While the United States enters into general income tax treaties with different countries involving various types of income (earned income, dividends, capital gains, royalties, interest income, etc.) the United States also enters into estate tax agreements with a limited number of countries for Non-Residents who have U.S. Situs as part of their estate.Golding & Golding – International Business Tax Lawyers
There are nearly 60 countries that the United States has entered into income tax treaties with, but there are less than 20 countries in which the United States has entered into estate tax treaties with.
Estate tax treaties are very important. Why? Because while a US resident or US citizen is generally entitled to utilize the gift and estate tax exemption, which is now at $5.43 million, the same rules do not apply for nonresidents who own US property. Rather, the estate tax exemption for nonresidents is a mere $60,000.
In other words, while a US resident (noncitizen) can own $2 million of the property and be subject to zero estate tax (presuming they did not use up all of their gift tax while they were alive), the same person who owns $2 million and is a nonresident would be subject to nearly $800,000 in estate tax. That is because the estate tax rate is $345,800 on the first $1M and 40% for every dollar on the remainder – and therefore the difference between being a resident and non-resident of the United States for Gift and Estate Tax can be a very costly endeavor.
The United States understands that this result can be very unfair, especially when dealing with countries in which the United States has a good relationship with and with which several foreigners have resided to the United States from (such as Canada).
As result, United States has entered into estate tax treaties with these countries in order to ease the unfairness in gift and estate tax for non-residents.
General Estate Planning – U.S. Residents
When it comes to estate planning in the United States there is a unified credit between gift tax and estate tax. In other words, a person has one “bucket” in which they can place their gift and estate tax exemption, which in 2015 is $5.43 million.
Therefore, excluding clawbacks and prior gifts generally a person can either give away $5.43 million while they are alive (with a $14,000 annual gift exclusion – which is modified with inflation or COLA) or if they do not give away any gifts while they are alive beyond the annual gift exclusion and they can die with $5.43 million and not have the pay a single dime estate tax. (If they were married to a US citizen, they can transfer all of their wealth to the US citizen spouse and none of it will be taxed; that is the “unlimited marital deduction” as well as application of “Portability” for a surviving spouse).
Thus, it pays to be either a US citizen or US resident when it comes to death and estate taxes. The same rules do not apply to nonresidents. Rather, nonresidents only have $60,000 worth of estate tax when they pass. (Generally, nonresidents also qualify for a $14,000 annual gift exclusion, as well as around $145,000 per year of gift tax exemption when the gift is being made to a spouse who is either a nonresident or resident Alien (there is an unlimited marital deduction when the non-US citizen leaves wealth to the US citizen only– but does not apply when the wealth is being left to a US resident)
As a result, if a nonresident has property in the United States that they would like to leave to a relative or other beneficiary (non-spouse), they will only have a $60,000 exemption which could result in very significant estate tax liability for the foreign nonresident.
**Not a great result for the non-resident
Estate Tax Treaties
The United States understands that this result can be very unfair – especially for nonresidents in countries maintain significant assets and investments within the United States. As result, these countries have estate tax included within their US tax treaty in order to try reduce tax liability on the death of a nonresident when it involves U.S. Property “Situs”
U.S. and Canada Estate Tax Treaty
One country in which the United States has estate tax treaty benefits with is Canada. If a Canadian resident who owned US property dies, they are generally entitled to similar estate tax benefits as a US resident (for their U.S. Situs Property). In other words, there will be entitled to take the entire unified credit of $5.43 million before any US Situs is subject to estate tax.
There are a few requirements, with the most important one being that the executor of the will or trust file a 706 “Estate Tax Return” form in the United States. It is very important that this form is filed in order to trigger the benefits – even if the estate is not required to file an estate tax form 760 it must do so to obtain the benefits – otherwise, the estate could be subject to estate tax.
How the Tax Treaty Works
It is important to note that the gift and estate tax exemption is only for US situs property. As a result, it is not as if the US and Canada tax treaty will provide the Canadian resident with the same unified tax credit that a person in the United States would have insofar as a person in the United States gets the $5.43 million credit on all assets worldwide. In other words, a US resident may have property in many different countries, but the United States was still provide that resident with the $5.43 gift and estate tax exemption (although there may be estate tax issues in a particular foreign countries in which the person owns property).
For a nonresident Canadian, that unified credit only extends the property within the United States. For example, if a Canadian resident has $10 million worth of assets with $2 million of his assets being located in the United States, then an equation is completed to determine the estate tax exemption.
The basic analysis is as follows:
- The first million dollars is subject to tax at $345,800
- The remainder of the state is subject to tax of 40%.
- This will provide the total estate tax that would be due
- Thereafter, the credit will be prorated in accordance with U.S. Assets vs. Overall Estate Values, which will result in a significantly reduced tax amount as opposed to the tax credit that would be consumed by the nonresident which is limited to $60,000.
Estate Tax Treaties – DOMICILE
When it comes to estate tax, domicile is very important and usually the key factor in determining the application of Estate Tax laws. That is because several of the benefits or lack thereof which come from the state tax treaties are based in the concept of domicile – which is different than the concept under income tax rules. Each estate tax treaty is different, and just because a person would qualify for treaty benefits under one treaty does not mean that the person would qualify for benefits under a different countries treaty.
Thus, when it comes to estate tax it is very important to read and understand the technicalities of each particular tax treaty for the country in which your client is a resident. The reason why domicile is so important,is because it will severely impact your ability to leave your estate to U.S. Residents tax free or make it subject to a 40% tax rate.
Example: David is a foreign national who resides overseas. He has a very valuable estate worth over $15 million. David also has several beneficiaries who reside within the United States and to whom he would like to leave significant assets. If David is not considered domiciled in the United States, then absent estate treaty protection (noting that there are a very limited number of estate tax treaties), David’s US Situs will be subject to a significant estate tax for any amount over $60,000.
Domicile – Positive and Negatives
On the other hand, if David only has avery limited number of US assets, but ends up being held to be domiciled in the United States, then his entire state would be subject to estate tax for any amount over $5.43 million. This would be a very bad result, when David has limited assets in the U.S. but still subject to U.S. Estate Tax on his worldwide estate.
Conversely, if David does have significant US assets, but they are close to (yet under) $5.43 million then he may consider trying to obtain some form of US residency (if planned properly) if his goal is to leave the wealth to the US residents while still being ever took came the higher of the two credits ($60,000 vs. $5.43M).
This is why planning is so important. Let’s say David has a significant amount of US assets but absolutely no intent of becoming a resident of the United States – and therefore will never qualify for the $5.43 dollar exemption. As a result, David should work with an experienced international estate planning lawyer to develop a strategy the possibly begin transferring assets to the beneficiaries while he’s still alive in various different types of trusts and investment strategies that the may still exert some control over the assets while avoiding significant estate tax in the future.
Countries with Estate Tax Treaties
The following countries currently have estate tax agreements/treaties with the United States:
- South Africa
Estate tax and be very complicated, especially with international tax issues are involved. If you have further questions, please feel free to contact our international tax law attorneys for further assistance.