Ines Zemelman, EA 20-May-12
In the US, estate tax is assessed according to the deceased resident’s total assets at the time of their death. Currently, the estate tax only applies to estates valuing over five million dollars. This is fortunate for those whose families would be left destitute after such a tax. In 2013, this threshold will be dramatically reduced to one million dollars (the estate’s gross value). If an estate’s value exceeds the threshold, Form 706 (an estate tax return) must be filed.
There are factors involved in determining expat estate tax liability. The most important is the principle of “unifying”. An expat’s gift giving and his/her estate taxes must be “unified”. In short, this states that, when an expat dies, every taxable gift he/she has given since 1976 must be added to the estate’s value when determining “total taxable transfers”.
In 2011 and 2012, the tax rate for expat estates is 35%. The rate will jump back to 55% in 2013. This was the rate before the Unemployment Insurance Reauthorization, Tax Relief, and Job Creation Act initiatives of 2010). If acutely planned, and if gifts are given smartly and with professional guidance, it is entirely possible to manage the estate taxes left to ones descendants. One is allowed to gift (in amounts not annually exceeding $13,000), to any U.S. resident, tax free. Amounts exceeding this threshold must be reported, and any amount exceeding $13,000 will be taxed.
Like the foreign tax credit that is available to expats filing their annual US tax return, there is also available a similar tax credit applied to estate taxes. If an expats estate faces double taxation (from the US and his/her country of residence, the taxes paid to a foreign government can be claimed as a credit on Form 706 (the expat estate return).
US Estate Taxes and the Non-US Spouse
You may be wondering how your spouse will handle your estate taxes if he/she is not a US resident. Good question! While there is an exemption granted to US spouses, a non-US spouse does not qualify. This means that the citizen’s estate will be taxed upon his/her death (if the value exceeds the threshold), even while a spouse survives. Property owned in the US will pass to the non-US spouse, but it will be taxed at estate tax rates (with a very minimal exemption). Fortunately, non-US property will not be subjected to US taxation.
To avoid this problem, some choose to transfer all of their assets from the US to foreign soil as they near old age or retirement. As a US citizen, this usually comes with an FBAR requirement, however. Additionally, the IRS may become paranoid and question the expats motive (as many have attempted to hide money overseas). Remember that income earned through these foreign assets and accounts is taxable in the US and must be reported on your tax return.
Don’t forget that the non-US spouse may apply for US citizenship to simplify the taxation process both before and after death. The downside for expats may be that residence on US soil is required for citizenship. This may very well be worth the time away from your foreign home, however. The estate exemption granted to US spouses allows them to inherit ten million dollars in tax free assets. Citizenship isn’t guaranteed, however, even if you choose to move back and pursue this strategy. I may pose too big of an inconvenience for some, but while planning for your spouse’s future, citizenship is definitely worth considering.
Possibly the least desirable strategy for avoiding death taxes posed by the US government, a married couple (US/non-US) may also choose to transfer all of their assets to the sole ownership of the non-US spouse. Of course, with the high divorce rate and the impossibility of predicting who who will die first make this a risky strategy. Also, the estate tax laws of your country of residence must be taken into consideration. Despite these drawbacks, though this is a solidly proven way of the reducing the tax obligation of the US spouse (while both spouses live and where estate taxes are concerned).
Several years back, many wealthier expats began to renounce their US citizenship altogether (an irreversible process), as a way of reducing their beneficiaries’ tax burden. Because of this trend, the IRS put their foot down with the breath-taking “exit tax”. The exit tax acts as if the exiting citizen has just sold every one of his/her possessions and then taxes the total value according to the highest available rate.
Obviously, renouncing your citizenship is an option, but it isn’t usually the most desirable one. It is very important to remember that if one resides outside of the US for more than ten years he/she will automatically become exempt from the estate tax as an expatriate.
The Top 4 Strategies to optimize Estate Taxes
It’s clear, from our discussion above, that wealthy expats simply do have a sever estate tax liability. Planning can reduce this liability, and we’ve broken down some of the most basic and proven strategies below. Of course, we suggest that you consult with an international tax professional before choosing your course of action.
- Get Married. If you are in a loving and committed relationship, do not put off getting married. Marriage is the most basic and most effective tax strategy. Of course, as a strategy and as previously discussed, this is much more effective of you are marrying a US citizen.
- Establish Trusts. Creating a trust of another effective way of reducing estate tax liability. Charitable Remainder Trusts, Life Insurance Trusts, Qualified Personal Residence Trust and many others should be discussed with your estate planner.
- Give Generously and Often. Reducing the value of your estate before your death is an extremely wise estate tax planning strategy. One may only gift $13,000 year (tax free), so to gift large sums of money, giving should be spread out over many years. Be a blessing to your friends and family and plan to leave a low taxed estate (which is also very kind to your spouse and family) at the same time.
- Buy. Hoarding your money is the most surefire way of leaving an estate tax burden. Shop, shop, shop...and don’t just purchase those things that will be included in your estate’s value (land, homes, etc.). Take vacations and buy gifts!
The article is merely an overview of an overwhelming amount of US estate tax information. For additional help with your estate tax planning, please contact the proven professionals at Taxes for Expats today!