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YOU THINK YOUR TAXES ARE COMPLICATED?
Be prepared: Owning US assets as a non-US citizen can crate big tax surprises.
We’ve all heard the line about death and taxes. What many haven’t heard, though, is the certainty that estate taxes for those who are not US citizens – but who have US assets – can be complicated and unexpected.
In other words, cross-border financial planning is complex. Even if you never set foot in the US and don’t open a financial account in the country, you may end up with cross-border estate tax issues. If you own US situs assets, which includes things like investments in US companies, real estate, or retirement accounts, but are a nonresident alien (NRA), you need to think about how your estate could be taxed on those assets when you die.
Although this article is not legal advice, I want to offer some points to help you figure out how much your estate could owe if you died tomorrow, and how you might think about restructuring your investments to protect your heirs from an unexpected bill from Uncle Sam.
For the uninitiated, you may think that the US Congress’s intent in writing tax laws was to scare people away from investing in the US. But it’s also true that US financial markets and low-cost brokerage firms offer a lot of compelling reasons for non-Americans to invest. An unexpected death, however, without some well thought-out estate planning can be unnecessarily costly to heirs.
You may have already hired an advisor or opened an account where your investments are managed and you may want to hire an attorney specializing in international taxation and estate planning. But be forewarned: Many investment advisors are measured by the total assets they manage and how many clients they retain. If your advisors are not experienced in cross-order tax planning, they may not understand all of the risks, and they may not have much incentive to dig deeper.
People often spend more time researching a new restaurant than they do a financial advisor.
In fact, make sure you know your financial advisor. People often spend more time researching a new restaurant than they do a financial advisor. Little to no qualifications are required to be called a financial advisor or financial planner. There are a lot of lofty titles for someone who is not much more than a commissioned salesperson. Also keep in mind that a more complex situation may require a small team of experts, and finding one individual with all of the necessary knowledge may be difficult or impossible.
With all that in mind, let’s start with the basic rule: Non-resident aliens who own US assets are likely to face estate taxes.
In some cases, an estate tax treaty might help to limit the amount of taxes paid, essentially avoiding or minimizing double taxation. The US has estate tax treaties with about 20 countries, which means that it may be possible to lower estate taxes in the US or in a home country. If there is no estate tax treaty, there could be double taxation. Without an estate tax treaty, the US allows a “unified credit” on the estate, a not-very-generous $13,000, which a person can give to others without having to pay gift or estate taxes. This translates into a nonresident alien with more than $60,000 in US assets having to pay US estate taxes ranging from 26% for estates starting at $60,000, up to 40% for amounts over $1 million.
So what can you do to minimize or eliminate this hefty estate tax? Here are a few suggestions.
Don’t have US situs assets in any financial account anywhere. For financial assets such as stocks, what matters is not the location of the account but the situs location of the underlying investments. The shares of US companies are considered foreign situs assets and generally not subject. toUS estate taxes for nonresident aliens. It is possible to own non-US situs assets in an IRA account or brokerage account based in the US. For example, shares of Nestlé are Swiss situs assets. In the same way, it is possible to own US situs assets (such as Apple shares) in a financial account outside the US. It is also possible to own US stocks that are non-US situs by owning a foreign mutual fund or an exchange-traded fund (ETF); this is something that can be useful for nonresident aliens trying to avoid US estate tax.
Own assets through a foreign company or trust, rather than individually. But do not try this without professional help. The principle here is that unlike an individual, a foreign company or trust does not die when the owner of the company or shareholder dies, so US estate taxes may not apply. Here’s an example: George and Martha are married nonresident aliens living in England, and they’ve left their entire estate to each other. If George dies first owning $360,000 in Apple shares and leaves his entire estate to Martha, George’s estate will owe US estate taxes on $300,000 of the shares. However, let’s assume that George created a company registered in the British Virgin Islands, with 1,000 shares, and he transferred ownership of those Apple shares from himself to his company. If George dies, his wife will inherit the company, which is not a US company, and thereby those 1,000 shares. She will not have to pay US estate taxes. One blogger who explains this subject well is Phil Hodgen, especially in the use of foreign trusts owning US real estate.
Buy life insurance. Life insurance is a common way for wealthier families to mitigate the impact of an expected estate tax and to pass on wealth. It’s not always the right solution if the insured person lives longer than expected or the premiums become too expensive, but it could be something to ask a qualified insurance professional about. In the right circumstances, life insurance can be used both to pay estate taxes and to pass on wealth.
Make the US citizen spouse the sole beneficiary of the estate. Under IRS code section 2056, under certain conditions, there is an unlimited marital deduction on the estate tax for property that passes to a surviving spouse – as long as the spouse. isa US citizen. This technique might not work in some countries where spouses or children have legal rights to a portion of a person’s estate, a concept generally referred to as forced heirship. In US law, it can work if the assets are titled “joint tenancy with right of survivorship”. In other words, if one person dies, the other continues to own the deceased person’s shares.
Know the risk and hold onto US assets anyway. Retention of risk is another strategy that may be appropriate for some individuals depending on the size of their estate, heirs (or lack of them), and the desire to save on professional fees. You may know that your US investments would be subject to an estate tax but figure that it is worth taking the risk that you will not die suddenly and will be able to sell those assets before dying. Or, you may figure that estate taxes are not your biggest concern and besides, paying extra fees for lawyers, advisors, accountants will cost too much over a long period.
Keeping all these choices in mind, it’s important to understand what generally doesn’t work.
Don’t ignore US state and estate taxes. Many US states impose estate or inheritance taxes, which may be in addition to US and foreign estate taxes and have different (and lower) limits than US federal estate tax. If you are living overseas and your advisor insists that you keep a US address on your accounts – presumably so that he or she can more easily work with you – the state where the account was opened or listed as the domicile for the account may try to claim income or estate taxes. Make sure you understand the implications – and risks – of using an incorrect legal address on your financial accounts.
Be concerned if your banker says to avoid the US in your investment account. Ever since the Foreign Account Tax Compliance Act of 2010, many advisors outside the US have suggested to their clients that it is better to avoid anything to do with the US. They often cite the potential estate tax for assets over $60,000. For. a well-balanced investment portfolio, this has been a big mistake over the past decade and will likely continue to be a future mistake. The US estate tax exposure is not difficult to work around and is not a valid justification for avoiding investments in US stock markets.
Be careful about advisors who may not understand cross-border issues. My colleagues and I continue to be amazed at the incorrect or incomplete advice being provided by individuals who are knowledgeable on some international issues. Over-confidence by a professional and blind faith in their knowledge can lead to disastrous consequences. Our advice to professionals is that it may be worth doing their own research or referring a client to another professional, or team of professionals, who are more specialized than they are.
Understand if an estate plan considers simultaneous deaths. Without proper estate planning, assets may not pass as intended. While it’s uncommon, deaths of a married couple around the same time should be considered, especially for a married couple where one or both are nonresident aliens and hold considerable US situs assets. Where US citizens may have unlimited marital deductions and $5.45 million exemption in 2016, if they pre-decease a non-citizen spouse, that “exemption” may drop down to $60,000 for those same US assets. Or, a couple may live in an area under a community property law with forced heirship rules and even though their will may state that a surviving spouse receives all of the assets, children, parents or others may be able to contest the will since they may be entitled to some of the estate. This situation may cause the marriage benefit in this part of the estate to disappear.
These are only a few of the common ways that estate planning can go wrong when people deal with cross-border issues involving US assets owned by non-citizens. The larger your potential estate, the more it may be worth having a professional or two review your situation. Make sure you and your advisor are not only competent but that there is a clear understanding of the inherent conflicts of interest in each advisor’s advice.
Every advisor has potential conflicts of interest: Attorneys and accountants may recommend structures that are unnecessarily complex, insurance agents may be selling the wrong type or too much insurance and financial advisors have an incentive to continue managing your assets. A team approach and a second opinion can often work best.
It’s essential to have an advisor who openly discloses conflicts of interest, presents alternatives in plain English and knows that they don’t know everything. Good planning often balances and anticipates many of the possible risks and outcomes. It would be a shame to unnecessarily pay large amounts of US estate tax when taking the time or spending the money for some clarity could have changed everything.