Any real estate agent will tell you that the three things that matter in the buying and selling of property are location, location, location. But tax advisors may need to be more geographically minded, as well.
Because the U.S. has a gift and estate tax with rates as high as 40%, both U.S. citizens and foreigners domiciled in the U.S. are subject to the U.S. gift and estate tax on their worldwide gifts - and, at death, on their worldwide estate.
Even foreigners not domiciled here may be subject to the U.S. estate tax if they own U.S. assets such as real estate and stocks.
As a result, advisors serving a foreign client moving here - even if only for a short two- or three-year stint - must understand the client's domicile and be aware of the basics of the U.S. gift and estate tax, because the rules are quite complex and can be challenging during the planning process.
A foreign person is considered domiciled in the U.S. if he or she is physically present and has the intent to remain in the country indefinitely. In theory, people can attain U.S. domicile the instant they step off a plane onto U.S. soil. Alternately, a foreigner could spend decades here and arguably not have the requisite intent to be considered domiciled in the U.S.
An executive moving to the U.S. on a short-term assignment of three to five years under an appropriate work visa would generally not be considered to be domiciled in the U.S., since the expectation is that they would return home after completion of the assignment. (If, however, the executive extends the term of U.S. residency or acquires a green card, the factors would probably swing in favor of the executive attaining U.S. domicile.)
The IRS and the courts typically look at several factors: visa status, whether a person owns or rents a home, presence of family members, club memberships, location of cemetery plots, location of physicians, statements in legal documents such as wills or trusts concerning domicile status - and whether the person has severed ties to the home country.
DOMICILED & TAXABLE
A foreign client who is domiciled in the U.S. will be subject to gift tax on any worldwide gifts. Additionally, upon death, the client's worldwide estate would be subject to U.S. estate tax. A domiciled individual will also have the same exemption amount - set at $5 million but indexed for inflation - as a U.S. citizen. During 2013, after inflation adjustments, the exemption amount is $5.25 million.
Given the size of this exemption amount, many foreigners need not be concerned with the U.S. gift or estate tax, but keep in mind that many U.S. states impose an estate or inheritance tax separate from the federal tax - and these state taxes typically have a significantly lower exemption amount. For example, if a foreign person lived in or owned New York real estate, the exemption would only be $1 million.
A foreigner is at a disadvantage under the U.S. gift- and estate-tax system because, unlike U.S. citizens, gifts or bequests to foreign spouses are not eligible for the unlimited U.S. marital deduction. While a U.S. citizen could gift $10 million to a U.S. citizen spouse without using up some of the exemption or paying any tax, a gift from a U.S. citizen or foreigner to a non-citizen spouse would constitute taxable gifts to the extent that they exceed the gift- tax annual exclusion amount.
In 2013, the annual gift-tax exclusion amount was $14,000 per non-spouse recipient; it's $143,000 for gifts to non-citizen spouses. A gift to a non-citizen spouse of $10 million would result in a taxable gift of $9.857 million; it would use up the $5.25 million exemption and result in gift tax of $2.1 million.
Although unavailable for gift-tax purposes, bequests to a non-U.S. citizen spouse can qualify for the U.S. unlimited marital deduction for estate-tax purposes if the bequest is to a qualified domestic trust. In effect, if the deceased spouse's assets are placed in such a trust, the U.S. estate tax will be deferred generally until the death of the surviving spouse - sooner if the surviving spouse receives distribution of principal from the trust.
Often, the qualified domestic trust is established pursuant to the terms of the decedent's last will, but it is also possible for the surviving spouse to fund such a trust, subject to certain time constraints. These trusts need to have a U.S. person serving as trustee, be solely for the benefit of the surviving spouse and require the distribution of income to the surviving spouse on at least an annual basis.
In addition, the executor of the deceased spouse's estate must make an election to qualify the trust as a qualified domestic trust.
WHEN TO MAKE GIFTS
The best time for a foreigner intending to permanently move to the U.S. to do estate planning is prior to obtaining domicile in the country. If gift-tax issues can be avoided in the home country - because, say, the country has no gift tax or the person has departed from the country for purposes of application of its gift tax - then the client should decide whether to make gifts prior to arrival in the U.S.
Additionally, a foreign client can decide during the planning stage whether it is appropriate to consider making gifts to either an onshore or offshore irrevocable trust for the benefit of a spouse, descendants and other family members. It may even be possible for the foreign person contributing the assets to the trust to also be a discretionary beneficiary.
If the trust is designed correctly, the assets held within the trust should pass free of U.S. gift tax and estate tax to the discretionary beneficiaries in accordance with the terms of the trust. Foreigners should retain ownership of sufficient assets outside the trust to maintain their standard of living without having to access the trust's assets.
Foreign clients moving to the U.S. on a transitory basis will most likely not be considered domiciled in the country, and therefore should only be subject to the federal gift tax if they transfer tangible personal property in the country. There is no exemption from the gift tax, except for the annual gift-tax exclusion of $14,000 per donee. Examples of gifts that would be subject to the tax include U.S. real estate, cash, art, automobiles, jewelry and valuable personal property in the country.
A non-domiciled foreigner living within or outside of the U.S. will only be subject to the federal estate tax to the extent of U.S. "situs" assets - including U.S. stocks or U.S. real estate - that exceed the exemption amount of $60,000. To not be subject to the estate tax, a foreign client may wish to hold title to those assets within a foreign corporate entity. Another option available to a foreigner is to simply acquire a life insurance policy to cover the U.S. estate-tax costs attributable to the U.S. "situs" assets.
When consulting on estate planning matters, it is always essential to clarify whether your foreign client is a U.S. citizen. The best way to avoid common pitfalls is to ask the right questions - and to make sure your clients provide as much information as they have on assets and their international move.
John Nuckolls, national director of private client services at tax and advisory firm BDO USA, contributed this article to Accounting Today.