US Estate Tax Concerns for Non-US Persons Update
USTAXFS Tax Director, Patrick Hoza, provides the latest on US Estate Tax concerns for non-US persons.
The United States imposes its Estate Tax not only on its citizens and residents but also on non-residents that die owning US situs assets. So, what might be taxable? Non-resident aliens (NRAs) are taxed on certain categories of US situs assets. The following is a list of some of the most common types:
- US situs real property (Treasury Reg. 20.2104-1 (a)(2))
- Shares in US corporations (IRC 2106(a)). As an aside, shares in a foreign corporation, even if the corporation has substantial interests and real property in the US are not regarded as a US situs asset.
- Shares in a US registered investment fund (“RIC”) including mutual funds or, mutual funds organized in corporate form if incorporated in the US (to the extent that the mutual fund assets are US situs)
- Tangible personal property such as jewellery, cars, artworks, etc. (Treasury Regulation 20.2104-1 (a)(2))
- Interests in US partnerships, however, there are caveats and analysis may be required.
- Certain trusts owned by the deceased holding US situs assets.
- Bank accounts connected to a US trade or business. However, regular US bank accounts not connected to a US trade or business are not regarded as US situs assets for estate tax purposes.
- Cash in a deposit box located in the US (IRC 2104(c))
What exemptions are available?
Having established what assets are chargeable to US estate tax, an executor must then determine their value and examine whether a filing requirement is present.
The US allows an exemption from taxation of $60,000 for the estates of NRAs. The estates of residents of a country with an Estate Tax Treaty with the US may benefit from an increased exemption. Switzerland is an example of a country with an estate tax treaty with the US. This treaty allows for a portion of the gift and estate tax exemption that US citizens enjoy based on US situs assets over worldwide assets. For 2023, this exemption stands at $12,920,000. However, this amount is scheduled to decrease in 2026 if Congress doesn’t pass legislation to stop the sunsetting of this exemption amount. This could reset the exemption back to what it was in 2017, $5,000,000 (but to be indexed for inflation), which, while still a hefty amount, is considerably less than the current level and would bring more nonresident estates into the US non-resident estate tax trap.
An unlimited exemption is available for US situs assets transferred to a US citizen spouse. If the spouse is an NRA, a special vehicle known as a Qualified Domestic Trust could be established which would allow for a deferral of the estate tax due until the death of the surviving spouse or a capital payment is made from the trust.
Charitable exemptions are available only for US-registered charities and a limitation exists on the proportion of debts and administrative costs that can be applied to arrive at the net value of the estate.
What are the filing requirements?
Assuming the estate is subject to US taxation Form 706-NA is required to be filed within 9 months of the date of death. An extension effective for six months is available by filing Form 4768. Penalties and interest can be applied to late-filed returns absent reasonable cause.
In addition, there is the possibility of an extension for payment of estate tax owed. This is separate from the time to file extension and requires certain factors to be met. Otherwise, late payment penalties and interest will apply to the balance due.
What taxes are payable?
US estate tax is charged on the excess of the estate above allowable exemptions and deductions and is charged at graduated rates beginning at 18% for estates with a taxable value of between $1 and $10,000 rising to a maximum of 40% on estates with a taxable value of over $1million.
What credits/exemptions are available?
The US does not allow an NRA credit for the estate taxes paid in other countries. However, the decedent’s local jurisdiction may allow a credit for US Estate taxes paid under its local law or under an Estate Tax Treaty with the US.
What are the Executors’ concerns?
The executor, while generally not legally liable for paying an estate’s tax debt, could be liable for the penalties and interest if they fail to file or pay the taxes on time. The executor should always confirm that the estate can pay its entire tax liability before paying other creditors or transferring estate tax property to beneficiaries. An executor may be liable for the tax bill if their negligence in distributing assets caused the estate’s inability to pay its own tax bill.
What recourse does the IRS have?
If estate taxes are unpaid, the IRS can go after the assets that have been distributed to the beneficiaries. This is because the income tax liability attaches to the assets of the estate.
How do I obtain an estate tax closing letter and what is it?
A closing letter is sometimes required by banks or brokerage accounts prior to funds being distributed. The letter is produced by the IRS and confirms that the necessary filings for the estate have been done and accepted and any tax due paid.
The process for obtaining a closing letter has changed. In the past, you could request the letter when filing form 706NA. However, due to changes, the IRS requires a request to be made via the Pay.gov website. As well, one should only apply for the letter 9 months after filing the 706NA form. There is a $67 fee required.
Are there planning opportunities available to mitigate estate taxes?
The value offered by US equity and real estate markets in the wake of the 2008 crash in asset prices tempted many NRAs to increase their exposure to the US. Planning opportunities involving the formation of non-US corporations or the use of trusts to hold US situs assets might help mitigate or avoid exposure to US estate taxes. Specific plans depend on the particular circumstances of each individual and we encourage you to contact US Tax & Financial Services to discuss your case.
Are there penalties to be worried about?
The short answer is, yes! There are late filing and late payment penalties that can apply. That being said, the IRS does understand that this is an area of law that most foreign executors are not aware of. There is a process to request an abatement of some or all of the penalties via what is called a Reasonable-cause determination. This is generally filed after receiving notice of penalties from the IRS.
If you have any questions regarding your tax planning, don’t hesitate to contact us.