In an increasingly globalized world, it’s common for taxpayers to have cross-border assets. Foreigners who invest in the United States are often surprised by U.S. tax rules and regulations, especially in the area of estate tax.
The Tax Cuts and Jobs Act (TCJA) significantly raised estate tax exemptions for U.S. taxpayers ($11.2M single, $22.4M joint). However, no increases were made to exemptions for non-resident aliens who are subject to estate tax if their U.S.-situated assets are valued at over $60,000.
The result is that, upon death, the estates of non-resident alien property owners may only receive a minuscule exemption and become saddled with an enormous tax burden.
Heavy estate and gift tax liabilities
Real property is by far the most common asset to fall under the tax trap—largely because most property holdings exceed $60,000 outright. Yet many other assets could also trigger the estate tax, including sizable holdings of tangible personal property or securities of U.S. companies (stocks, bonds, etc.).
Many estates will seek to mitigate tax burdens via gifting before a person passes. However, there are heavy restrictions on the types and values of exclusions:
- Annual exclusion of gifts to a non-U.S. citizen spouse is $152,000 per year
- Annual exclusion of gifts to non-spouses is just $15,000
While these exclusions help, they’re generally not large enough to avoid the tax trap entirely. Keep in mind that U.S. gift and estate tax only apply to U.S.-situated assets. For example, non-U.S. real estate would not be subject to tax.
Avoiding the tax trap
With $60,000 being such a low estate tax exemption, proactive tax planning is a necessity.
One strategy to avoid heavy estate taxation is to transfer assets to a foreign holding corporation (often called a “blocker”). This process is complex and expensive. It might also come with unintended tax consequences in the country where the foreign entity is incorporated. Additionally, this solution may not be effective for personal assets such as a primary residence.
A solution to this could be a qualified domestic trust (QDT), an option that becomes available when a non-resident alien marries a U.S. citizen. A QDT can provide a qualified unlimited lifetime marital deduction on established property, which mitigates the burden of estate tax on the surviving spouse.
Life insurance should also be considered. Life insurance death benefits are not subject to estate or gift tax and can be offshored in a trust to avoid taxation on investment returns within the policy.
When proper tax planning fails, a tax treaty could come to the rescue for certain taxpayers. The United States currently has estate tax treaties with a small number of countries, including Canada, Germany and Switzerland. Treaties can limit the type of assets subject to the estate tax or increase the amount of estate tax exemption available to a non-resident alien from the treaty country.
Consult with a qualified tax attorney
The non-resident alien tax trap is easy to fall into and difficult to avoid for non-residents with significant holdings in the United States. The standard $60,000 exemption for non-resident aliens simply isn’t enough to shield survivors or estate heirs from heavy taxation.
Proper tax planning is essential in recognizing future tax obligations and structuring ownership of assets in a way that minimizes estate and gift taxes owed.
Work with an international tax professional to determine the best course of action based on your holdings and circumstances.