U.S. Estate Tax Planning in the Cross-Border Context

Journal of Financial Planning: April 2021

Paula M. Jones, Esq., has over 20 years of experience advising clients on all aspects of domestic and international estate law for moderate to high-net-worth individuals and business owners. She combined her large firm expertise with small firm attention when she opened her own practice in 2016. Jones frequently speaks and has authored several articles in respected industry journals. Her website is www.paulajoneslaw.com.

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Cross-border individuals and families are one of the most misunderstood, yet fast-growing, segments of a financial planner’s potential clientele. Most cross-border clients do not fit the stereotype of the super-wealthy trying to hide their assets offshore, ducking taxing authorities. Instead, they are individuals for whom international travel has become the norm. They are U.S. persons who have acquired non-U.S. assets, or they are non-U.S. persons who have acquired U.S. assets. They are the executives and employees of large corporations who are shipped to various global destinations to work for a period of time before being shipped again to yet another destination.

Amid all of this activity, cross-border individuals marry those with citizenships different from their own and raise their children in non-U.S. countries. Even an increasing number of U.S. individuals who have remained stateside for their entire lives find that their grandchildren are being born abroad, due to their children’s global activities.

All of these trends will continue—and will become more commonplace. All financial planners should be familiar with the unique issues that apply to the cross-border client’s estate plan, as a vital part of a client’s overall financial plan.

U.S. Basis for Estate Taxation

Sorting through the complexity of a cross-border client can seem daunting at first, but an effective way to minimize confusion is to first determine the basis on which a client is brought into the U.S. estate tax system.

The U.S. claims authority over individuals or their assets in order to tax them for U.S. estate tax purposes. There are four bases on which this is done:

(1) U.S. Citizenship. U.S. citizens, regardless of where they reside in the world, are subject to the U.S. estate tax upon their death. The gross estate of a U.S. citizen includes “all property wherever situated” to the extent of the decedent’s interest.¹ This means that a decedent’s property, regardless of where it is located in the world, is includible for U.S. estate tax purposes. As of 2021, each U.S. citizen has a U.S. estate tax exemption amount of $11.7 million against his or her worldwide property.² The Biden administration has suggested they might seek to lower this exemption amount to $3.5 million as part of any new tax bill passed. If the law stays as is, however, on January 1, 2026, the exemption amount will automatically revert to the previous exemption amount of $5 million.³ Either way, there is a chance that far more individuals will be subject to the U.S. estate tax in the near future, so planning now must consider these changes.

(2) U.S. Resident. As stated before, U.S. residents, regardless of citizenship, are subject to the U.S. estate tax upon their death. The gross estate of U.S. residents includes all property, wherever situated in the world. U.S. residents have the same U.S. estate tax exemption amount as U.S. citizens, outlined in paragraph (1).⁴

The legal definition of “resident” for U.S. estate tax purposes is vastly different than the definition of residency for U.S. income tax purposes, or for U.S. immigration purposes. A “resident” for U.S. estate tax purposes is a “decedent who, at the time of death, had domicile in the United States.” A person acquires domicile by living in a particular location, “for even a brief period of time, with no definite present intention of later removing therefrom.”⁵ Domicile, once acquired, is presumed to continue until it is shown to have been changed. To establish a new domicile, a decedent must do two things: (1) reside in the U.S., and (2) have the intention to remain there indefinitely.

With no quantifiable way to evidence one’s residency, how does the U.S. determine the intent of an individual, now deceased? A series of factors is considered, including the extent of residential real estate owned by the decedent in each jurisdiction (including both primary and secondary homes), whether real estate was owned or rented, and the size and value of any home.⁶ Evidence also includes a decedent’s personal ties to a location, such as the residence of family members, where the decedent held club memberships, ties to any religious community and the location of doctors and trusted professionals. The residence recited on legal documents, such as passports, visa applications, voter registration, income tax returns, and one’s will are also important factors, as well as the location of personal possessions and even one’s planned burial site.⁷

(3) U.S. Situs Assets. Individuals who are neither U.S. citizens nor U.S. residents may be outside the U.S. estate tax system jurisdiction, however, if they own property deemed to have a U.S. situs, they are still subject to the U.S. estate tax—but only on those U.S. situs assets.⁸ U.S. situs property, for U.S. estate tax purposes only, includes real estate and tangible personal property physically located within U.S. borders, as well as stock held in U.S. corporations.

Unlike the high exemption amount for U.S. citizens and residents, the U.S. estate tax exemption amount for noncitizen nonresidents is only $60,000.⁹ Financial planners should note that the U.S. estate tax reaches almost all noncitizen nonresidents, not just the wealthy, as is the case with U.S. citizens and U.S. residents. For instance, if a noncitizen nonresident has a gross worldwide estate of only $300,000, including a parcel of U.S. real estate worth $150,000, a U.S. estate tax return must be filed at death and U.S. estate tax will be due. Financial planners must be careful not to overlook these types of clients, simply because they do not have the wealth normally associated with U.S. estate tax planning clients.

(4) Former U.S. Citizens and U.S. Residents. Individuals who have either renounced their U.S. citizenship or residency may still, under certain circumstances, be subject to U.S. estate tax on a portion or all of their future estate, the details of which are beyond the scope of this article. The current law applies to those individuals who renounced on or after June 17, 2008, and generally targets high-income individuals and/or those with a high net worth.¹⁰

Once it is determined how a cross-border client is exposed to the U.S. estate tax, it is important to identify those areas where estate planning can minimize that exposure. Many of those planning opportunities are unique to the cross-border client.

Transfers to Spouses

Married individuals who leave their estate to a surviving spouse are normally afforded an “unlimited marital deduction” against the U.S. estate tax, negating any U.S. estate tax due.¹¹ However, this deduction may or may not be available in the cross-border context.

If a surviving spouse is not a U.S. citizen, any marital deduction normally afforded in the estate of the first spouse to die is disallowed.¹² Take note that the citizenship status of the decedent spouse is irrelevant. Even if a noncitizen spouse dies leaving everything to a U.S. citizen spouse, the unlimited marital deduction is available in the estate to offset any U.S. estate tax due. Note that one’s married status does not negate the availability to both U.S. citizens and U.S. residents of the U.S. estate tax exemption amount, so transfers above and beyond this amount are those in need of a marital deduction to completely eliminate any U.S. estate tax due.¹²

There are planning options to avoid the U.S. estate tax incurred due to the limited marital deduction. A noncitizen recipient spouse can become a U.S. citizen prior to the filing of the deceased spouse’s U.S. estate tax return, at which point the marital deduction is available on an unlimited basis. Cross-border clients with noncitizen spouses can incorporate a qualified domestic trust (QDOT) into their estate plans, enabling an unlimited marital deduction against the extent of all QDOT assets.¹⁴ If a QDOT was not planned for in advance, a surviving noncitizen spouse can create and fund one, then take a marital deduction against all QDOT assets, as part of the deceased spouse’s estate settlement.

Expatriation

Highly skilled foreign professionals living in the U.S. are prevalent among cross-border clients seeking U.S. estate planning advice. With one’s U.S. immigration status tied to employment, a client’s retirement plan may involve leaving the U.S. and returning to one’s country of origin. A U.S. exit tax is imposed on (1) individuals who give up their U.S. citizenship; or (2) individuals who have been lawful permanent residents for at least eight of the previous 15 years, who give up their green cards.¹⁵ The exit tax acts as a trigger of capital gain on the individual’s worldwide assets, after an exemption amount of $744,000 (in 2021) is applied against that unrealized gain.¹⁶

Only “covered expatriates” are subject to this exit tax. A “covered expatriate” is an individual with either (1) a net annual income tax of $172,000 (in 2021) for the five years preceding the expatriation, or (2) a net worth of $2 million or more.¹⁷

If financial planners are able to identify a client’s desire to expatriate far enough in advance, they provide their clients with the best chances for exit tax planning. It is possible that cross-border clients are able to give up their U.S. green cards before time runs out and the exit tax is triggered. Shifting income and/or assets of clients to reduce their net worth to stay below the exit tax exemption amount is another important planning option. Some cross-border clients may decide that remaining in the U.S. indefinitely is the best plan and may pursue U.S. citizenship, avoiding any exit tax exposure now or in the future.

Pre-Immigration

Another populous segment of cross-border clients is those who would like to establish formal ties with the U.S., but who have not yet done so. Before noncitizen nonresidents pursue U.S. residency or citizenship, they have an opportunity for planning now to avoid U.S. estate taxation in the future.

Noncitizen nonresidents are exempt from U.S. estate taxes, as previously stated in this article, on everything except for U.S. situs assets. Therefore, prior to establishing U.S. residency, these cross-border clients may want to make transfers of non-U.S. situs assets to future beneficiaries, ensuring freedom from U.S. estate tax on those assets in the future. To extend the benefits of this planning opportunity, the transferred assets can be directed to a U.S. trust, benefitting as many generations as possible, avoiding the U.S. estate tax at each generation, and allowing wealth to build.

The prevalence of cross-border clients will continue as globalization marches on. Knowing the fundamental rules about the U.S. estate tax in this context enables the financial planner to minimize complexity and provide comprehensive client advice. 

Endnotes

1. See IRC §2031.
2. Ibid.
3. See IRC §2010(c)(3).
4. See IRC §2056(d).
5. See Treas. Reg. §20.0-1(b)(1).
6. See Paquette v. Commissioner, T.C. Memo 1983-571.
7. See Estate of Kahn, v Commissioner, T.C. Memo 1998-22.
8. See IRC §2101(a), IRC §2103.
9. See IRC §2102(c)(1).
10. See IRC §877A.
11. See IRC §2056(a).
12. See IRC §2523(i).
13. See IRC §2010(a).
14. See IRC §2056(d)(2).
15. See IRC §877(e).
16. See IRC §877A(a)(2), IRC §877A(a)(3).
17. See IRC §877A(g)(1).