How to navigate US estate tax

Non-US citizens owning US assets need to plan ahead if they don’t want to leave inheritors facing a big bill.

In brief

• US estate tax charges can be up to 40%.
• Exemptions are limited, with assets over US$60,000 potentially subject to tax.
• Executors failing to file and pay could be asked to settle amounts due.

Many investors have taken a renewed look at their financial position and future plans given the significant inflationary pressures and market turmoil in financial markets.

For many, that includes investment strategies that provide exposure to the US. These can have US tax implications for non-US citizen and non-US-domiciled (NDA) individuals, not least in terms of estate tax. The tax implications of US situs assets held at death, and particularly intangible assets such as shares in US companies, required careful consideration as part of this forward planning.

The current maximum rate of US estate tax is 40%, and this tax can be relevant in any situation where a non-US person owns taxable US situs assets, directly or indirectly, through a structure considered to be US tax transparent.

Taxable assets include but are not limited to the following:

• Real estate
• Shares in US incorporated entities
• Artwork (other than on loan/transit)
• Cash deposits with US brokers

If US assets are held jointly, each individual’s contribution to the acquisition should be carefully documented. Failing that, the US Internal Revenue Service (IRS) may assume a worst-case and include the asset’s entire value within the estate of the first joint owner to die. US assets held within certain trust arrangements may also not be protected. That’s especially true if the non-US settlor has retained significant powers over the trust arrangement.

Some US situs assets are not subject to US estate tax, including checking and savings accounts, US government bonds, tax-exempt municipal bonds and American depository receipts (ADRs). There are also some exclusions for certain assets. They are relatively minor, however, and not always straight forward.

Limited exemption

Currently, an estate tax charge should not arise for an NDA if the taxable US estate’s net value does not exceed US$60,000. Any liability is calculated by reference to the net value of the US situs estate, and deductions are available for liabilities directly allocable to US assets, such as a non-recourse debt on US real estate. Even so, the US$60,000 exemption is fairly trivial, particularly compared to the current gift and estate tax exemption available for US citizens and domiciled individuals of US$12.92mn.

A limited deduction is also available for more general estate expenses, but these are allocable based on the value of the US estate as a proportion of the worldwide one. An unlimited marital deduction against the net US assets, meanwhile, is available only if the surviving spouse receiving the assets is a US citizen.

It is a common misconception that assets passing to a surviving spouse will automatically qualify for relief. This can cause timing issues where the local country estate tax planning is relying on tax deferral. If a marital deduction is not automatically available, it can be gained using certain US domestic trust arrangements. This would serve only to defer the US estate tax liability rather than reduce it, however.

The US also has a limited network of estate tax treaties with other countries, including the UK and Ireland. Specific treaties may limit overall exposure to US estate tax, but this will depend on the particular circumstances of the deceased’s situation, including their domicile status.

Utilising treaty reliefs, again, requires careful planning.

Given limited exemptions, the best way to avoid exposure to US estate tax may be to ensure that the individual is not considered to own the US assets. This can be achieved using corporate entities, partnerships or appropriately structured trusts. The structuring must be carefully planned to ensure it is effective, however. It will need to take account of the tax implications in any other relevant jurisdictions and the costs of implementation and continued maintenance.

It should be noted that a nominee arrangement may be put in place by a custodian for logistical ease. This will not be enough to avoid US estate tax, though, as the asset's ultimate beneficial owner remains the individual. Similarly, holding US shares in a non-US brokerage account will not offer any estate tax protection.

Greater information flow to the IRS through Foreign Account Tax Compliance Act (FATCA) and related Form W-8 reporting ensures accurate identification of US asset ownership. This will require updating when there is a change in ownership for any reason.

Keeping compliant

If a US estate tax liability arises, it will be the executors’ responsibility to settle any amount due. If they don’t, the IRS could look to the executors personally, the beneficiaries of the estate or even the custodian of the US assets.

Where the value is over US$60,000, executors will need to sign and file a Form 706-NA with the IRS. The normal due date for filing is nine months following the date of death, although the IRS can extend this on request. The date for payment of tax due is also nine months following the date of death, though can’t be extended. Late filing and late payment can incur potential penalties.

Executors will also need to complete and file a Form 706-NA to claim any appropriate treaty relief available. Once the IRS has reviewed and agreed this, it will issue a Federal Transfer Certificate. Executors require this to transfer ownership of the US assets to the beneficiaries of the estate. If assets are transferred without the certificate, the IRS could look to the custodian that has facilitated the transfer to settle any US estate taxes due.

A Federal Transfer Certificate is required even if the value of US assets owned is under US$60,000. In this case, though, the executor can make a direct request for a certificate without filing a Form 706-NA.

The IRS advise that issuance of the Federal Transfer Certificate can take six to nine months following a submission. In practice, it can be longer. If US assets are likely to be a significant source of liquidity for the beneficiary, this needs to be borne in mind.