In November, 1988, Congress passed the Technical and Miscellaneous Revenue Act (TAMRA), which drastically increased the amount of estate taxes paid by foreign taxpayers (defined as non-U.S. residents or non-U.S. citizens for estate tax purposes) who own property in the United States. These changes increased the estate and gift tax rates, and restricted a foreign taxpayer's marital deductions (the tax-free transfer of property from one spouse to another). The following is a general description of the gift and estate tax treatment for foreign taxpayers:
The U.S. taxes its citizens and residents on their world-wide assets. Therefore, one must first determine whether a non-U.S. citizen will be considered a U.S. resident for estate tax purposes. Note: the definition of "residency" for estate and gift taxes differs from those determining income taxes.
"Residency" for estate tax purposes involves the concept of "domicile": Did the foreigner intend to remain in the U.S. permanently? Salient factors include (1) the filing of U.S. tax returns and any visa applications; (2) length of stay(s) in the U.S.; (3) the style of living in the U.S. compared with that in other countries; (4) the family, economic, and social ties with other countries; and (5) the foreigner's citizenship.
Given the differences in definitions of residency, a foreigner may qualify as a U.S. resident for income tax purposes, yet not for gift and estate tax purposes. And vice-versa! Depending on his or her world-wide holdings, the foreigner with a small percentage of U.S. assets is probably better off being considered a foreign taxpayer (a non-U.S. resident) for estate and gift tax purposes.
A foreign taxpayer is subject to U.S. estate tax on property he or she owns on the date of death within the U.S.; interests in real estate located in the U.S. is always considered U.S. property. Mortgages and other debts that are secured by real property, however, are considered debts. U.S.-based assets -- like Treasury Bills, stock in U.S. companies, debts owed by U.S. citizens or residents -- are considered part of the foreign taxpayer's estate for U.S. tax purposes, when those assets are held in his or her name. Bank accounts are not included in the foreign taxpayer's U.S. estate. Cash and tangible property (such as jewelry, art, furniture, automobiles, equipment, and valuables) in the U.S. are considered part of the estate, except for works of art being exhibited in the U.S. The personal property of diplomats, however, is excluded from the U.S. estate.
While stock in a U.S. corporation is considered a U.S.-based asset, stock in a foreign corporation is not. Sophisticated foreign investors often use foreign corporations formed in tax haven jurisdictions -- Cayman Islands or the British Virgin Islands -- to acquire U.S.-based assets and thereby circumvent U.S. estate taxes on those assets.
Changes to the estate and gift tax law for foreign taxpayers have raised the top bracket from 30% to 50% -- the identical rate applied to all U.S. taxpayers -- while the estate and gift tax exemption remained at $60,000, only one-tenth the exclusion for a U.S. resident or U.S. citizen. Generally, property is valued at its fair market value on the date of death or transfer.
Liabilities which are non-recourse (the creditor looks solely to the asset for repayment) serve to reduce the value of an estate. Recourse liabilities (the creditor looks to the taxpayer for repayment) are treated differently. A recourse liability can reduce the value of the U.S. estate only if the foreign taxpayer discloses his or her world-wide holdings and liabilities -- something many foreigner taxpayers shun -- and then only percentage of foreign taxpayer's world-wide recourse debt can be applied. Given these rules, a savvy foreign taxpayer may purchase U.S. real property and use non-recourse debt (often borrowed from a related company), to keep the property's values less than $60,000 for estate tax purposes. For example, a purchase of a building by a foreign taxpayer for $500,000 that is financed with non-recourse mortgage of $450,000, has a $50,000 value for U.S. estate tax purposes.
The 1988 law mandates that transfers between a U.S.-citizen spouse to a non-U.S. citizen spouse will be denied the advantageous marital deduction unless that transfer is into a "qualified domestic trust." The marital deduction is important because it permits a spouse to receive property without the imposition of a gift or estate tax, until his or her death. Without a marital deduction, the gift or estate tax is levied when the transfer is made. All estate plans in which one of the spouses is a non-U.S. citizen should contain provisions addressing this issue.
If a transfer to a non-U.S. citizen spouse does not strictly satisfy the qualified domestic trust requirements, then the marital deduction becomes non-existent, and the deceased spouse's estate could be subject to an immediate tax. The qualified domestic trust, in general, requires that a U.S. citizen be appointed as trustee and all distributions of trust principal will be subject to estate tax on distribution. The remaining trust principal will be taxed at the surviving spouse's death. The trustee of a qualified domestic trust is personally liable for the payment of the estate taxes.
The qualified domestic trust provisions do not apply if a surviving spouse becomes a U.S. citizen prior to the due date of the decedent's estate tax return, in which case the decedent's estate will be entitled to the full marital deduction
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**NOTE: The information contained at this site is for educational purposes only and is not intended for any particular person or circumstance. A competent tax professional should always be consulted before utilizing any of the information contained at this site.**