Private Client Services Update – Estate Planning Considerations for Non-Citizens
New immigration legislation is on the near horizon, or at least it is the subject of active debate in Congress. The result of new legislation may be a welcome clarification of status for families of non-citizens residing in the U.S., and an influx of new immigrants with special skills and ability to generate wealth. Non-citizens who reside in the U.S. have some, but not all, of the gift, estate and generation-skipping transfer (GST) tax exemptions available to U.S. citizens; however, just like U.S. citizens, all of their property, whether located in the U.S. or elsewhere, is potentially subject to U.S. estate and GST tax. Non-citizens and their families need to carefully consider the special rules applicable to transfers of property by and to non-citizens.
Non-citizens are either U.S. residents or non-U.S. residents. An individual is a U.S. resident for transfer tax purposes if he or she is “domiciled” in the U.S. For federal estate tax purposes, domicile is determined by establishing a physical presence in a place without the present intention of moving from that place. Domicile is an important but elusive concept, one which has not been consistently defined by case law. Moreover, although an individual can have only one domicile for transfer tax purposes, different definitions of domicile in other countries make it theoretically possible for a U.S. resident to be domiciled in both the U.S. and in the resident’s country of citizenship. Under U.S. court decisions, intention is more important than physical presence. While green card holders are typically considered U.S. residents, the determination of residency for income tax purposes is different from the determination of domicile for transfer tax purposes. Domicile for U.S. transfer tax purposes is based on an examination of all the relevant circumstances.
A U.S. resident’s worldwide assets are subject to U.S. estate tax at the same rates that apply to U.S. citizens, and U.S. residents have the same exemptions as U.S. citizens: $5,250,000 this year for federal estate, gift and GST tax purposes. In calculating the federal estate tax on a decedent’s estate, the value of a decedent’s gross estate is reduced by the value of all property passing to the decedent’s surviving spouse (the “marital deduction”). If the decedent’s surviving spouse is not a U.S. citizen on the date of the decedent’s death, the decedent’s estate will not be entitled to the marital deduction, unless the property passes to the surviving spouse in a qualified domestic trust (QDOT). This is true whether the property consists of retirement account assets, life insurance proceeds, probate property, the marital home, or any other asset.
A QDOT must have at least one U.S. trustee and must satisfy the general marital deduction requirements under U.S. estate tax law. If the fair market value of the assets passing to the QDOT exceed $2 million, either: (A) at least one trustee must be a United States bank or a U.S. branch of a foreign bank; (B) the trustee must furnish a bond in favor of the Internal Revenue Service in an amount equal to 65 percent of the fair market value of the trust principal; or (C) the trustee must furnish an irrevocable letter of credit in an amount equal to 65 percent of the fair market value of the trust principal. Finally, the assets of the QDOT must be included in the surviving spouse’s taxable estate upon his or her death. The surviving spouse receives the income from the assets of a QDOT, free of estate tax. Principal distributions from the trust are, however, subject to estate tax. This is a significant difference from a marital trust for a U.S. citizen.
U.S. residents can make $14,000 annual exclusion gifts, can elect to use portability, and can split gifts. Gifts from a citizen or non-citizens spouse to a non-citizens spouse are not entitled to the unlimited marital deduction; only $143,000 (indexed for inflation) of assets can be transferred annually free of gift tax to a spouse who is not a U.S. citizen. The spousal transfer may be in any form, outright or in trust, that qualifies for the marital deduction but for the disallowance of the unlimited marital deduction to a non-citizens spouse.
Balancing assets between spouses for transfer tax purposes must be carefully considered against the back-drop of non-tax considerations, such as creditor issues, the possibility of divorce, and corporate governance issues in the case of closely-held businesses, as more assets held by the non-citizens spouse in his or her name mean fewer assets to be placed in the QDOT at the death of the citizen spouse. If generation-skipping transfers are contemplated in the context of a large estate, spouses also should have sufficient assets in their sole names before the first spouse dies to use the GST tax exemption, currently at $5,250,000, to maximize multi-generational transfers of property and to minimize the uncertainty created by QDOT provisions regarding the identity of the transferor for purposes of allocating the GST exemption.
Non-U.S. Residents (Non-Resident Aliens)
An individual who is not a U.S. citizen or resident (domiciliary) is a non-U.S. resident. Non-U.S. residents are subject to U.S. estate and gift taxation only on transfers during life or at death of assets located in the United States. Intangibles, such as stock in a U.S. or foreign corporation, generally are not U.S. situs property for gift tax purposes, but they are for estate tax purposes. Real property and tangible personal property that are physically located in the United States have a U.S. situs for gift tax purposes. Non-U.S. residents have only a $60,000 exemption from Federal estate tax, unless a treaty provides a greater exemption. Non-citizens who have significant U.S. situs property, and who do not have significant non-U.S. situs property, should consider taking steps to establish U.S. domicile; although they will subject their worldwide estate to U.S. estate tax, they will be entitled to a full unified credit, rather than the $13,000 credit—equivalent to the $60,000 exemption—available to non-U.S. residents. While non-U.S. residents can make annual exclusion gifts, if they are married to a non-U.S. resident, they cannot split gifts, and as noted above, tax-free gifts to non-citizens spouses are limited to $143,000. Transfers by non-U.S. residents to skip persons are subject to GST tax only if the transfers are subject to gift or estate tax. Non-U.S. residents have a GST exemption of $1 million.
Effect of Treaties
U.S. residents who own property in another country and non-U.S. residents who own property in the U.S. should also consider whether a treaty may apply to a transfer of property. Bilateral estate and gift tax treaties generally avoid double taxation of transfers by permitting each country to tax property located within its borders; they may also provide an increased credit or exemption amount to a non-U.S. resident.
Estate planning for non-citizens is complex. The lawyers at Kaufman & Canoles can help you understand the laws and prepare a plan that minimizes the tax burden on your family.
Alison Lennarz is of counsel at Kaufman & Canoles in the firm’s Williamsburg office. Her practice includes estate planning and administration, tax planning, tax compliance and tax controversy. Her clients include U.S. citizens with property outside the United States, U.S. residents and non-citizens. She studied law in both France and the United States, and she is fluent in French.
The contents of this publication are intended for general information only and should not be construed as legal advice or a legal opinion on specific facts and circumstances. Copyright 2021.