Don’t Fall Victim to This Devastating U.S. Estate Tax Trap

Important Estate and Gift Tax Considerations for Nonresident Aliens

In today’s global economy, many non-American citizens have accumulated significant assets in the United States. Whether you earned assets by temporarily working in the United States, received a U.S. inheritance or have been married to a U.S. citizen, you may be subject to significant tax liabilities simply for holding U.S. assets. Your loved ones, in particular, may be in for an unpleasant estate tax surprise after you pass away.

Non-U.S. citizens or green card holders who reside permanently outside the United States are referred to as nonresident aliens (NRAs) by the U.S. Internal Revenue Code. For income, gift and estate tax purposes, the IRS treats NRAs quite differently than U.S. citizens, which is why it’s important to understand your potential tax liabilities and develop an effective tax planning strategy. One particularly devastating tax implication relates to how U.S. situs assets (assets held within the United States) are handled when settling the estate of a foreign national.

Here, we provide an overview of these potentially devastating estate taxes, as well as strategies to help you avoid them.

U.S. estate tax basics

Estate tax generally affects only a small percentage of Americans — whether they reside in the United States or abroad. Recent tax law changes significantly increased the federal estate and gift tax lifetime exclusion amount to very high thresholds, which is of great benefit to most American households.

These recent changes to tax law include the following benefits.

• An unlimited marital deduction, which grants the ability to transfer an unlimited amount of assets to a U.S. spouse with no estate tax liabilities.

• The standard lifetime tax exemption, which allows U.S. citizens to transfer up to $12.92 million per individual ($25.84 million per married couple) tax-free to heirs during their lifetime or following their death (as of 2023).

• A special annual gift tax exclusion that allows a U.S. citizen with a non-U.S. citizen spouse to exclude up to $175,000 per year from gift taxes (2023). A U.S. citizen can also gift appreciated assets to a non-citizen spouse, which can be an effective estate and tax planning strategy under the right circumstances.

What estate taxes must an NRA pay?

In contrast, NRAs are only granted a $60,000 exemption on U.S. situs assets. The remaining assets are subject to steep estate taxes that start at 18% and can quickly increase to 40%. Although NRAs don’t qualify for the unlimited marital deduction or the standard lifetime gift tax exclusion, they can pass an unlimited amount to a U.S. spouse free of estate tax.

Note: Only a U.S. citizen may qualify for both the unlimited marital deduction and the standard lifetime exemption.

What are considered U.S. situs assets for estate planning purposes?

While U.S. citizens and domestically domiciled individuals are subject to U.S. estate tax on their world-wide estates, NRAs are only subject to estate tax on their U.S. situs assets. The following assets are typically considered U.S. assets subject to estate tax.

• Real estate

• Tangible property

• Stock of U.S. corporations, including shares of U.S. stock held in a foreign bank account

• Partnerships centered in the United States that survive a partner’s death

Note: It’s important to carefully document contributions to jointly held U.S. accounts in order to avoid a worst-case scenario with the IRS. If assets aren’t carefully tracked, the IRS may decide to include the entire account in the estate of the first-to-die joint owner rather than just that individual’s portion of the account.  

What assets aren’t considered U.S. situs assets for estate planning purposes?

The following asset types are typically not considered U.S. situs assets and are therefore not subject to U.S. estate tax for NRAs.

• Cash held in a U.S. bank account that isn’t used in connection with a U.S. business (cash in U.S. brokerage accounts is considered U.S. situs)

• Bonds

• American Depository Receipts (ADRs)

• Undertakings for Collective Investment in Transferable Securities (UCITS)

• Life insurance proceeds

Note: Although NRAs are only subject to U.S. estate tax on their U.S. assets, they may also be subject to the estate tax law of their home country (or any other jurisdiction in which they own property).

Ways to avoid the NRA estate tax

One of the best ways to avoid the NRA estate tax is by working with a qualified international wealth advisor who is familiar with the estate planning challenges of non-U.S. citizens with U.S. assets. Your advisor should be able to provide guidance on strategies to help mitigate your tax liabilities, including any combination of the following.

Estate tax treaties

The United States currently has estate tax treaties with 15 different countries. Many of these treaties significantly reduce or eliminate the amount of estate tax owed on U.S. situs assets.

For example, non-U.S. citizens living in Australia can benefit from the U.S.-Australia Estate Tax Treaty. Under Article IV of the treaty, the same estate tax exemption threshold of $12.92 million (as of 2023) extends to residents of Australia who have assets in the United States.

Be sure to work with an advisor who has experience navigating any tax treaties that may exist between the United States and your country of residence.

Countries with U.S. estate tax treaties

Gifting assets

Giving assets to friends, family and charities can be a great way for NRAs to remove assets from their U.S. taxable estates. NRAs are generally subject to gift tax during their lifetime on gratuitous transfers of tangible property, such as real estate or an art collection. However, intangible property (such as stocks and bonds) isn’t subject to gift tax and can be transferred to a U.S. or non-U.S. citizen tax-free.

NRAs can use the annual gift tax exclusion of up to $17,000 in tangible property per recipient per year (as of 2023).

Note: While intangible assets may not be subject to gift tax, they’re still subject to estate tax.

Undertakings for Collective Investment in Transferable Securities (UCITS)

UCITS are a type of non-U.S. investment registered on a foreign exchange. UCITS aren’t considered U.S. assets and therefore aren’t subject to U.S. estate tax.

Many NRAs invest in UCITS though a U.S. broker in order to achieve a diversified portfolio of equity and fixed income investments at a reasonable cost. Although these investments are slightly more expensive than their U.S. ETF counterparts, they can help avoid the U.S. estate tax problem. Not all brokerage firms offer UCITS as an investment option, which is another reason it’s wise to work with an experienced financial advisor who can help you explore this option.

Qualified Domestic Trusts (QDOT)

If a U.S. spouse is married to an NRA and the U.S. spouse’s estate exceeds the lifetime exemption, establishing a QDOT may be an effective strategy. A QDOT allows the U.S. citizen’s property to be transferred to a trust to support the NRA surviving spouse.

Following the surviving spouse’s death or termination of the trust, the remaining property passes to the remainder beneficiaries via the estate of the first-to-die spouse after estate taxes have been paid by the first-to-die spouse’s estate. This practice allows the estate to take advantage of the first-to-die spouse’s lifetime transfer tax exemption.

Foreign partnership or corporation

If all beneficiaries of the NRA’s estate are non-U.S. citizens, it may make sense to establish a foreign partnership or corporation. However, the rules and requirements for forming such corporations are complex, so it’s wise to seek the assistance of a qualified tax advisor.

Life insurance

If all other strategies fail, an NRA can manage estate tax risk by purchasing a life insurance policy (which is not considered a U.S. situs asset) on his or her own life to cover the potential future cost of estate tax.

The potential estate tax implications of owning U.S. assets as an NRA can be severe. However, with proper planning and the guidance of an experienced international tax advisor, you can avoid or significantly reduce your U.S. estate tax liability, even while investing in U.S. assets.

At Creative Planning International, we specialize in helping clients navigate complex cross-border tax and financial challenges to avoid costly mistakes. We understand the complicated interactions of multi-jurisdictional tax and regulatory regimes and help clients develop efficient tax and financial planning strategies. Because we serve in a fiduciary capacity, you can be confident we’re acting solely in your best interests at all times.

For more information, request a meeting with a member of our team.