What is U.S. Situs for Estate Tax (How Treaties Can Help)

What is U.S. Situs for Estate Tax (How Treaties Can Help)

What is U.S. Situs for Estate Tax  

When it comes to assessing whether a Non-Resident, Non-Citizen’s (NRNC) assets may become subject to U.S. Estate Tax, it is important to determine whether the asset is considered a U.S. asset or foreign asset. That is because NRNCs are typically only subject to U.S. estate tax on their U.S. situs assets. In other words, an NRNC is not subject to estate taxes by the United States Government unless the asset is considered a U.S. asset. Let’s review what U.S. situs is and how a treaty may help reduce or minimize the estate tax implications by reviewing Chapter 4 of the Internal Revenue Manual.

U.S. Situs Definition

Let’s break down the definition and application of the concept of ‘U.S. situs’ by working through the IRS materials on situs.

First, what is situs in general?

• • • “The place to which, for purposes of legal jurisdiction or taxation, a property belongs.”

Estate Tax Return Filing Requirements for Estates with International Issues

From a baseline perspective, it is first important to determine whether or not the taxpayer is considered a U.S. person or not for estate tax purposes (which is different than being a U.S. Person for Income Tax Purposes. This will impact which assets will become subject to estate tax purposes in the United States for which exemption the taxpayer’s estate will qualify for.

As provided by the IRS:

• • • The U.S. estate tax filing requirements of a decedent’s estate are determined by whether, at death, the decedent was a U.S. citizen; whether, at death, the decedent was a U.S. resident for estate tax purposes; and if the decedent was not a U.S. citizen nor a U.S. resident, at death, whether the decedent had U.S. situs property. For estate tax purposes, residence of a decedent is determined based on domicile; it is not the same definition of residence that applies for income tax purposes under IRC 7701(b).

    • The world-wide estate of a U.S. citizen or a U.S. resident is subject to U.S. estate tax and the executor of such an estate is required to file a U.S. estate tax return. A noncitizen nonresident decedent will be subject to U.S. estate tax on U.S. situs assets. If the value of the gross estate plus the decedent’s lifetime gifts, subject to certain adjustments, exceeds the filing threshold the executor of an estate of a U.S. citizen or U.S. resident decedent is required to file a Form 706, and report the fair market value of all of the decedent’s world-wide ownership interests.

    •  In contrast, the executor of an estate of a noncitizen, nonresident decedent is required to file a Form 706-NA to report property located within the United States worth more than $60,000. Note that certain bank deposits and debt obligations are not considered property located within the United States. See IRC 2105(b). The filing requirements are the same for estates of U.S. citizens (regardless of whether they die abroad) and non-United States citizens resident in the United States for estate tax purposes (domiciled in the United States). There are special rules that apply to certain expatriates and residents of United States possessions.

What is Form 706-NA?

Form 706 NA is the non-resident, non-citizen version of Form 706 (Form 706 is used for US persons with estate tax filing requirements).

As provided by the IRS

• • • “Form 706-NA , United States Estate (and Generation-Skipping Transfer) Tax Return, Estate of nonresident not a citizen of the United States, is filed by estates of decedents who were (i) nonresidents, noncitizens of the United States, or (ii) residents of U.S. possessions whose U.S. gross estate (made up of U.S. situs property) value exceeded the filing requirement of $60,000 at the time of death.”

How to Determine U.S. Resident/Citizen or Not

This portion of the Internal Revenue manual makes it clear that IRS examiners are required to do a deeper dive to determine whether or not the taxpayer is considered and now domicile non-U.S. citizen or resident of the United States or not. It explains what general actions the agent should take.

As provided by the IRS:

Non-Domiciled, Non-United States Citizens and Residents of United States Possessions:

• • • The examiner should conduct a complete factual and legal analysis of each case where the decedent and/or donor are identified as a non-domiciled, non-United States citizen. Verifying the domicile of the decedent and/or donor is critical since all foreign situs property owned by a nonresident, noncitizen is not subject to U.S. gift or estate tax.

    • The examiner should also verify when a decedent and/or donor is identified as a resident of a possession of the United States. A decedent who was a U.S. citizen and a resident of a U.S. possession at the time of death will be treated as a U.S. citizen for estate tax purposes unless such individual acquired U.S. citizenship solely by being a citizen of the possession or by birth or residence within such possession. See IRC 2209.

Determining Whether Property is Located in the United States

Whether or not certain types of assets are considered to be U.S. citizens or not will impact whether they are subject to estate tax, especially in situations in which it is an NRNC. Let’s look at the basics of the sourcing rules for U.S. situs.

As provided by the IRS:

Real estate and tangible personal property

Real estate and tangible personal property are located in the United States if they are physically located there. Note. An exception is made for works of art that are owned by an NRNC decedent and are located within the United States if, on the date of death, the works of art are:

• • • Imported solely for public exhibition,

    • On loan to a nonprofit public gallery or museum, and

    • On exhibition or en route to or from exhibition.

Stock

• • • Generally, no matter where stock certificates are physically located, stock of corporations organized in or under U.S. law is property located in the United States, and all other corporate stock is property located outside the United States.

Insurance proceeds.

• • •  Proceeds of insurance policies on the decedent’s life are property located outside the United States.

Debt obligations within United States.

• • • Debt obligations are generally property located in the United States if they are debts of a U.S. citizen or resident, a domestic partnership or corporation, a domestic estate or trust, the United States, a state or state’s political subdivision, or the District of Columbia.

Debt obligations outside United States.

• • • The following debt obligations are generally treated as located outside the United States.

    • Debt obligations (whether registered or unregistered) issued after July 18, 1984, if the interest on them would be eligible for tax exemption under section 871(h)(1) had such interest been received by the decedent at the time of the decedent’s death. However, if the debt earns contingent interest, some or all of it may be considered property in the United States (section 2105(b)(3)).

    • Certain short-term original issue discount debt obligations.

    • See section 2105(b)(4) for details.

Deposits

• • • The following deposits are treated as located outside the United States if they are not effectively connected with conducting a trade or business within the United States.

    • A deposit with a U.S. bank or a U.S. banking branch of a foreign corporation.

    • A deposit or withdrawable account with a savings and loan association chartered and supervised under federal or state law.

    • An amount held by a U.S. insurance company under an agreement to pay interest.

    • A deposit in a foreign branch of a U.S. bank.

    • If an asset is included in the total gross estate because  the decedent owned it at the time of death, apply the above location rules as of the date of the decedent’s death. However, if an asset is included in the decedent’s total gross estate under one of the transfer provisions (sections 2035, 2036, 2037, and 2038), it is treated as located in the United States if it fulfills these rules either at the time of the transfer or at the time of death.

    • For example, if an item of tangible personal property was physically located in the United States on the date of a section 2038 transfer but had been moved outside the United States at the time of the decedent’s death, the item would be considered still located in the United States and should be listed on Schedule A.

    • If the decedent was a U.S. expatriate subject to 877(b) at the time of death, the decedent is treated as owning a prorated share of the U.S. property held by a foreign corporation in which the decedent directly or indirectly owned at least 10% of the voting stock and, directly, indirectly, or constructively, owned more than 50% of the stock by vote or value (section 2107(b)).

The Impact of Tax Treaties on U.S. Estate Tax

Just as the United States has entered into several bilateral income tax treaties and FATCA Agreements, they have also entered into several estate tax and gift treaties. These types of estate and gift tax treaties can impact whether or not certain assets are subject to a state tax and if they may become exempt based on the treaty language:

As provided by the IRS:

1. 1. • Estate and gift tax treaties provide rules to minimize and avoid double taxation that can arise when two countries both have the right to tax the decedent under their domestic laws. Treaties do so by providing primary and secondary taxing rights, situs rules, and special rules dealing with credits, deductions and exemptions.

      • Each United States estate tax treaty is unique and must be consulted if applicable. Estate tax treaties vary; some provide a list of rules whereby the two countries party to the treaty agree as to the situs of certain property and thus the primary taxing right with respect to that property. Other estate tax treaties generally provide that unless property is expressly addressed in the treaty, the state of residence has the primary right to tax. In these residence-type treaties, the nonresidence country can usually exercise taxing rights over real property and business property located in such country. The United States generally retains the right to tax its U.S. citizens and residents under the treaty.

      • Liability for estate or gift tax for a nonresident, noncitizen may vary based on the governing treaty. A list of current treaty agreements may be found at: Estate and Gift Treaties.

      • If an estate claims treaty benefits that change the tax treatment that property would normally be subject to under the Code, a notice invoking those treaty rights must be filed with the return. The notice is provided by attaching a statement or Form 8833, Treaty-Based Return Position Disclosure, under Section 6114 or 7701(b) .

      • Some treaties increase the unified credit allowed to nonresident noncitizens by the Code and allow a prorated unified credit based on the ratio of property in the U.S. over the gross estate, wherever situated. Examiners must consult the applicable treaty for specific provisions, as each treaty has unique terms and provisions.

      • Some of the most common estate tax treaty issues arise from the United States’ treaties with Canada and the United Kingdom. IRM 4.25.4.3.1 and IRM 4.25.4.3.2 highlight some, but not all, of the rules from those treaties.

What is the Unified Credit?

The idea behind the unified credit is that taxpayers can avoid having to pay U.S. estate tax on relatively smaller states. For example, a $13,000 estate tax credit or centrally exempt $60,000 worth of US assets for NRNC:

As provided by the IRS:

• • • In general, a unified credit against estate tax of $13,000 is available to estates filing Form 706-NA.

    • If the decedent was a resident of a United States possession, the unified credit is the greater of $13,000 or $46,800 multiplied by the ratio of U.S. situs property to the gross world-wide estate.

    • Treaty provisions and any unified credit previously allowed against gift tax can change the amount of available unified credit.

    • The Canadian Marital Credit (IRM 4.25.4.6.3) may be allowed in addition to the unified credit.

Tax Treaty May Provide More Favorable Terms

As mentioned earlier, come in the United States has entered into about 15 different estate tax treaties which may serve to reduce any estate tax by providing foreign death tax credits between the treaty countries.

As provided by the IRS:

1. 1. 1. 1. If an estate tax treaty provides more favorable terms than the statute to the estate of a U.S. citizen or resident decedent and the executor of such estate elects to claim the benefits of the applicable treaty, the treaty provisions apply (rather than the IRC statute). The Form 706 should indicate the treaty provision being invoked.

         2. For a list of countries with current estate and gift tax treaties, see the instructions for Form 706 or Estate and Gift Tax Treaties.

A credit claimed under a treaty is also figured on Schedule P (similar to statutory credits) with the following exceptions:

• • • • The situs rules of the treaty determine whether the property is located in one or the other treaty country.

      • Credit is only allowed for taxes specified in the treaty. Local taxes may not be eligible for the credit unless specifically stated in the treaty.

      • If allowed under the treaty, credit may be apportioned among properties deemed situated outside or within both countries.

      • The amount entered on line 4, Schedule P is the amount from Part 2, line 12 on page 1 of Form 706, less any amounts claimed as credit for pre-1977 gifts or credit for tax on prior transfers.

If the credit is authorized by treaty, it is equal to the most beneficial of:

• • • • The credit figured under the treaty provisions, or

      • The credit figured under the statute, or

      • A combination of the credit figured under the treaty plus the credit figured under the statute in the case of death taxes paid to a political subdivision or possession not covered by the treaty.

Decedent Foreign Asset Reporting or U.S. Tax Non-Compliance

Sometimes, it is not until after someone has passed away that the estate learns that the taxpayer may have had some foreign account reporting requirements that were missed — which could result in fines and penalties for the decedent and/or the estate. This could be because the taxpayer was previously a U.S. person for income tax purposes and/or may have been an NRNC but had certain US assets that qualified as a US person that owned foreign accounts, assets, or investments, that would have required reporting to the U.S. government on forms such as the FBAR and FATCA Form 8938.

Late Filing Penalties May be Reduced or Avoided

For Taxpayers who did not timely file their FBAR and other international information-related reporting forms, the IRS has developed many different offshore amnesty programs to assist taxpayers with safely getting into compliance. These programs may reduce or even eliminate international reporting penalties.

Current Year vs Prior Year Non-Compliance

Once a taxpayer missed the tax and reporting (such as FBAR and FATCA) requirements for prior years, they will want to be careful before submitting their information to the IRS in the current year. That is because they may risk making a quiet disclosure if they just begin filing forward in the current year and/or mass filing previous year forms without doing so under one of the approved IRS offshore submission procedures. Before filing prior untimely foreign reporting forms, taxpayers should consider speaking with a Board-Certified Tax Law Specialist who specializes exclusively in these types of offshore disclosure matters.

Avoid False Offshore Disclosure Submissions (Willful vs Non-Willful)

In recent years, the IRS has increased the level of scrutiny for certain streamlined procedure submissions. When a person is non-willful, they have an excellent chance of making a successful submission to Streamlined Procedures. If they are willful, they would submit to the IRS Voluntary Disclosure Program instead. But, if a willful Taxpayer submits an intentionally false narrative under the Streamlined Procedures (and gets caught), they may become subject to significant fines and penalties. 

Need Help Finding an Experienced Offshore Tax Attorney?

When it comes to hiring an experienced international tax attorney to represent you for unreported foreign and offshore account reporting, it can become overwhelming for taxpayers trying to trek through all the false information and nonsense they will find in their online research. There are only a handful of attorneys worldwide who are Board-Certified Tax Specialists and who specialize exclusively in offshore disclosure and international tax amnesty reporting. 

Golding & Golding: About Our International Tax Law Firm

Golding & Golding specializes exclusively in international tax, specifically IRS offshore disclosure. 

Contact our firm today for assistance.