Death and (U.S.) Taxes: An Introduction to Tax Planning for U.S. Expats

In March and May, the International Tax Blog featured highlights from the first two articles in our series Uncle Sam Wants You (To Pay Tax) by Chris McLemore and Erin Fraser of Butler Snow LLP, published in Tax Planning International Review. These articles addressed key U.S. income tax pitfalls for Americans living abroad, and basic U.S. expat income tax planning tips

Now, McLemore and Fraser have published a follow up article entitled The Only Two Certainties, in which they consider challenges and planning techniques for expats with regard to U.S. transfer taxes.

Transfer taxes are taxes of up to 40 percent imposed on gifts and estates. Counter-intuitively, transfer tax is imposed on the donor or decedent, rather than on the recipient or beneficiary. U.S. citizens and domiciliaries are subject to these taxes with respect to their worldwide assets. Others are subject to tax with respect to property situated in the U.S. only.

While the U.S. has one of the highest rates of transfer tax in the world, it also provides generous exemptions – particularly where the recipient is a U.S. spouse. In 2015, individuals are permitted an annual gift tax exclusion of US$14,000 per recipient per year, and a cumulative lifetime gift and estate tax exemption of US$5.43 million. Furthermore, gifts or bequests to a U.S. citizen or domiciled spouse may be made entirely free of transfer tax. 
McLemore and Fraser explain that where a U.S. citizen’s spouse is a non-U.S. citizen living abroad, the situation becomes more complicated in a number of ways. For example:

  • Spousal gifts in excess of US$147,000 (per annum) are taxable.
  • Where property is owned jointly with rights of survivorship (the typical way spouses take title to real property), special complications arise: First, the entire property is generally included in the U.S. citizen’s estate, and may therefore be taxable if it exceeds the U.S. exempt amount. Second, if the non-U.S. spouse is the survivor, and ownership passes to him or her by operation of law, the transfer will not necessarily qualify for the unlimited estate tax marital deduction. Third, if, in view of these concerns, spouses sever a joint tenancy to hold title as tenants in common, this transaction in itself may be treated as creating a taxable gift. Holding property as tenants in common from the outset may therefore be preferable.
  • Non-U.S. spouses do not benefit from the unlimited estate tax exemption unless the assets pass into a special “Qualified Domestic Trust”. This trust (referred to as a QDOT) includes special provisions and restrictions to ensure that the assets are taxed prior to distribution, or upon the death of the surviving non-U.S. spouse. It is possible to establish a QDOT after the death of the U.S. spouse by transferring assets to a QDOT, but this transfer may have legal or tax implications in the survivor’s country of residence. Again, it may be preferable to establish the QDOT while both spouses are still alive. 
  • In the case of same sex partners, marriages under foreign law are recognized for U.S. purposes, but civil partnerships are not, and are therefore not accorded any spousal benefits – even if the partners live in a country that does not recognize same-sex marriage.

In sum, for U.S. expats, the complexities of U.S. tax endure beyond life itself – but a bit of advance planning can help families to face those two proverbial certainties (“death and taxes,” as Benjamin Franklin famously quipped) with greater assurance and clarity.

Uncle Sam Wants You (To Pay Tax): The Only Two Certainties by Chris McLemore and Erin Fraser, is published in the July, 2015 issue of Tax Planning International Review. This is their third article in a series addressing U.S. tax considerations for U.S. expatriates. In a forthcoming piece, they will address the expatriation procedure for Americans wishing to renounce their U.S. citizenship.

by Joanna Norland, Technical Tax Editor, Bloomberg BNA