If you or your spouse is a non-U.S. citizen, different rules apply to your estate plan. One misstep can lead to unpleasant tax surprises, so make sure you understand the differences.
Rules for citizens: Worldwide taxation
U.S. citizens are subject to federal gift and estate taxes on all of their worldwide assets, with an exemption for gifts and bequests up to an inflation-adjusted $5.34 million (in 2014). They’re also entitled to an annual gift tax exclusion (which is currently $14,000 per recipient; $28,000 for married couples who "split" gifts). Married couples enjoy an unlimited marital deduction, which allows them to freely transfer property to each other without triggering gift or estate taxes.
Rules for noncitizens: Domicile matters
The tax treatment of noncitizens depends on whether they’re "domiciled" in the United States. Your country of domicile depends on your particular facts and circumstances. In general, however, the IRS views you as a U.S. domiciliary if you live in the United States — even briefly — with no present intention of moving.
Noncitizen U.S. domiciliaries enjoy many of the same advantages as citizens, including the $5.34 million exemption, the $14,000 annual gift tax exclusion, and gift splitting (with a spouse who’s a U.S. citizen or domiciliary). But the marital deduction is not available for transfers to a noncitizen spouse, regardless of whether he or she is domiciled in the United States.
That doesn’t necessarily mean that transfers to a noncitizen spouse are taxable. You can still use your exemption amount to shield up to $5.34 million from taxation, and there’s a "super" annual exclusion for gifts to a noncitizen spouse (currently, $145,000).
Although transfers to a noncitizen spouse that are in excess of your exemption amount are taxable, you can obtain some of the benefits of the marital deduction by leaving assets in a qualified domestic trust (QDOT). QDOTs must meet certain requirements designed to ensure that the assets stay in the United States and ultimately are subject to estate taxes. Unfortunately, they don’t quite duplicate the marital deduction.
For example, if you leave an inheritance to a citizen spouse, he or she can avoid estate taxes by spending the money or giving it away (using his or her own exemption or annual exclusion). But when a noncitizen spouse withdraws principal from a QDOT, the general rule is that it’s immediately subject to estate taxes as part of your estate. There are, however, exceptions that may exempt the withdrawal from the estate tax.
Rules for nonresident aliens
What if you’re a "nonresident alien" — that is, neither a U.S. citizen nor a U.S. domiciliary? In that case, you’re subject to U.S. gift and estate taxes only on property "situated" in the United States. But if you do own property in the United States — for example, real estate or personal property, such as cars, boats, collectibles, and certain interests in U.S. companies — be aware that the exemption amount for nonresident aliens plummets from $5.34 million to a paltry $60,000.
In some cases, it may be possible to avoid U.S. transfer taxes by setting up a foreign corporation to hold U.S. property.
Have a plan
If you or your spouse is a noncitizen, consult your advisors to evaluate the potential impact on your estate plan and to discuss strategies for avoiding unintended tax consequences.
If you have any questions regarding this article, please contact Friedman LLP at firstname.lastname@example.org or 877-538-1670.