Cross-Border Estate Planning for International Families
As the global economy expands, so does the need for proper international estate planning. Estate planning can be a relatively complex process in any situation, but the process becomes even more complex when it involves a non-U.S. citizen and multiple jurisdictions. The next section is an introduction to some basic international estate planning issues for green card holders and other foreign nationals living in the United States.
Who is subject to U.S. Estate Tax?
U.S. citizens, domiciles, and U.S. situs assets are subject to U.S. estate tax. Being subject to the estate tax as a U.S. citizen is easy to determine but understanding when a non-U.S. citizen is considered domiciled is much harder. Under IRS rules, a foreign national is a U.S. domicile if he or she is present in the US with the intention of making the United States his or her home and with no present intention of ever leaving.
For example, an executive moving to the United States on a short-term assignment (several years) would generally not be domiciled in the United States. The expectation is that the executive would return home after completion of the assignment. If, however, the executive extends the term of U.S. residency or acquires a green card, the factors would probably swing in favor of the executive attaining U.S. domicile. There are no set rules for determining domicile, but obtaining a green card is a very objective fact that points towards domicile. Courts will review immigration status and many other subjective factors when deciding such cases.
Many families find themselves in mixed nationality marriages. When two U.S. citizens are married, the surviving spouse can inherit any amount of money free from immediate federal estate taxes. This is not true for a non-U.S. citizen married to a U.S citizen. Any assets passed to a non-U.S. citizen spouse (even if they are a resident alien and hold a green card), are subject to federal estate taxation over the allowable exemption ($11.58m in 2020). A trust structure, commonly referred to as a QDOT (Qualified Domestic Trust), may alleviate some of these adverse effects which is discussed later in this article.
Exempt assets from U.S. federal estate tax for an estate of a non-U.S. decedent is limited to $60,000. Any amount over $60,000 is fully subject to estate tax. The U.S. has a number of estate, gift, and inheritance tax treaties in effect with other countries. In certain instances, the exemption amount may be increased by an applicable estate tax treaty provision. Estate and gift tax treaties may also alter other rules related to the taxation of the transfer of assets.
Creating U.S. Estate Planning Documents – Wills and Living Trust
As the U.S. estate tax exemption limits are currently quite high, most individuals do not need to focus on planning strategies to avoid estate tax. Estate and probate planning will likely focus on efficiently passing assets to the correct beneficiaries. Effective estate planning will often center on a will, trust, medical directives, and power of attorney documents specific to the state of residency.
An attorney licensed in the state of residence will be able to prepare these documents. In the United States, a will is used to direct how assets will transfers at death. Unlike many other jurisdictions, individuals may freely direct assets to pass to anyone (no forced heirship). A will is also vitally important for individuals with children as guardianships may be set up if both parents pass. In addition to a will, most attorneys will also prepare other legal documents such as medical directives and financial power of attorneys.
A living trust (revocable trust) is another common U.S. estate planning tool. A living trust is legal arrangement through which assets are placed into a trust for benefit during an individual’s lifetime and then transferred to designated beneficiaries at death. For U.S. income tax purposes, the trust is an alter-ego of the grantor. The main benefits of a living trust arrangement are to provide privacy on the disposition of assets on death and avoid/minimize probate costs. When using a will, an estate will go through probate, the court proceedings through which assets are distributed according to a decedent’s wishes by the executor.
A living trust, on the other hand, does not go through probate, which often means a faster (and private) distribution of assets to heirs and continued management of assets post death. Foreign nationals may use a living trust to arrange their affairs while living in the United States. However, caution is warranted when leaving the United States with a living trust arrangement as a new country of residence may not recognize this legal agreement and possibly impose punitive taxes on the trust. See note on international estate planning and the difficulties of moving a trust across borders.
Mixed Nationality Marriage: Using a Qualified Domestic Trust (QDOT)
A couple where both spouses are U.S. citizens have a combined estate exemption of $23.16m (2020). In addition, U.S. citizen spouses may also utilize the unlimited marital deduction to transfer wealth estate & gift free between each other. Families whose wealth is under the lifetime exemption limits often do not need extensive U.S. estate tax planning.
However, in a marriage where one spouse is not a U.S. citizen (not merely a U.S. permanent resident/domiciliary), there is no unlimited marital deduction. The U.S. spouse only has their lifetime exemption of $11.58m (2020). Assets above this amount, even if passed to the non-U.S. spouse, are subject to U.S. estate & gift tax.
U.S. citizens married to a green card holders and non-U.S. citizens often utilize a planning technique called a qualified domestic trust (QDOT). QDOTs were more common when the U.S. estate tax exemption limits were lower. Today, QDOTs are still an important planning tool for a U.S. citizen spouse with wealth approaching the $11.58m lifetime allowance. Estate planning attorneys may also liberally incorporate these into estate plans in case estate tax exemption limits change in the future.
A QDOT is a special kind of trust that allows non-U.S. citizens who survive a deceased U.S. spouse to take the marital deduction, even if the surviving spouse is not a U.S. citizen. A QDOT may be elected after death by the executor of an estate to preserve these tax benefits. After assets are placed in a QDOT, the surviving non-U.S. spouse receives income from the trust but does not own trust assets. Trust distributions of income to the non-U.S. citizen surviving spouse are exempt from the estate tax.
It is important to keep in mind that a QDOT only defers estate taxation; U.S. estate taxes will still be due at the surviving spouse’s death. To avoid this, a non-U.S. spouse may acquire U.S. citizenship. This is strategy is only possible if either the surviving spouse was a U.S. resident at decedent’s death, or no taxable distributions were made from the QDOT prior to the surviving spouse becoming a citizen.
A QDOT may not always be the best solution for a mixed-nationality couple. If non-U.S. citizen spouse lives or intends to live in a jurisdiction that does not recognize or punitively taxes trusts, a QDOT may be counterproductive. An alternative strategy may be purchasing life insurance within an irrevocable life insurance trust that can provide for the estate tax upon the death of the U.S. citizen spouse.
Receiving Foreign Gifts or Inheritances from Abroad
The United States will not tax a foreign inheritance received by a U.S. citizen or resident. However, a U.S. citizen or resident who receives a gift or inheritance from a nonresident alien, foreign trust or estate over $100,000 must report the receipt on a timely filed Form 3520. Failure to file risks a penalty of up to 25% of the value of the gift or inheritance. Beyond the reporting the actual foreign inheritance, foreign property or investments may be subject other U.S. tax reporting.