Foreign investors with assets in the United States often encounter complex estate tax rules that can significantly impact taxation of their U.S. assets at death. If the individual is a non-resident, non-citizen of the U.S. (NRNC), the U.S. estate tax applies only to assets situated or deemed to be situated within the U.S. (for example, U.S. real property or stock in a U.S. corporation). The rules are complex, though. For example, certain assets which might appear to be situated within the U.S., such as U.S. bank accounts, might not be treated under the tax law as U.S. assets.
Graduated tax rates are imposed depending on the total value of the U.S. estate, with rates as high as 40%. A mere $60,000 exemption from tax is provided for NRNCs who own U.S.-situs assets. Estates of NRNCs must file a U.S. estate tax return on IRS Form 706-NA if the taxable estate which is comprised of U.S.-situs assets exceeds this number.
Understanding how an estate tax treaty may mitigate this tax burden is critical. This article delves into the fundamentals of U.S. estate tax treaties, their limitations, and the nuances involved in leveraging their benefits.
How Estate Tax Treaties Mitigate Double Taxation
Estate tax treaties aim to minimize double taxation, a common issue when two jurisdictions claim taxing rights over a decedent’s assets. There are various ways in which a treaty can address this issue. One method is by allocating taxing rights. Treaties designate primary and secondary taxing rights based on location of the asset or the taxpayer’s domicile. Another method to reduce or eliminate double taxation is by allowing tax credits or enhancing exemptions. Finally, the treaty may contain agreements on the “situs” (the legal location) of various assets to clarify which country has the taxing rights.
The United States has negotiated estate and gift tax treaties with 14 countries, alongside an income tax treaty with Canada that includes estate tax provisions. These agreements vary significantly in scope and applicability, requiring careful examination of specific treaty terms.
Key Variations In Treaty Approaches
U.S. estate tax treaties generally fall into two categories:
- Situs-Based Treaties: Older treaties, signed before 1966, primarily allocate taxing rights based on asset location. For example, treaties with Australia, Japan, and Switzerland use situs rules to determine which country has primary taxing authority over particular assets.
- Domicile-Based Treaties: More modern treaties, signed after 1966, focus on the decedent’s domicile at the time of death. These treaties often reserve taxing rights for the domicile country but allow the non-domicile country to tax real property and business interests within its borders. Examples include treaties with France, Germany, and the United Kingdom.
U.S. estate tax treaties often extend benefits beyond what is permitted under domestic laws. For example, some treaties increase the $60,000 exemption for U.S.-situs assets for NRNCs. Others allow prorated exemptions based on the proportion of U.S.-situs assets to worldwide assets or provide deductions or credits for taxes paid to the treaty partner country.
To claim these benefits, the estate must disclose worldwide asset values on the U.S. estate tax return. Additionally, filing Form 8833, Treaty-Based Return Position Disclosure, is mandatory when asserting treaty benefits and must be filed along with the estate tax return.
No Relief For The U.S. Citizen Or U.S. Domiciliary
U.S. estate tax treaties do not provide relief for U.S. citizens or U.S. domiciliaries. Before examining why, it will help to understand the meaning of the term domiciliary. For U.S. estate tax purposes, a “domiciliary” is an individual who resides in the United States with no definite present intention of leaving. Unlike mere physical presence, domicile is determined by the individual’s subjective intent to remain indefinitely, which can be evidenced by factors such as property ownership, business interests, family and social ties.
When an American dies abroad or owning assets in foreign countries, the various estate and taxation matters become complex because foreign and U.S. laws will come into play. The interplay between U.S. laws and the local laws of the country where the decedent lived or owned assets cannot be ignored. Many persons believe that the existence of the relevant U.S. estate tax treaty will alleviate U.S. estate tax entirely, or at least eliminate U.S. estate tax on assets located in the foreign country.
Unfortunately, this is not the case. It often comes as a rude awakening that U.S. estate tax treaties provide little solace for U.S. citizens and domiciliaries. The “savings clause” embedded in most treaties ensures that the United States retains the right to tax its citizens and domiciliaries as if the treaty did not exist. The savings clause “saves” or preserves a country’s right to tax its own citizens and domiciliaries despite the treaty, regardless of the individual’s residence or other ties to a treaty country.
The precedent set by Estate of Vriniotis v. Commissioner (79 T.C. 298, 1982) underscores this principle. The decedent was a dual national holding both U.S. and Greek citizenships; he was domiciled in Greece and owned property there. The estate of Mr. Vriniotis argued that the U.S.-Greece estate tax treaty exempted the estate from U.S. estate tax. The Tax Court upheld the application of U.S. estate tax and held that the treaty merely provided credit for taxes paid to Greece, reinforcing the extensive reach of U.S. estate tax laws for citizens.
Practical Considerations
Leveraging a U.S. estate tax treaty is not a straightforward process. Each treaty has unique terms and provisions, making expert tax guidance essential. Furthermore, the disclosure of the value of global assets can complicate matters, particularly for estates concerned about privacy or additional scrutiny.
By understanding the interplay between U.S. estate tax rules and treaty provisions, foreign investors and their advisors can mitigate potential tax liabilities effectively. However, in order to achieve a successful result, the process requires diligence, careful planning, and professional expertise.
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