Inheritance tax in the USA: not just for US citizens

Editor: Kevin Anderson, CPA, J.D.

US taxation system

The U.S. tax system is based on a citizenship model rather than a residence model, so its impact is potentially worldwide. Residence and domicile are irrelevant for US citizens, who are liable for worldwide income tax, worldwide gift tax and worldwide inheritance tax.

How do non-U.S. citizens become subject to U.S. inheritance tax on all or part of their U.S. inheritance? The application of U.S. inheritance tax laws to non-U.S. citizens depends on residence, location of assets, and application of the treaty.

Place of residence matters

A non-U.S. citizen residing in the United States (U.S. domiciliary) has the same lifetime tax exemption amount as a U.S. citizen and is also subject to inheritance tax on worldwide inheritances.

How is residency determined for a non-U.S. citizen? A person establishes residence in a particular place by living there, even if only for a short period of time, without a definite intention to leave it in the future. Residence without the requisite intent to remain permanently will not be sufficient to establish residence, and an intent to change residence will not result in such a change unless accompanied by an actual move.

Establishing residence requires both actual presence in a particular place and intent to make that place one's home. Intent may be established by the presence of many factors, including, but not limited to, the following:

• Location and duration of current residence
• Location of health care services, civic organizations, and places of employment
• Driver's licenses, voter registration and vehicle registration
• Place of work
• Permanent residence or visa
• Statements of Intent
• Bank accounts
• Reasons for changing residence and renting or owning a home

No single factor is decisive on its own, but obtaining a green card (residency) usually leads to the conclusion that a non-citizen is residing in the United States.

The location of the assets also matters.

If it is established that a non-U.S. citizen does not reside in the United States, the analysis shifts to the location of the assets. Non-U.S. citizens who do not reside in the United States are generally subject to estate tax only on their assets located "within the United States."

A non-U.S. citizen who does not reside in the United States (a non-citizen domiciliary) has an exemption amount limited to $60,000, which converts into a credit of $13,000 against U.S. estate tax.

Any asset located within the territory of the United States is considered an asset situated in the U.S.

Movable property located in the territory of the United States also has a presence in the territory of the United States.

Personal belongings and items of a non-U.S. citizen who is not residing in the United States and dies while traveling in the United States are not subject to U.S. estate tax laws.

Additionally, works of art owned by a non-U.S. citizen who does not reside in the United States are not considered property located in the United States, provided that the art was (1) imported into the United States solely for exhibition purposes; (2) issued to a public gallery or museum; and (3) was on display or in transit to or from the exhibition at the time of death.

Company stocks are considered to be in the territory of the United States if they are issued within the country.

Ordinary debt obligations owned by and held by non-U.S. citizens who do not reside in the United States are considered property located in the United States if the primary debtor is a "person of the United States or the United States, a state, or any political subdivision of the United States or the District of Columbia."

Life insurance policies for non-U.S. citizens who do not reside in the United States are not considered to be located within the territory of the United States, thus avoiding U.S. estate tax.

Bank deposits have no place in the territory of the United States unless they are related to trade or business activities in the United States.

The location of a partnership interest is uncertain; however, the IRS's position is that partnership interests are generally located where the partnership's main activities are conducted.

The significance of tax treaties

If an inheritance from a non-resident domicile is subject to U.S. estate tax, a tax treaty, if available, may mitigate its impact. Tax treaties are particularly important for non-resident domiciliaries with connections to the United States and another country, as they may be subject to more than one estate tax. They can take advantage of tax treaties that may alleviate or eliminate the obligation to pay estate tax in two or more countries.

Tax treaties on inheritance are usually categorized based on location or residence. Location treaties typically grant the right to levy inheritance tax in the country where the assets are located, overriding the domestic tax rules of other countries involved in the treaty.

Agreements on residence designate a single fiscal residence for a person who claims residence in multiple countries. The country that the agreement designates as the fiscal residence typically has the primary right to levy inheritance tax. Residence agreements may provide exceptions, thereby leaving the right to tax certain assets located in the territory of a non-tax country.

The USA is a party to location agreements with Australia, Finland, Greece, Ireland, Italy, Japan, Norway, South Africa, and Switzerland. The USA and Canada also have a protocol amending the US-Canada Income Tax Treaty and other matters related to US estate tax and Canadian capital gains tax at death.

The USA is a party to residence agreements with Austria, Denmark, France, Germany, the Netherlands, and the United Kingdom.

Planning before acquiring assets

Planning before acquiring assets in the United States can potentially reduce the uncertainty associated with the status of the estate of non-resident domiciliaries.

Here are several planning options regarding real estate acquisition in the USA (USRP):

• A non-U.S. citizen who does not intend to hold the USRP for a long time can fully own it and manage the risk of U.S. estate tax by purchasing sufficient life insurance - which is not considered to be located in the U.S. - on their life to cover potential future U.S. estate tax liabilities that may arise.
• He can also take non-revocable loans on USRP, which will reduce his cost dollar for dollar as part of the estate of a non-civil domicile.
• If the USRP is not connected to heirs from the United States, it can be owned by a foreign company. There will be no U.S. estate tax since the shares of a foreign company are not considered to be located within the territory of the United States.