Beware of tax traps when estate planning for non-U.S. citizens

Posted On: FEBRUARY 2024

If you’re not a U.S. citizen, or if you’re married to a noncitizen, estate planning can be a bit more complicated. To avoid costly tax traps, it’s important to have a basic understanding of how the U.S. gift and estate tax laws apply to noncitizens.

A question of domicile

Noncitizens can become subject to U.S. gift and estate taxes if they’re domiciled in the United States. Under IRS guidelines, an individual becomes domiciled in a country “by living there, for even a brief period of time, with no definite present intention of later removing therefrom.”

To determine a person’s “present intention,” the IRS considers a number of factors, such as the amount of time the person spends in the United States; their green card or visa status; the location of their business interests and residences; the location of their health care providers, jobs, places of worship and community ties; the place where their vehicles are registered and where they’re licensed to drive; the place where they’re registered to vote; and the domiciles of their friends and family members.

Noncitizens who are deemed to be domiciled in the United States are subject to U.S. gift and estate taxes on their worldwide assets, much like U.S. citizens. And, like U.S. citizens, they’re eligible for the federal gift and estate tax exemption ($13.61 million for 2024) and the annual gift tax exclusion ($18,000 per recipient for 2024).

A significant difference between U.S. citizens and noncitizens, and a potential tax trap for the unwary, is that the marital deduction isn’t available for transfers to noncitizens. Ordinarily, married couples can transfer an unlimited amount of assets between each other — during their lifetimes or at death — without triggering gift or estate taxes. But estate planning strategies that rely on the marital deduction may not be available to noncitizen domiciliaries.

There are other options, however. For example, a spouse can:

  • Make tax-free transfers to his or her noncitizen spouse up to the transferor’s unused gift and estate tax exemption.
  • Make annual exclusion gifts. The annual exclusion for gifts to a noncitizen spouse is $185,000 for 2024.
  • Transfer assets to a qualified domestic trust (QDOT) that meets certain requirements. Amounts transferred at death to a QDOT for the benefit of a noncitizen spouse qualify for the marital deduction. However, estate tax is merely deferred rather than eliminated. The surviving spouse can withdraw income from the trust, but any distributions of principal immediately become subject to estate tax. And the entire amount becomes taxable when the surviving spouse dies (unless he or she becomes a U.S. citizen).

Tax trap for nonresident aliens

A person who’s neither a U.S. citizen nor a U.S. domiciliary — that is, a “nonresident alien” — is subject to U.S. gift and estate taxes only on assets that are “situated” in the United States. Examples include U.S. real estate and personal property located in the United States (with certain exceptions). Intangible property — such as corporate stock, bonds or promissory notes — is deemed to be situated in the United States for estate tax purposes (but typically not for gift tax purposes) if it’s issued by a domestic corporation or by a U.S. citizen or the U.S. government.

Here’s where the potential tax trap comes into play: The exemption amount for U.S.- situated assets owned by nonresident aliens is only $60,000, compared with $13.61 million for U.S. citizens or domiciliaries. Depending on the value of a person’s property in the United States, this can result in significant gift and estate taxes.

There may be strategies for avoiding these taxes, such as holding the assets through a properly structured and operated foreign corporation. Also, in some cases, tax treaties between the United States and a nonresident alien’s country of citizenship may provide some relief.

Steer clear of the traps

If you or your spouse is a noncitizen, talk to us about the potential estate planning ramifications. We can help you develop strategies for steering clear of the traps and minimizing any adverse tax consequences.

© 2024