Foreign Nationals in the U.S. - Estate Tax, Wills & Guardianship - Part 2
Both residents and non-residents may make unlimited transfers of property at death to a U.S. Citizen surviving spouse free of estate tax by utilizing the estate tax marital deduction.
However, bequests to a non-U.S. Citizen spouse (even if a U.S. resident) do not qualify for the unlimited marital deduction.
Two limited exceptions apply:
- The surviving spouse becomes a U.S. citizen before the U.S. estate tax return is filed, and was resident in the U.S. between the date of the decedent's death and the surviving spouse's naturalization, or
- The property passes to a Qualified Domestic Trust (QDOT) or similar contractual arrangement for the benefit of the surviving spouse.
A full discussion of the QDOT and U.S. marital deduction is beyond the scope of this article. In brief, a QDOT defers estate taxation until the death of the surviving spouse. It can be funded either pursuant to the terms of the deceased spouse's Will or the surviving spouse can establish the trust prior to the due date of the estate tax return.
The trust is to be solely for the benefit of the surviving spouse during the lifetime of the surviving spouse and must have a U.S. trustee. Income from the trust is required to be distributed to the surviving spouse on at least an annual basis. The trustee may make distributions from the principal of the trust to the surviving spouse, but generally, distributions of principal are subject to estate tax. Estate tax will also become due upon the death of the surviving non-citizen spouse or the cessation of qualification of a trust as a QDOT.
Other Solution Strategies
There are further planning techniques available that should be reviewed carefully, including, but not limited to, structuring the ownership of U.S. assets through bona fide offshore entities, securing non-recourse financing on U.S. real estate assets, and arranging tax effective life insurance for the replenishment of a foreign estate's U.S. estate tax exposure.
Impact of Estate & Gift Tax Treaties
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, but very few such Estate Tax Treaties exist.
Further complications - and opportunities - arise in the area of gift taxation imposed on non-residents that may be subject to tax on the gifting of U.S. situs assets. Gift taxation shares the same tax rate structure as estate taxation although the rules differ and professional advice should be sought.
The Importance of U.S. WiIl Provisions
A Will is a document that disposes of an individual's assets at his or her death. If an individual dies without a Will, known as intestacy, generally the local law of the decedent's domicile governs the ultimate division and distribution of the decedent's assets to his or her heirs, as defined by such local law. Such division of assets may not be the individual's intent. A Will provides the Testator of the Will with the opportunity to modify such default provisions in order to reflect specific intent.
For inbound foreign nationals, in certain cases a U.S. Will may govern the disposition of U.S.-situs assets. If a non-domiciliary holds U.S.-situs real property, shares in a cooperative apartment or tangible personal property, a U.S. Executor of the Will may dispose of those assets under the U.S. Will provisions.
Whether or not a foreign national not domiciled in the United States needs a United States Will depends on many factors, but is often recommended when such a person (1) holds U.S.-situs assets, particularly U.S. real estate, (2) has minor children, or (3) has no other Will and is domiciled in a common law jurisdiction. There may also be concerns about the validity of any existing foreign Will as viewed under U.S. law, or more practically, issues of probating (or "proving") a foreign Will in a foreign language in the appropriate U.S. state jurisdiction.
The Will may be restricted to the disposition of U.S. assets only. It is critical that any U.S Will is appropriately coordinated with any existing Will if a dual Will scenario is chosen and that individual circumstances are discussed with legal counsel.