada Income tax treaty. A list of current gift and estate tax treaty agreements negotiated with the United States may be found here.
How an Estate Tax Treaty Works
Each United States estate tax treaty is unique, so the relevant treaty must be examined very carefully. It’s complicated and proper tax advice is highly recommended. This is not a DIY exercise.
Estate tax treaties vary, but broadly speaking they fall into 2 general categories. Treaties signed before 1966 apply the estate tax based on the location or “situs” of the property, by giving the situs state the primary right to tax. Treaties signed after 1966 generally apply the estate tax based on the domicile of the taxpayer. When an estate tax treaty works predominantly through the concept of “situs”, it is essentially providing a list of rules whereby the two countries that are signatories to the treaty agree as to the legal location or situs of certain property, and thus which country has the primary taxing right with respect to that property. The United States is a party to situs-type treaties with Australia, Finland, Greece, Ireland, Italy, Japan, Norway, South Africa, and Switzerland.
More modern estate tax treaties that work by reference to the “domicile” of the decedent at the time of death provide that the country of “domicile” will have the primary right to tax. In these “domicile” types of treaties, the non-domicile country can usually still exercise taxing rights over real property and business property located in that country. The United States has signed domicile-type treaties with Austria, Denmark, France, Germany, the Netherlands, and the United Kingdom.
Some treaties grant deductions or exemptions or increase exemption amounts provided under domestic law. Most treaties grant these deductions and exemptions to decedents who are citizens or domiciliaries of either contracting country. The effect of such a provision is to afford the advantage of the credits or deductions to the citizen of a contracting country who may be domiciled in a nontreaty jurisdiction. Some treaties increase the USD60,000 allowed by the US to non-domiciliary noncitizens and permit a proration based on the ratio of the decedent’s property in the US over the gross estate of the decedent’s assets worldwide. The relevant treaty must be examined for specific provisions, as each treaty has unique terms.
It is very important to note that using an estate tax treaty generally means that the worldwide value of assets must be revealed to the Internal Revenue Service on the US estate tax return. Additionally, when an estate claims treaty benefits, a special notice claiming those treaty rights must be filed with the estate tax return using Form 8833, Treaty-Based Return Position Disclosure. (More detail on Form 8833 is here).
February 22, 2024
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