More and more people are becoming globally mobile, relocating from country to country. As a result, estate planning attorneys are being asked questions about income and estate and gift tax ramifications of property from outside the United States.
One of the questions most frequently being asked is "Will I be subject to tax on an inheritance or gift from abroad if I bring the asset into the United States?"
The short answer is that the United States does not impose inheritance taxes on bequests. Transfers by gift of property not situated in the United States from foreign nationals not domiciled in the United States are also not subject to U.S. gift taxes. However, advisors need to be aware of the many other U.S. tax rules that may apply to such a gift or inheritance.
This article describes the U.S. tax rules that apply to transfers by gift or inheritance of property from abroad to U.S. citizens, U.S. lawful permanent residents ("green card" holders), or foreign nationals residing in the United States.
U.S. Estate Taxes
The estate and gift tax rules of the Internal Revenue Code include two basic structures for transfers by bequest. One structure covers death transfers by U.S. citizens regardless of where they are domiciled at death. This structure, with some exceptions for transfers to non-U.S. citizen spouses, applies to estates of foreign nationals who are domiciled in the United States.
Foreign nationals who are green card holders are generally considered domiciled in the United States for both U.S. estate and gift tax purposes. This is consistent with the immigration law definition of a U.S. lawful permanent resident as an individual who intends to reside permanently in the United States.
Depending on the facts and circumstances, foreign nationals who reside in the United States, but who are not green card holders, may be considered domiciled in the United States for purposes of these tax rules as well. Transfers by foreign nationals not domiciled in the United States are covered by a different estate tax structure that imposes taxes on transfers of certain property situated in the United States.
Estate taxes based on the Code rules may be changed by an estate or gift tax treaty. The United States has estate tax treaties with the following countries:
The Income tax treaty with Canada also includes articles that minimize the double tax previously caused when assets were subject to the Canada's deemed disposition at death tax which is a capital gains tax rather than a death tax.
As long as the decedent who transfers the asset by bequest or is neither a U.S. citizen nor a foreign national domiciled in the United States, no U.S. estate tax is imposed on the transfer. The United States does not impose inheritance taxes on the beneficiary's receipt of a bequest, therefore there is no U.S. tax resulting from the death transfer. Also, the United States also does not impose an income tax on inheritances brought into the United States. However, other U.S. reporting and tax rules may apply to the asset.
U.S. Gift Taxes
The U.S. gift tax rules apply to gratuitous transfers by U.S. citizens and foreign nationals domiciled in the United States regardless of the location of the asset transferred. Certain exemptions apply to gifts regardless of the domicile of the donor or location of the asset. As with the gift tax rules for U.S. citizens, there is an annual exclusion of $10,000 per donor for each donee gift. Gift splitting is not available to foreign nationals not domiciled in the United States. Gifts to U.S. citizen spouses are free of gift tax. Gifts of up to $100,000 per year to a non-U.S. citizens spouse can be given free of tax.
Gifts by foreign nationals not domiciled in the United States are subject to U.S. gift tax rules only if the asset transferred is situated in the United States (referred to as "U.S. situs" property). Whether property is U.S. situs for purposes of these rules is defined by arcane rules found in sections 2104 and 2105 of the Code.
In general, U.S. real estate and tangible personal property that is located in the United States is U.S. situs property but intangibles are not. (However, intangibles such as stock in U.S. companies or debt instruments of U.S. entities or governments are situated in the United States for U.S. estate tax purposes.) Special rules apply to treat U.S. bank accounts as situated outside the United States.
The United States has gift tax treaties, either separate or in combination with estate tax treaties with the following countries:
These treaties may eliminate the U.S. gift tax on certain transfers that are otherwise subject to U.S. gift taxes under the Code. An exemption from gift tax under a treaty is made on a gift tax return. The applicable treaty must be analyzed for application to the transfer.
U.S. Income Taxes
U.S. persons are subject to U.S. income taxes on worldwide income. Therefore, U.S. persons who own income producing property located abroad are subject to U.S. income taxes on that income. U.S. persons for purposes of U.S. income tax rules include U.S. citizens and U.S. lawful permanent residents, regardless of where they reside. The definition of U.S. persons also includes foreign nationals who are resident aliens for U.S. tax purposes. Resident aliens are foreign nationals who meet either the "green card" test or the 183-day substantial presence test of section 7701(b) of the Code. The application of U.S. income taxes to property that is transferred or held in trust depends on the status of the grantor or beneficiary, whether U.S. or foreign, under these income tax rules.
Translation into U.S. Dollars
To determine taxable income for U.S. tax purposes when the income producing asset is denominated in a foreign currency, the income and expenses related to the asset must be translated into U.S. dollars using the appropriate exchange rate. If payments are periodic such as monthly interest, the amount is translated into U.S. dollars using the average exchange rate for the year. Non periodic transactions are translated using the spot rate for the day. Historic exchange rates are available from the Federal Reserve Board by free subscription or on their web site at WWW.BOG.FRB.FED.US.
Income from property located abroad may be subject to foreign income taxes as well as U.S. taxes. Periodic income such as interest is usually subject to a withholding tax at source. If the income is from a country with which the United States has an income tax treaty, this withholding tax can be reduced or eliminated by submitting the appropriate withholding certificates to the payor of the income. Otherwise, the beneficiary can compute a foreign tax credit on Form 1116 of Form 1040. Foreign tax credits offset U.S. taxes attributable to foreign income in the individual's tax return. If there is no positive income, as in the case of a rental loss, the foreign taxes may be taken as an itemized deduction.
A transfer by death or gift into a foreign trust for the benefit of a U.S. person will impose substantial reporting requirements upon the foreign trustee and U.S. beneficiary as well as subject income distributed to the beneficiary to U.S. income taxes. If the bequest or gift is transferred into a foreign trust by a U.S. person, the U.S. income and reporting rules will apply to income to the trust under the foreign grantor trust rules whether or not the income is distributed to a U.S. person. A foreign trust for purposes of these rules is a trust that is not a domestic trust. A domestic trust is a trust that meets two criteria: 1) A court within the U.S. is able to exercise primary jurisdiction over the administration of the trust; and 2) One or more U.S. fiduciaries have the authority to control all substantial decisions of the trust.
Stock Ownership in a Foreign Corporation
If stock in a foreign corporation is transferred by gift or bequest to a U.S. person, the ownership of that stock may trigger several U.S. anti tax avoidance rules. Generally, these rules are intended to prevent income from certain passive assets from accumulating off-shore free from U.S. taxation. Three main sets of rules comprise this anti-deferral regime: the controlled foreign corporation rules, the foreign personal holding company rules, and the passive foreign investment company rules. These rules that were designed for major multi- national companies apply with equal force to small closely held foreign companies.
Controlled Foreign Corporations
A controlled foreign corporation (CFC) is a foreign corporation in which U.S. persons, each of whom is at least a 10 percent shareholder, own as a group, more than 50 percent of the vote or value. Under the stock attribution rules for determining whether a foreign corporation is a CFC, stock ownership is attributed from an individual's spouse, children, grandchildren and parents who are also shareholders. If a nonresident shareholder is a spouse, child, grandchild, or grandparent of the U.S. person, that person's stock is not attributed to the U.S. person for purposes of determining CFC status.
Foreign Personal Holding Company
A foreign personal holding company (FPHC) is a foreign corporation is which 5 or fewer U.S. persons own, as a group, more than 50 percent of the vote or value. The scope of the attribution rules for FPHC status is broader than the attribution rules for CFC status. Ownership of stock is attributed to a U.S. person from any lineal descendant or ancestor whether or not the relative is a U.S. person or a nonresident alien. Stock is attributed from siblings regardless of their U.S. tax.
To qualify as FPHC the corporation's gross income must consist of at least 60 percent passive income. Once that threshold is met, the corporation will continue to be treated as a FPHC if at least 50 percent of its gross income is from certain passive sources.
Passive Foreign Investment Company
A foreign company is a passive foreign investment company (PFIC) if one of two tests is met: 1) 75 percent of the gross income of the corporation is passive or 2) the corporation's assets consist of 50 percent or more of passive assets. Passive assets are assets that produce passive income. No threshold of stock ownership by U.S. persons is required for a corporation to qualify as a PFIC.
Reporting on Bequests and Gifts from Abroad
All bequests and gifts received by U.S. persons from foreign persons that exceed $100,000 in the calendar year are reportable to the IRS on Form 3520, Annual Return to Report Transactions With Foreign Trusts and Receipt of Certain Foreign Gifts. The amount and description of the bequest must be disclosed. However, the IRS does not require disclosure of the identity of the decedent or donor.