While recent changes to the U.S. estate tax—a tax on assets trans-ferred at death—have reduced or eliminated the financial burden on U.S. citizens and domi-ciliaries, the rules applying to persons who are neither U.S. citizens nor domiciled in the U.S., remain unchanged and can exact a heavy toll, particularly on residents of countries with which the United States does not have a transfer tax treaty.
Nevertheless, some very basic planning—if done in advance and with care—can help to minimize the impact of the U.S. estate tax on foreign nationals living in non-treaty countries, including Bel-gium, China, Luxembourg, and Russia. Advance planning can also eliminate the risk of non-compliance with reporting re-quirements pertaining to gifts or bequests from outside the United States to persons or trusts inside the United States.
U.S. estate taxes have temporar-ily been made far less burden-some for U.S. citizens and non-citizen domiciliaries. Between Jan. 1, 2011, and Dec. 31, 2012, there is no federal estate tax on assets of less than $5 million because the exemption from tax has been increased to $5 million. This means that a U.S. married couple can effectively shield up to $10 million from estate tax. For decedents with assets greater than $5 million, the maximum federal tax rate has been reduced to 35%.
However, there has been no similarly favorable increase in the exemption for persons who are domiciled outside of the United States and who are not citizens of the United States. Instead, the exemption from estate tax for them remains at only $60,000.
The United States imposes an estate tax on “U.S. situs” prop-erty even if it is owned by a non- U.S. citizen domiciled outside of the U.S. An obvious example of a U.S. situs asset is real estate located in the United States. A less obvious—but equally taxed—U.S. situs asset is stock in a corporation organized in the United States. If, for example, a non-citizen non-domiciliary dies owning $10 mil-lion of stock in General Electric, that person’s estate would owe approxi-mately $3.5 million in U.S. estate tax because the new $5 million exemption from estate tax does not apply to non-U.S. citizens domiciled outside of the United States. Instead, as noted above, U.S. law still only allows a $60,000 exemption from the estate tax per individual.
It is important for individuals who are neither U.S. citizens nor domiciled in the United States and who own U.S. situs property to understand the U.S. rules relating to those assets. Custodi-ans, brokers and transfer agents can be required to assist in the collection of the U. S. tax. For example, in the above scenario, unless the decedent appointed a U.S. executor, the transfer agent, custodian or broker holding the decedent’s U.S. company stock could in some circumstances become sub-ject to liability if it transferred the stock to a new owner without first receiving written clearance from the U.S. taxing authorities.
While the U.S. estate tax applies to ownership interests in U.S. corpora-tions, it does not apply to most U.S. bonds and bank accounts and, through 2011, to some U.S.-organized mutual funds. It is also important to note that while some countries, such as the United Kingdom, France and Germany, have estate tax treaties with the United States that eliminate or reduce U.S. estate tax exposure, most do not. In fact, only 17 countries have estate tax treaties with the United States, and, many countries that one might expect to have tax treaties with the U.S., such as Russia, Belgium, Luxembourg and China, do not.
In most cases, careful planning can reduce or eliminate the effect of U.S. estate tax on the assets of a non-citizen, non-domiciliary.
U.S. Reporting Requirements
The United States also has reporting rules that apply to gifts or bequests of assets from a person outside the United States to a person or a trust inside the United States—a scenario that has become much more common in recent years as more children of non-citizen, non-domiciliaries attend college or graduate school in the United States and then remain in the United States. These reporting rules apply even if no tax is due to the United States, and the penalty for failing to file the report can be as much as 25% of the total amount of the property transferred.
Finally, U.S. citizens or income tax residents who have bank and other financial accounts outside of the United States are required to report the existence of these accounts annu-ally. The willful failure to report such accounts can lead to civil penalties of up to $100,000 or 50% of the assets held in the foreign account (whichever is greater), and criminal penalties of up to $250,000 and five years impris-onment. Although the mechanics of complying with these reporting re-quirements is not difficult, many indi-viduals are simply unaware of these rules, or discover them when it is too late. The U.S. Internal Revenue Service recently announced a second special voluntary disclosure initiative (“OVDI”) for taxpayers who come forward before August 31, 2011 to report previously undisclosed accounts outside the United States. Taxpayers taking advan-tage of the OVDI may avoid criminal penalties and receive reduced civil penalties for failure to previously report assets in non-U.S. accounts.